In China, local governments often offer tax incentives and other incentives to attract investors. These incentives are subject to limitations and, at times, may involve “hidden costs” for the investor. These limitations or “hidden costs” are not usually disclosed to the investor. The following ten points should be kept in mind upon evaluating the investment incentives in China.
1. The incentives must be “legitimate”, i.e. in accordance with the national legislation. In case of conflict with the national legislation, the national legislation will prevail. For example, local investment incentive policies must comply with the relevant China five-year plan, currently the Twelfth Five-Year Plan (2011-2015).
2. Local investment policies refer to the tax incentives as “subsidies” (补贴). The tax incentives are neither tax exemptions nor tax refunds as they do not impact on the company’s tax obligations. The companies enjoying tax incentives will still have to pay taxes, although they will be entitled to a “refund” several months down the line.
3. In China, the tax revenue is split between the central government and the local governments at different levels: province, municipality, city, district, etc. The amount of the tax refund is limited to the portion of the relevant tax revenue (e.g. corporate income tax) allocated to the local government offering the incentives.
4. Tax refunds are usually implemented between April and May of the following year. While this system works well in the first tier cities (Beijing, Shanghai and other major cities), the risk of delay or failure to pay these tax refunds cannot be completely ruled out for smaller cities.
5. Investment incentives may induce a foreign investor to choose a rather remote location for the registration of its company. Establishing a company in an outlying district may involve additional costs such as the travel expenses and working hours that the company’s employees or consultants need to travel to the governmental offices of the place of registration to perform administrative or tax formalities.
6. Local governments also offer subsidies for the rent of offices. These “subsidized” lease contracts, however, are usually offered for short periods of time (1-2 years) and only to allow the registration of the company within the jurisdiction of the local government. Upon the expiry of the first term of the lease agreement, it is uncertain whether local governments will require payment of a rent (if the lease was rent-free) or a rent increase.
7. The use of a “subsidized” registered address for the sole purpose of registering a company may cause problems with the local tax office. In fact, tax offices require that a company’s registered address must be the place where the company carries out its business operations.
8. The investor’s decision to register a company in an outlying district in order to benefit from certain incentives could lead to the registration of a company’s branch (分公司 – without legal personality) in a more central district. The establishment of a company’s branch may involve additional administrative and management costs.
9. The subsequent transfer of a company’s registered address from an outlying district to a more central one takes considerable time and, more likely, the local governments may ask the company to reimburse the incentives it has benefitted from.
10. The investor should try to obtain a written agreement from the local governments setting out the investment incentives in detail. Governmental officials change and the new officials might not be willing to implement the investment incentive policies at the same terms as their predecessors. It would be advisable that a consultant is also involved to review and assess a local investment policy to identify its implications and potential risks.
For more on this topic, you could also read Investing in China: Ten Points to Consider in Evaluating Local Investment Incentive Policies, published on Bloomberg Law Reports