Economics Essays - Foreign Investors

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Foreign Investors

China: three “new laws” will affect the investment environment of foreign company

In the past 30 years, China has made big progress in the economic development, especially in the area of foreign investment environment, China is known as one of the best places for foreign investments in the world.

At the beginning of China’s reform and opening, government policies provided good circumstances for the foreign investment companies, such as preferential policies in enterprise income taxes. With the development of economy, Chinese government paid more and more attention on the construction of law system, the foreign investment laws are involved in it.

In China, the initial foreign investment laws are a series of laws, such as the Law on Chinese-Foreign Equity Joint Ventures, Law on Chinese-Foreign Cooperative Joint Ventures, Law on Foreign Sole Proprietorship Enterprises, these laws provide organizational forms for foreigners to invest in China, and guarantee their rights and interests. At that time, these laws made a great contribution to the increase of foreign investments.

In 2001, China entered WTO. As a member of WTO, China amended foreign investment laws to fit for the international regulations.

In 2006, China issued “Provisions for merger and acquisition of Domestic Enterprises by Foreign investors (the 2006 regulations)”, if the transaction affects national economic security, involve a major industry, or results in the transfer of famous trademarks or traditional Chinese brands, foreign investors must get Chinese government approval.

Now, China has established the framework of market economy, can provide good production and management environment to foreign investors. Chinese government has issued about 500 regulations on foreign investments successively. Under the national economy and industry development strategy, China made an integrated policy to lead the foreign investments to the right direction.

New Catalog for the Guidance of Foreign Invested Enterprises was issued on the end of 2007. At the beginning of 2008, new Enterprise Income tax law and Labor Contract law came into effect. With the implementing of three “new laws”, the investment environment in China has some changes, the topic will focus on what the changes are and what are the challenge and opportunity to foreign companies.

PART1: Catalog for the Guidance of Foreign Invested Enterprises (Revised 2007)

“Catalog for the Guidance of Foreign Invested Enterprises (Revised 2007)”, which took effort on December 1, 2007, was issued by the CNDRC (China's National Development and Reform Commission) in last November.

In this Catalog, foreign investments were divided into three different categories: "encouraged," "restricted" and "prohibited" categories. For investments in the encouraged category, local governments can approve without the recourse to central government. For investments in the restricted or prohibited category the permission of central government is both required and routinely denied.

Compared with the old one, the new catalogue makes amendments on five facts:

First, new catalogue insists the policy of reform and opening. To carry out the promises to WTO, China adds various service sectors wider to foreign investment, including logistics and outsourcing, reduces the limitation provisions in foreign investments.

Second, Chinese government encourages foreign investors put investments in the clean industry, advocates foreign investors protecting environment and using regenerative energy. New investment catalogue adds the above contents to encourage investors save resources and protect environment.

Third, Chinese government adjust the export policy, do not just implement the guidance policy of encouraging export.

Fourth, the earlier catalog focusing on China's western regions were abandoned. Different regions in the China have the same footing with respect to encouraged investment in new catalog.

Fifth, in sensitive areas of the economy, such as national security, China authority is still very cautious to permit the entry of foreign investments.

There are some new challenges for the foreign investors. The earlier catalogue prevents the foreign investment inflowing into traditional publishing, media and social research sectors, and now the restriction expanded to cover Internet. Other new restrictions include the “Investment in manufacturing solely for export, heavily polluting or energy-intensive industry.”

From these changes, we can see that the new catalogue brings the restrictions in investment areas. Actually, the National Development and Reform Commission issued the 11th Five Year Plan on Foreign Capital Utilization in November of 2006, stated that China will move foreign investment from emphasizing the quantity to quality. China wants to make changes in approach towards to foreign investment.

Chinese government is reforming foreign investment environment. The 2007 catalog is one of its steps. It has brought some changes,foreign investors should pay attention to these changes. As one high official said:“China intends to use foreign investments rather than be used by foreign investors.”

PART2: Enterprise Income Tax Law

China enacted a new Enterprise Income Tax Law and this law came into effect on January 1, 2008. The Chinese government’s standpoint is to make the foreign investment companies and domestic companies enjoy the equal tax standard, the fair competition is promoted.

Previously, the actual average income tax burden on Chinese companies and foreign enterprises were 25 percent and 15 percent separately.

This policy made domestic companies face tougher competition than foreign enterprises, it is unfair to domestic companies and not in line with WTO for treating domestic and overseas investors equally.

According to Article 4 of the New Tax Law, enterprises owned by domestic or foreign investors shall be levied income tax at the same rate of 25%.

Existing FIEs established before the effective date are provided a transitional period or a "Grandfather Rule" by The New Tax Law. The tax incentives already approved will be allowed to continue to 2012, as Article 57 said.

According to Article 57, for existing FIEs which have not started their tax holidays can have holidays calculated commencing from the effective date of the New Tax Law; for those that have started their tax holidays can continue to enjoy the remaining holidays

Not all the foreign companies will lose preferential treatments in China.

We can conclude from the new tax law that,projects concerning environmental protection, agricultural development, water conservation, production safety, high-tech development and public welfare undertakings will continue to be offered tax incentives to investment in. high-tech foreign-funded companies and research-focused companies can still enjoy a 15-percent income tax rate, and small and medium-sized foreign companies with slim profits are only required to pay income tax at 20 percent. Enterprises in special economic zones and less-developed western areas of the country will enjoy certain tax breaks.

“The bonded zones the preferential rate will still apply to be in the Shenzhen Special Economic Zone, economic development zones set up in coastal cities such as the Hongqiao Economic and Technological Development Zone in Shanghai, and high- and new-tech development zones, including Zhongguancun Science Park in Beijing.”

Implementation at the local level is likely to remain uneven, as some provincial and municipal governments may continue to offer various investment incentives. The blow by phasing in changes over a five-year period will be softened by the grandfathering scheme.

The new tax law will or will not affect foreign investment in China? I think the new tax law is a sward with two sides.

On one side, most foreign investors have to burden higher tax rate, which will increase the product cost for them. However, we must notice, except for the preferential tax rate for foreign investors, Chinese government’s basic attitude is encouraging foreign investment, and many provinces in China has its advantages for foreign investment, such as abundant resources, convenient shipping conditions and etc. So, foreign investors shouldn’t deny all the good advantages of China’s investment environment just because of the tax change.

A manager of Nestle (China) regards, for foreign investors, China's overall environment such as the social stability, rapid economic development are more important than tax exemptions.

In fact, 159 countries charge 28.64 percent on average and the U.S. and Japan charge more than 40 percent, compared with them, 25 percent is a lower rate for foreign investors. Even lose the preferential treatment than ever, foreign investors still can enjoy a lower rate in China than other countries. So, China still has its advantages for foreign investors.

For foreign investors, they have to rethink their investment plans to minimize their tax bill in order to maximize their Chinese investment. Experts give them some good suggestion: They should reassess their firm's China tax strategy, rethink their overall investment strategy, China business model, site selection, and how to finance investments. Foreign investors who have established or potential invest in China should review of their China tax strategy, raising questions of how their China approach fits in with a globally efficient tax strategy. In order to lower their China tax burden, foreign investors should employ more traditional tax planning methods in the future, for example, the use of different supply chain, transfer pricing, and intellectual property structures.

PART3: Labor Contract Law

The new Labor Contract Law was published by the Standing Committee of the National People’s Congress of China On June 29, 2007, it came into effect on Jan. 1, 2008.

This law brings fierce arguments in Chinese society. Because, in this law there are many contents considered being too rigid for employers to manage employees. Then, what kind of law it is?

The Labor Contract Law aims to regulate Chinese disordered labor market. This is the first time the Labor Contract law entitled employees who worked in one company for 10 years or more to sign contracts that protected them from dismissal without cause. Employers should contribute to employee's social security accounts, wage standards for probation and overtime should be set up.

The new regulation strengthens employees' position, the grey areas that some low-wage firms have exploited to avoid compliance with the spirit of existing legislation is reduced. Greater unionization of workers is promoted. The law lays down lengths for new employees' probationary periods. "Non-compete" clauses which was used by employers but proscribed employees from working in competition with their employers after leaving the firm, is also restricted. The law prohibits the repeated use of short-term contracts so that avoid employers to fire workers without stating a cause.

According to statistics, more than 570,000 foreign enterprises had set up in China since the country opened its door to outside investors in the 1980s. About 25 million people were employed as of the end of 2005. It’s a great number for Chinese labor market.

An official government survey stated that many foreign companies in coastal provinces overworked and underpaid their employees. So, the law will affect all these workers and employers.

Before the law issued, several foreign business committees have expressed their ideas that if this law comes into effect they will consider giving up Chinese market. Many foreign investors think the law will drive up their human resources costs, reduce the flexibility that has made China the world's factory. In their opinion, this law will make china lose its advantages in cheap labor market and have a marginal impact on foreign direct investment into China, It also will let many firms shift their location from China to other developing countries,such as India or Vietnam.

Some foreign manufacturing factories maybe have affected by the raised labor costs. According to the Asian Shoe Association’s survey, 500 shoe factories have closed down in Guangdong province due to higher labor costs.

However, the lawmakers think some foreign companies have misunderstood some clauses of the law, regarding that the labor contract law itself favored neither employees nor employers.

For example, some employers regard that "no-fixed-term contract" would either bring heavy burden or less efficiency to the employers. Actually,   No-fixed-term contract has been widely adopted in developed countries that could bring a more stable relationship between employee and employer, "No-fixed-term contract does not mean a lifelong job and the new law has granted employers right to fire employees with no-fixed-term contracts if the employees violate laws or are no longer capable for the job," an official with NPC's Standing committee said.

Even though in the short term, many firms in areas such as supermarkets, restaurants, construction and low-end manufacturing will be affected by the new law, due to the higher cost for workers’ salary and other social security payments. In long term, the foreign investors will find that the law will reduce labour disputes, workers will be more loyal to good employers, the law benefits both employee and employer. Most foreign investors thought the changes of the new laws are inevitable for any economy, and China is not an exception

For foreign investors, it is good to draft an employment handbook to minimize liabilities and identify terms in order to

avoid risks. It is necessary to make sense to review existing employment contracts to assess liabilities, cater for any redrafting, and also to review new employment contracts to be offered to future staff.

Some experts suggest, “Employers do have leeway in the dismissal procedures for terminating staff, however these should be correctly identified and signed off by the employee.”

PART4: Conclusion

China is one of the world’s best destinations for foreign investors in 2007. According the statistics from the PRC Ministry of Commerce s, overall FDI surged in 2007, rising by 13.8 percent. Ministry of Commerce statistics from November 2007 stated that, foreign-invested enterprises played a major role in China’s economy, accounting for nearly 58 percent of imports and exports.

The National Bureau of Statistics states that foreign invested enterprises employ more than 14 million people, this is a great figure.

As “Forecast 2008 foreign investment in China” analysis, these new laws and regulations will influence foreign investments in china in 2008. For example, the Enterprise Income Tax Law and Labor Contract Law will bring about major changes to tax rates, employer-employee relations and labor costs. Although the revision of “the Catalog for the Guidance of Foreign Invested Enterprises” contains few major changes to the broad mix of industries that are encouraged and discouraged for foreign investors, it makes important changes in specific sectors and will affect new foreign investments across a variety of fields.

From three “new laws” changes we can get the conclusion that China will stick to the open-up policy and promote a quantity-to-quality transformation in attracting foreign investment. China will open deeply on stock ownership, the destination, and business area of foreign investment in the service sector. At the same time, China push for“ indigenous innovation”as seen in major policy documents such as the 11th Five-Year Plan for high-tech industries and MOFCOM’S 2007 Guidelines for Attracting Foreign Investment.

Foreign investors can see great opportunity under these new guidelines. They may put focus on the areas that Chinese government encourages and promotes, such as services, new-and high-technology area, energy and the environment area.

The service is an important area for development, and Chinese government encourages foreign investment in hi-tech services. “Ministry of Commerce has launched a new website and various reports to document the development of the service sector and promote its growth. Of particular interest are new areas like business process outsourcing and logistics.”

The central government “has been supporting firms that invest in new-and high-tech areas. The new catalogue extends and expands on the technologies and sectors that are encouraged under the new catalogue.” The new enterprise income tax law also retains certain tax incentives for new-and high-tech areas. “The 2008 legislative calendar includes several new laws that relate to innovation and intellectual property, headlined by the patent law and trademark law.”

“Chinese policymakers have pledged to tie energy efficiency and environmental protection to a variety of other areas, including job performance reviews for officials and the ability to secure bank loans for enterprises.” The Chinese government will continue work on draft versions of circular economy law, calling for greater efficiency in the use of resources, and the energy law, boosting investment in clean energy and renewable in 2008 .

Maybe some foreign investors regard that three “new laws” will bring them investment risk. Thinking that there are more limitations in the new investment catalogue to guide FDI and the tax law cancelled the tax privileges for foreign investors, the labor contract law is too rigid to save their labor cost.

The famous risk management fellow Ewald said three “the things itself is not risk, there doesn’t exist risk in the world. On the other hand, anything can change into risk. It depends on how people analyze and think it.”

In my opinion,the new legal and social environment in China is not risk for foreign investors, especially the tax law and labor contract law shouldn’t be the barriers on the way of foreign investment. China attracts foreign investment for various reasons, for example, the large market of 1.3 billion population , great annual GDP growth of about 8%, relatively stable government. Foreign investors should notice that China is a good investment place for them, but not a paradise with all flowers and without worries.

From three “new laws”, foreign investors may find many opportunities.