KEY POINTS:
While we all hope for a record gold medal performance from our athletes at the 2008 Beijing Olympics, indications are that New Zealand businesses could also deliver a gold medal performance in China in the future.
With the Free Trade Agreement between New Zealand and China in place, businesses should be well positioned to capitalise on the opportunities that China offers.
Besides the benefits brought about by the FTA, China's new legal and policy direction could also mean greater business opportunities than before.
For a start, the legal system in China, which has a reputation for being complex and opaque, is becoming more transparent and the recent legal changes better align China's legal system to those in Western countries.
Further, agriculture, forestry, fishery and environmental protection projects - areas where New Zealand businesses have a competitive edge - now fall within the list of "encouraged" industries and activities which may qualify for tax rate reductions and other incentives in China. These changes are reflected in the recent reform of China's corporate tax laws and the revised Catalogue for the Guidance of Foreign Investment.
New Zealand businesses with interests in China should carefully examine these legal and tax developments to determine how they affect their current business model, investment structure and financing strategy. Also relevant to this exercise are the proposed changes to New Zealand's international tax rules (due for introduction in the 2009-10 year) which should encourage outbound expansion and raise the competitiveness of businesses.
China's Enterprise Income Tax (EIT) law unifies the income tax levied on domestic and foreign enterprises to create a level playing field for all. It introduces a single tax rate of 25 per cent, lower than the average tax rates of neighbouring countries, in an effort to increase competitiveness and boost China's attractiveness to foreign investors.
Before the new EIT Law, Chinese domestic companies were subject to an income tax rate of 33 per cent, while the preferential tax treatment for foreign invested enterprises (FIEs) resulted in these entities paying income tax at a rate of only around 15 per cent.
Upon unification, both domestic enterprises and FIEs will be subject to identical tax rates, and rules on income and deductions. Tax incentives will also apply equally to both.
Note that under New Zealand's current international tax rules, New Zealand-owned companies effectively cannot take advantage of any preferential tax treatment offered in China, as profits earned by foreign companies controlled by New Zealand shareholders are taxed in New Zealand as they are earned.
That is, even if a Chinese subsidiary is subject to a lower tax rate in China (because of tax incentives or otherwise), the effective tax rate on the subsidiary's profits is generally topped up to the New Zealand corporate tax rate.
By reducing the preferential treatment enjoyed by foreign companies, the new Chinese tax rules should arguably put New Zealand businesses on a better footing with competitors.
Better still, New Zealand's proposed international tax rules will exempt "active income" earned offshore by New Zealand-controlled foreign subsidiaries. Once this occurs, New Zealand businesses should be able to benefit from the revamped lineup of tax incentives on offer in China.
The new EIT law represents a clear shift away from the previous approach of offering tax incentives for foreign-invested manufacturing operations and investment in certain special economic zones, to one that focuses more on encouraged industries and social issues, along with some regional-based preferential treatment. Tax incentives include the lower concessionary 15 per cent tax rate for new and high-tech enterprises, the continuation of the R&D super-deduction, and partial or full tax exemptions for "encouraged" industries and projects relating to infrastructure and environmental protection.
Another major change to China's tax rules is the significant decrease in export VAT refund rates which came into force on July 1, 2007. These changes were to slow exports and reduce China's ballooning trade surplus. Among the measures introduced are the elimination of VAT rebates for pollution-causing, resource-consuming products and a reduction of rebates on clothing, toys, shoes and other products that have become irritants to China's trading partners.
The changes to the tax laws clearly reflect a new direction in China's economic development. China realises that it cannot continue to expand its economy on the back of merely producing products on a low cost basis for the rest of the world. Instead, it must move up the value-added chain, by moving to higher value products and higher-value technology and enhancing the competitiveness of its domestic businesses. The legislative changes also mark China's strategic move away from an export-oriented to a domestically driven economy.
The latest version of China's Catalogue Guiding Foreign Investment in Industry became effective on December 1 last year. The purpose of the catalogue is to provide guidance to Chinese government officials at all levels on the approval of foreign investment and the development of regulations and policies covering foreign investment.
The catalogue also sets foreign ownership limitations on specific types of investment projects. As a result, how your investment is classified in this catalogue determines whether the project is possible, and if so, at what level of ownership. It also affects the type of allowable incentives as well as the complexity and duration of the approval process.
The current update is driven by new economic realities and sets forth the Government's corresponding vision for foreign investment. Since 2004, China's GDP has grown by approximately 30 per cent, its trade surplus with the US has roughly doubled, and the country has completed the WTO accession process. Foreign investment is now clearly expected to support two overarching policy goals: achieving sustainable economic development and aiding China's ascent up the global value chain.
As government policy plays a critical role in shaping China's business environment, it will be important to study the new policy document closely, as it could mean success or failure for your business in China.
Therefore, while the Free Trade Agreement and the legal and tax reforms enhance the overall prospects of New Zealand businesses in China, it will still be important to assess the precise implications of these reforms and to ensure that your China strategy is aligned with the current Government policy.
* Jenny Liu is an associate director at Deloitte and leader of its China/New Zealand Tax desk
