Beijing moves to end foreign favours

With the passage through the Chinese parliament in the coming days of an innocuous-sounding bill on corporate tax, Beijing will be drawing a symbolic close to nearly three decades of ­policies favouring foreign investment.

Companies with part foreign ownership and projects in nearly 60 specially designated economic zones at present pay a corporate tax rate of 15 per cent – less than half the 33 per cent levied on local enterprises.

The first special economic zone was set up in Shenzhen in 1980, as a way to attract and quarantine foreign investment but such zones have since proliferated as localities competed to lure overseas money.

The bill, which has been debated for seven years since it was first proposed in 2000, will equalise tax rates between local and part foreign-owned companies at a mid-rate of about 25 per cent, starting next year.

“It is a big deal – not because the real effect is large but because it signals a very different policy orientation to the orthodoxy of the 1990s, which was that foreign direct investment is the magic bullet,” said Yasheng Huang, of the MIT Sloan School of Management.

Foreign investment as a percentage of all capital spending in China has never been dominant, reaching a peak of about 16 per cent in the mid-nineties before falling to about 5 per cent now, according to UBS, the investment bank.

The tax concession, however, was symbolic of the greater value attached to overseas investment because of the superior technology and management skills that foreigners were believed to possess.

Foreign executives visiting China were courted by top leaders. Many secured meetings – and developed what they considered to be personal relationships – with Jiang Zemin, China’s leader for more than a decade from 1989, and Zhu Rongji, his economic tsar.

However, a change of leaders in 2002 and a rapidly evolving economic landscape have produced a rethink.

The new leadership team of Hu Jintao and Wen Jiabao have deliberately eschewed one-to-one meetings with foreign business leaders. In part, this is because they prefer to identify themselves with poorer members of society rather than wealthy businessmen but also because investment is forthcoming anyway.

“An overwhelming majority of foreign companies invest in China – not because of tax reasons, but for business reasons, like the vast market and the ability to supply to upstream customers in China,” said Alan Yam, of PwC in Shanghai.

Most of the world’s multinationals have operations in China but the bulk of overseas money has come from Taiwan, Hong Kong and, indeed, by a circuitous route, from China itself, often invested in low-cost factories for export.

The Chinese money “round trips” out of and then back into China, through Hong Kong or tax havens, such as the British Virgin Islands, to secure the tax break.

“There has been a lot of fake foreign investment,” said Sun Gang, a professor at a think-tank attached to the Finance Ministry in ­Beijing.

With Beijing struggling to manage both rising protectionist sentiment in the US and the European Union and its swelling chest of foreign exchange reserves, offering incentives to exporters of cheap goods is no longer a priority.

“The last thing China needs at the moment is local governments blindly throwing more preferences at foreign investors to put in more low-end production facilities, resulting in even more foreign exchange inflows and even higher exports,” said Jonathan Anderson of UBS in Hong Kong.

Companies that invested before the passage of the law will retain the low tax rate – under some circumstances for up to five years – and the government intends to continue to offer targeted incentives for high-tech production facilities.

Business leaders, such as Herbert Hainer, the chairman and chief executive of Adidas, see little reason to leave China, where the company sources about half of its 200m shoes and 300m pieces of apparel every year.

“We have built up the skills and the know-how for manufacturing and also the supply chain, which is more and more a competitive advantage in getting to the market fast,” he said during a visit to Beijing.

“And our suppliers have linked themselves so closely to Adidas that to de-couple them would not be easy. So in the next few years, I do not see any significant change in our sourcing from China.”

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