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| Foreign Investments in China: Who Gains? Who Loses? (Part 1) |
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Over the past 20 years, contributions from foreign investments to China's economic development are obvious to all. They have not only introduced technologies and management experience and addressed some employment issues, but also accelerated China's integration into the global economy. But at the same time, China has paid a dear price for environment, land and tax receipts, and now even become a global focus on its trade surplus and raw materials demands.
The recent tax reform in China, which unifies the tax rates between most foreign companies and Chinese companies at 25%, will no doubt help alleviating some unfair and illegitimate benefits received by foreign companies. But there is still considerable leeway for those offenders.
Actual fiscal cost much higher than tax benefits given
The first cost is that many governments, especially local governments, will also give foreign investors extra tax rebates or incentives in items such as value added taxes, customs duty and municipal rates. The second cost is that foreign-related companies can usually acquire lands at prices lower than market prices or prices offered to Chinese counterparts. Not only many local governments are already having unsustainable land management practices, they will also lose considerable land proceeds. The third cost relates to utilities incentives given to foreign companies, such as water, electricity and social service costs.
Transfer pricing: effective tool for tax evasion |
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The second way to make money out of transfer pricing relates to service trades. Foreign companies can claim management fees, consulting fees and technology or patent fees to achieve profit transfers to entities outside or inside China. Take the example of a Hebei Province-based ceramic company. This company had an agreement with its Hong Kong-based parent company, which was eligible to receive advisory fees based on 32% of subsidiary's revenue. This amounted to $8 million in 2005, which was equal to 300% of subsidiary's profit in China.
Thin capitalisation: channel for false losses
In order to achieve tax avoidance, some foreign-related companies in China would borrow as much as possible from their shareholders, and their debt/equity ratios are far lower than the international standard of 1:1. Thus they could make a loss on books through thin capitalisation, and transfer actual profits to overseas parent companies through debt and interest repayments.
Apart from lost of tax receipts, the above capital transaction methods also presented China with issues related to foreign debt management and money laundering.
New entities: carriers for tax evasion by old entities For example, a well-known Taiwanese food group had shown a tendency to keep setting up new entities in China, in order to benefit from the initial tax incentives. Related companies in the group always showed huge profits in the first two years, and reducing profits in the next three years of halving taxes. When the incentive period expired, its companies would immediately become unprofitable or even loss-making.
Another example for massaging profits between new and old entities relates to the above-mentioned related party transactions. A Korean shoe making company operating in Qingdao City controlled import and export prices through its overseas parent company, which let old entities in China bear extra costs for new entities. Thus the old entities were always showing huge losses, while new entities were always showing huge profits. During tax incentive period, new entities had had a return on equity of 757%, a sharp contrast to its continuing losses in old entities in the same business in China.
Source: www.southcn.com |
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