For although it is clear that the central government intends to abide by the WTO obligations the biggest challenge for implementation lies in overcoming the lack of understanding of WTO rules at China’s local government and enterprise levels where, evidence suggests, opposition to this still exists. According to a regulation issued in April 2001, local governments are prohibited prom engaging in protectionism but this directive has not had its full desired effect.
Therefore, in order to tackle this problem and ensure compliance to WTO requirements at local level, the Chinese authorities have committed to issuing yearly reports on the progress of the implementation of the liberalisation laws, the problems that have been encountered and the ways it is planning to deal with them. Bearing in mind all of the above regulatory changes, this report concludes that in general the legal aspects of the macro environment are developing fast in a direction which favours the growth in foreign direct investment.
Through taking clearly defined committed steps towards improving the Chinese regulatory environment, the government is likely to increase the confidence of foreign investors. Hence, it is expected that this aspect of the Chinese macro environment will actively foster the establishment of an increased number of WOFEs, JVs and MJVs. Economic factors In the 1980s when China first opened its economy to the world, the country’s main attraction to foreign investors lay in the lower tax incentives offered to multinationals.
These were effective in the early part of the reform discussed above and were perceived as a compensation for the lack of many other developed factors that foreign investors65 sought. Following the most recent changes in the country and the fact that it is now well on its way of becoming fully integrated into the global economy, recent surveys suggest that foreign investors are no longer “seduced” primarily by financial benefits. According to an OECD report, at present, most multinationals are also looking for an overall economic system that “…
is much fairer, simpler, more transparent and more conductive to private investment whether domestic or foreign. “66 Nevertheless, taxation of FDI profits remains perhaps one of the most important economic considerations for many MNEs. The latter is crucial since it determines a company’s bottom line (profit after tax figures) and as such is indicative of the business’s performance in front of its shareholders. The current problem with the Chinese taxation system is, that similarly to its legal counterpart, it is considered as too complicated and ambiguous; therefore difficult to implement in practice by many of the new investors.
This fact is clearly indicated by the survey performed by the DTT67 quoted above. The majority of the respondents interviewed in the latter – 58% – stated that they would like to increase their understanding of the Chinese taxation system and the implications for this of China’s entry into the WTO. For although the WTO does not specially address taxation, the majority of the business featured in the survey believed that the WTO principles of non-discrimination and transparency will transform Chinese taxation system.
In spite of the above deficiency of its taxation environment, in the past few years the Chinese government has taken a variety of steps which aim to raise further the country’s attractiveness to foreign investors. At present, the Chinese government levies low tax on enterprises with foreign participation, and offers preferential tax policies to the sectors and regions where investment is encouraged by the state. For example, the Income Tax on enterprises with foreign investment is currently levied at the rate of 33 percent.
The income tax on enterprises with foreign investment located in special economic zones, state new- and hi-tech industrial zones, or economic and technological development zones is levied at the rate of 15 percent. The income tax on production enterprises with foreign investment located in coastal economic open zones, special economic zones, or in the old urban district of cities where economic and technological development zones are located is levied at the rate of 24 percent.
Finally, the income tax on enterprises with foreign investment that are engaged in projects such as energy, communications, port and dock is levied at the reduced rate of 15 percent. At the same time, production enterprises with foreign investment that have an operation period exceeding 10 years are exempt from income tax for the first two years from the year they begin to make profit and allowed a 50 percent reduction for the following three years.
Enterprises with foreign investment engaged in agriculture, forestry and animal husbandry, and enterprises with foreign investment established in remote and underdeveloped areas, upon approval by the State Bureau of Taxation, are allowed a 15 to 30 percent reduction on the income tax for a period of another 10 years following the expiration of the period of tax exemption and reduction as provided for above.
The income tax on enterprises with foreign investment located in mid-west China that are engaged in projects encouraged by the government is levied at a reduced rate of 15 percent for a period of another three years following the expiration of the Five-Year period of tax exemption and reduction. The enterprises with foreign investment that adopt advanced technology are exempt from income tax for the first two years and allowed a 50 percent reduction for the following six years.
In addition to the two-year tax exemption and three-year tax reduction treatment, foreign-invested enterprises producing for export are permitted to apply a reduced income tax rate of 50 percent as long as their annual export accounts for 70 percent or more of their sales volume. The foreign partner in an enterprise that reinvest their share of the profit in a project with an operation period of no less than 5 years is also refunded 40 percent of the income tax already paid on the reinvested amount.
To add to the above, since 1st January 1994, the Chinese government has levied a unified value-added tax, consumption tax and business tax on enterprises with foreign investment and domestic enterprises. Technology transfer and technological development by foreign enterprises and enterprises with foreign investment are exempted from value-added tax, as a measure to expand domestic demand and to encourage technological renovation in foreign-invested enterprises.
For foreign-invested enterprises engaged in projects in the encouraged categories, the value-added tax on China-made equipment purchased by the enterprises within their total amount of investment is refunded fully if the equipment is listed under the catalogue offered with income tariff exemption. Lastly equipment imported for foreign-invested or domestic-invested projects that are encouraged and supported by the state enjoy tariff and import-stage value-added tax exemptions.
Despite the stated preferential tax treatment of foreign invested enterprises in China, many companies currently operating in the country or looking to establish local representation are concerned due to the lack of information on forthcoming changes. The government is said to be working currently on a major restructuring of taxation system and is considering, among other things, unifying the dual-track enterprise income system as well as shifting the value added tax from production to consumption based.
Under the current system input VAT paid in respect of capital expenditure cannot be used to offset output VAT. Under the consumption-based system such input VAT will be creditable. However, it remains largely unclear whether the taxation reforms will benefit foreign investors. Another important aspects of taxation reform is foreseen to be the unification of the current dual track income tax system where foreign invested enterprises and domestic enterprises are governed by different tax laws.
Although the corporate tax rate for both is 33%, tax holidays and other incentives (as described above) currently reduce the effective tax rates for foreign invested enterprises to 17% and 27% for domestic enterprises68. Once the unified system is put in place, however, both local and foreign businesses will be subject to the same unified tax rate expected to be between 25% and 30%. Foreign invested enterprises currently enjoying tax holidays are expected to have their privileges extended to make sure they get the benefit of their previous agreements but there is no fixed timetable for unification.
In line with the concerns over the implementation of the WTO commitments there is also scepticism whether taxation enforcement will become completely consistent with the release of the new taxation reforms. In the recent past China had not developed a comprehensive set of taxation laws but instead relied on broadly stated principles. Even with the WTO commitment for transparency it is evident that this system will not be reformed overnight but it is expected that a more predictable system of laws will be available in the future.
In addition to the above concerns over the changes in the Chinese taxation system, many multinationals view fraud and piracy as one of the greatest risks of their operation in the country. According to the DDT survey more than 39% of all current and prospective investors in China perceived these as major concerns, with respondents in certain market sectors69 rating it even higher than political risk and instability. This is not surprising. The problems of fraud and piracy have had a pronounced negative effect on the sales and market reputation of many international firms operating in China.
A survey conducted by the United States based Business Software Alliance estimates that as much as 96% of all the business software used in China is pirated70. Similarly according to the Business Week Magazine, many foreign manufacturers in China estimate that 30% of products bearing their name, constitute pirated copies71. The overall losses to multinational enterprises for 2002 from piracy were approximated to USD 168 million with the majority of these being in the areas of home entertainment, internet, television, etc. , and the total amount of losses between 1998 and 2002 adds up to USD 688 million72.
Realising the hindrance of piracy to foreign direct investment, the Chinese patent, trademark and copyright administration bodies have recently taken a variety of measures to reduce intellectual property right piracy across the country in order to protect both domestic and international enterprises. According to official data provided by the State Administration of Industry and Commerce, in 2003 public security authorities uncovered and terminated more than 34,000 cases of copyright infringement and 37,489 trademark violation cases73.
The nature of the problem however lies in the lack of legal precision and complete enforcement of the present Intellectual Property Protection Laws. The latter, for example, specify the maximum penalties for patent, trademark and copyright violation but not the minimum. For this reason the deterrent effect the law is expected to play is not fully achieved since its application is allowed to vary from case to case. In addition, the seriousness of the violation is often difficult to establish until the case had been brought into court and the law does not state clearly the procedure of taking intellectual property (IP) violation cases there.
For this reason, although the IP legislation in the country is in accordance with the WTO standards, the Chinese government still is unable to protect foreign investors from counterfeit manufacturers, and research shows that there is very little public respect for IP in the country74. And while confidence in the patent application process appears to be strong, concerns about the extent of the IP rights violation remain strong with the majority of the foreign investors.
Naturally, the taxation and fraud related problems discussed above are likely to be treated as some of the not particularly favourable conditions of the macro environment by foreign investors. At the same time, however, it is important to remember that, economically, China is one of the fastest growing nations in the world, with many commercial opportunities and rapidly expanding consumer and business markets. Therefore, it is likely that multinational enterprises may not be deterred at entry but these would most probably attempt to devise new methods of market representation in order to combat the problems of fraud and piracy.