Zone doubt

Russel Cai, head of investment promotion for European and American clients at the Wujin Hi-Tech Industrial Zone in Changzhou, a city near Wuxi, says his zone has a lot to offer foreign companies setting up shop in China.

“It’s a package,” he said. “It’s not just low costs.”

For Cai and representatives of industrial zones across China, this phrase is becoming something of a mantra as they reposition themelves in an evolving market. With labor costs on the rise, tax policy changes removing incentives and a tougher line from Beijing on foreign investment, China is now a more expensive place to do business.

There is also uncertainty about the implementation of these new rules.

“The current policy on investment is ‘We don’t want massive foreign investment in quantity. We want to shift foreign investment to just the quality areas,’” said Steve Dickinson, a Shanghai-based attorney at boutique international law firm Harris & Moure.

“It’s a great goal. But can they do it? That’s what we’re trying to figure out.”

One of the issues is the corporate income tax law, under which the tax rates levied on both domestic and foreign enterprises are set at 25%. Some industries in key sectors such as high-tech enjoy a preferential 15% rate.

For domestic companies, most of which had been paying 33%, this represents a big tax cut. For foreigners, however, the rate is higher than before.

Those higher tax rates have some companies considering other options.

“It’s having an effect,” said Cai. “I think it’s the same all around China … labor-intensive companies will choose Vietnam, [manufacturing firms] will choose India.”

Cai is unfazed by the prospect of companies leaving. Some firms in the Wujin zone expressed an interest in Vietnam, but ultimately decided that China offered a better business environment. He believes that companies with a China focus will similarly find that the advantages of staying put trump the lower costs elswhere.

Silent treatment
But some express doubts about the government’s strategy to encourage investment in specific industries. While China has listed out possible tax incentives, Dickinson points to what he calls “total silence” on the specifics of which industries enjoy which benefits – a sign, he says, of a fierce institutional battle crossing ministries and regions.

“In China, total silence from the government means a big problem,” he explained.

To further complicate matters, even if a foreign firm operates within the officially sanctioned industries, it can be difficult for it to access lower tax rates. A recent PricewaterhouseCoopers tax brief noted that companies faced high barriers in being recognized as “high and new technology” enterprises.

These barriers included requiring Chinese subsidiaries of foreign firms to own core proprietary intellectual property. This isn’t something most multinationals feel comfortable doing.

SEZ confusion
Another area of concern is China’s fabled special economic zones (SEZs). The corporate income tax law will gradually eliminate tax incentives offered in SEZs, increasing taxes for existing companies from 15% to 25% over a five-year period – in the process eliminating a major reason for the zones’ existence. New investors, meanwhile, will enjoy no tax breaks at all.

According to John Lee, a partner at accountancy firm KPMG in Shanghai, authorities in border areas like Shenzhen and Zhuhai will probably respond by offering subsidies. However, the 11th Five-Year Plan on the utilization of foreign investment prohibits local-level tax breaks not authorized by the central government.

“[Local subsidies would] in effect buy down the effective tax rates,” he said.

Cai is nevertheless sanguine about the future of foreign investment, saying that Wujin’s business remains strong.

“The major reason [foreign firms come here] is for our human resources. We have a local market and local suppliers … These are good for companies wanting to manufacture products in China.”