Conducting Cost of China Business Assessments

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By Dezan Shira & Associates

June 17 – With the adjustment of China’s corporate tax base six months ago to a universal rate of 25 percent for all businesses, barring a few exceptions for encouraged industries, and the abolition of the profits tax breaks of manufacturing industries, many now mourn the passing of the “good old days” in China when foreign investors were largely financially encouraged to invest. At the time, local governments nationally went on a spree to attract them.

Not all of that investment was particularly good for China, and neither were some of the so-called incentives quite what they were cracked up to be either. China attracted a lot of investment that was bad for the country. It attracted inefficiency, outmoded industrial processes that were 30 years out of date in the West let alone China, industrial polluters, poorly treated work forces…the list went on and on. Foreign investors were largely free to bring to China, especially in manufacturing, old processes long discredited elsewhere. Cue an entire who’s who of exploiting businesses wanting to eke as much as they could both from an underpaid workforce and poor technology already long written off the books. China’s adjustment of the tax base and its insistence of higher standards of employment ethics concerning labor were specifically designed to curb the worst of these practices, and force them to either comply, or leave. The true cost of conducting business in China would now be levied.

The result has not been a dramatic slow down of FDI. In fact, quite the reverse – China’s FDI increased 50 percent as we noted here a few days ago, and international businesses are pouring in to invest as China’s middle class is now starting to buy global brands.

But what of the true cost of business, what of any new tax incentives?

The true cost of business in China lies now with compliance. Essentially, the mood has changed, and you need to be paying attention to the right money, in the right places. That means an in-depth knowledge not just of the legal aspects of business set ups, but also tax compliance, staff welfare and where appropriate, additional licensing requirements all need to be checked off. Items to consider include:

Registered capital
Have you fully understood exactly how much money is required to start up? It is that amount and not any “minimum registered capital” amounts that matter. You will need experienced China-based tax and operational knowledge to assess this issue. It is an operational cash flow question, not a legal requirement. Don’t get caught out.

Total investment capital and debt equity
There is a relationship between “total investment” and “registered capital.” The total investment figure includes debt equity in the form of loans and so on. It is capped, you need to know how the percentage amount works and how to structure this to get it into your business licensing approvals and onto your starting balance sheet.

Staff welfare
Welfare is an additional amount that needs to be paid to staff, on top of salary. It also varies from region to region, and city to city, although as a ballpark figure you need to allocate at least 50 percent of the salary as an additional expense. You need advice from a firm familiar with the city you intend operating in to help you work this out.

Customs duty on machinery importation
If you are injecting machinery into China as part of your investment, you need to get it through customs. They now levy a 100 percent import duty and VAT on that equipment on importation, generally reclaimable back at 20 percent per annum over a 5 year period, provided that 100 percent of the goods are exported to overseas customers. You need to know if you can include that as part of your registered capital or not (you can, but there is an investment ratio to follow and some calculations to do to work out how that impacts on registered capital requirements), and make allowances for this additional expense. If not, you start your China life with an unexpected China customs bill to meet before you even got into production.

VAT on sales
Have you factored in the following:
• How much you intend to buy in China, and the length of time before you are able to offset VAT? This can be a serious cash flow question.
• How much you are actually able to claim back on export and the length of time until the rebate arrives? Again, a cash flow issue.
• Your customers may not like paying VAT on your products. Have you factored in the fact you may lose some business if you wish to be in compliance?

There are many other issues to examine when looking at this issue, with two additional layers of required intelligence to determine correctly the cost of doing business in China.

Regional variations
The Chinese central government levies different costs and financial considerations on different parts of China, in accordance with each specific regions general wealth and development; these impact foreign investors. The minimum salary level for example, is determined by a number of factors that both differ from region to region, and can also vary on qualifications of personnel. If considering different areas, you need advice on the differentials, otherwise your business plan gets out of whack from the start.

Operational costs
Setting up a business in China is not just a question of getting legal advice. Many lawyers for example will not touch the tax implications of corporate establishment or handle any post registration licensing procedures (such as the customs or tax bureau). Coupled with that is the business sense that experience in China will bring. Industries can be treated differently, as can the various financial procedures for administering them. You need to engage with consultants that can provide the full picture, and not just a partial overview.

Tax incentives
With the adjustment of China’s corporate income tax base six months ago, many of the previously available tax incentives disappeared as the 25 percent income tax base was unified. But tax incentives continue, albeit in a more subtle manner. Tomorrow we will deal with the new tax incentives on offer in China: how to get them, what they are, and under what circumstances they apply.

Dezan Shira & Associates is a premier boutique professional services firm in China providing legal and tax advice to foreign investors in the country. Established in China 16 years ago, they maintain nine China offices. This website and the China Briefing Magazine are produced by the firm. For advice on foreign investment legal and tax issues in China, please email info@dezshira.com or visit www.dezshira.com.

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