The week before Christmas was a busy one for Philip Lau, chairman and managing director of Starlite, a Hong Kong-based manufacturer of audio and visual products. On December 21, Mr Lau paid HK$63m ($8.1m) for a large tract of land in Xinhui, a city on the western side of the Pearl River Delta, for use for a new factory.
Mr Lau had been racing against time. Just 10 days after Starlite and the Xinhui municipal government did the deal, provincial regulations came into effect requiring such land be sold by auction only. A determined bidder could have forced Starlite to pay more or perhaps even have stymied its expansion project entirely. “It’s not easy to find 3.6m sq ft of land,” Mr Lau says.
For its part, Xinhui was able to lock in a major new export-oriented investor that will provide the area with employment opportunities and tax revenues for years to come. Last year, Starlite, whose customers include the likes of Wal-Mart and Tesco, booked a HK$79.1m profit on turnover of HK$1.82bn.
In a country that routinely attracts more than $60bn a year in foreign direct investment, Starlite’s land acquisition was a minor coup. But it also foreshadowed, at a micro level, the end of an era for foreign investors and the beginning of a new chapter in China’s economic development.
Five years after China acceded to the World Trade Organisation, the breaks, large and small, traditionally enjoyed by overseas investors are being relegated to the dustbin of history.
“China is not dying for foreign investment today,” says Carson Wen, partner at Jones Day and also a deputy representing Hong Kong in China’s National People’s Congress.
Mr Wen cites the famous complaint of Cheng Siwei, an NPC vice-chairman, that while a DVD player is worth $40 when it leaves a Chinese factory, $21.50 of that is due patent holders, mostly overseas, in the form of royalties; the factory can expect just a sliver of profit.
“China will only welcome foreign investment if it helps the country move up the value chain,” Mr Wen says. “Obviously China doesn’t see its mission in life to be the workshop of the world, earning just $3 on every DVD player.”
At the NPC’s annual session last month, Mr Wen and his fellow deputies passed two landmark pieces of legislation that have radically altered China’s relationship with foreign capital.
The first, the enterprise income tax law, will end a five-year tax break long enjoyed by overseas investors, including a two-year tax holiday after attaining profitability and a 50 per cent reduction in tax due over the subsequent three years. Starlite officials admit that the imminent passing of the tax changes helped catalyse the company’s deal in Xinhui.
In the past, unscrupulous investors prolonged the tax-free period through transfer pricing. By selling goods to Hong Kong intermediaries, China-based factories could be kept in the red and profits booked in the territory.
An even more brazen dodge involves so-called “zone-hopping”. After ex-hausting its tax holiday in one locale, a company could close its operations and re-open them elsewhere in the country, thereby starting the clock all over again.
Such profiteering was the exception rather than the rule, as most investors were happy to obey the letter of a law that already afforded them generous special treatment. As a result, China’s emergence in the mid- to late 1990s as one of the world’s great manufacturing powers was largely incentive-led.
In scrapping the tax holidays – foreign and domestic companies will instead pay a unified 24 per cent rate – the Chinese government is betting that overseas investors will cling to the other advantages China offers as a manufacturing base, such as excellent infrastructure.
“People invest in China not for low tax and low costs, but because of the [domestic] market and the value that China can add,” Mr Wen says.
The second landmark piece of legislation passed last month, the property law, is best seen through the prism of domestic politics as another step in the Long March to protect the rights of private property holders in a nominally socialist state.
But the law, which was 14 years in the making and went through more than seven readings, places as much emphasis on the protection of state property, which its drafters wanted to protect from below-value appropriation by private interests and overseas investors alike, as on private property. As such, it complements the enterprise income tax law’s determination to create a level playing field for domestic corporate interests.
“The dissipation of state assets [through privatisation] has always been a major concern,” notes Mr Wen. “[The property law] is a balanced approach to protecting property of all types. The state sector is still the core of the economy in co-existence and co-operation with capital of different nature.”