Structuring Investment into China Lili Zheng, International Tax Partner Deloitte & Touche LLP March 2, 2003 1
Agenda Post-WTO Investing in China A Common Myth About Investments in China Structuring Your Investment into Greater China 2
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Significant Spending Plans Planned expenditure of all 680 respondents - US$4.5 billion per annum. 38% plan spend to increase in the next 12 months. 44% of those already in China plan to spend over 6% of their company s s annual revenue on expanding in China. 26% of those yet to invest in China will commit over 6%. 4
China A Growing Priority Importance to respondents: Now In the next 3 years Already 51% 86% in China Not yet 25% 57% in China 5
China Expansion Visions 89% of respondents already in China intend to expand their investment. 23% intend to reduce investment. Overlapping 12% will restructure. 76% of US respondents plans for China business unaffected by September 11. 6
Unfamiliar Grounds Only 7% of respondents felt familiar with China s WTO commitments for their industry. 74% of respondents with investment in China ranked taxation and customs as their top area of interest 7
China Challenges Complex external environment Deficiency in qualified human capital Competition for customers and resources Foreign exchange control Sarbanes-Oxley deployment Cultural issues -- Duo zuo duo cuo, bu zuo bu cuo Do a lot, many mistakes; do nothing, no mistakes -- Bu zai qi wei, bu mo qi zheng If not in position [of responsibility]; just let it be -- General lack of trust in corporations, particularly foreign enterprises 8
A Common Myth About Investing in China Contrary to popular belief, China has actually been a very profitable place for foreign investors and MNCs Data shows that some of them are making good profits: $30b repatriated last year implies an 8% return on cumulative FDI of past 10 years. According to American Chamber of Commerce, 64% of 200 foreign companies surveyed reported that their operations in China are profitable. Some such as Coca Cola has been profitable for eight straight years. About 40% of Taiwan investment in China are profitable (WSJ 1/8/03) US$ bn 50 FDI inflows 45 Outward profit repatriation 40 35 30 25 20 15 10 5 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Source: Goldman Sachs, Wall Street Journal 9
Vehicles to Conduct Business in China: Early Stage Entry strategies Business objective. Import and export Licenses & franchises E.g., High-tech & services PE issues and E-business E operation Contract projects E.g., Construction contracts Contract manufacturing Labor intensive processing 10
Vehicles to Conduct Business in China: Later Stage Entry Strategies Entity selection Representative office: The low cost first step for many investors to have a present in China Joint venture: Leverage local partners Equity joint venture Cooperative joint venture Wholly foreign owned enterprise: Fully control your operation Joint stock company: Potential IPO in China and overseas 11
Entering China General Tax Considerations Site Selection Enterprise, Inc. Manufacturing, distribution, intellectual property, capital Capitalization Equity / Debt Repatriation / Distributable Reserves Form of Organization Holdings, Ltd. Limited liability company; joint stock company; WFOE; partnership. Hong Kong Start-up Considerations Tax holiday Local tax incentives Manufacturing Company China Deductibility of start-up, technical assistance, managerial services Capitalization of construction costs and interest Permanent Establishment threshold Circulation of goods, services and capital 12
Entering China Hong Kong Intellectual Property Company Enterprise, Inc. Technology Holdings, Inc. Manufacturing Company Technology Holding Ltd. In Hong Kong Participates in financing and owning relevant intellectual property rights Grants royalty-free license to manufacturing company Reduces income in China and need to repatriate from China Avoids 14.5% withholding tax in PRC Pays Enterprise, Inc. for lp through a cost sharing Hong Kong arrangement or buy-in payment May engage in sales activities Unique sourcing opportunities available in Hong Kong Funds international market development Serves as holding company to direct capital to Manufacturing Co. and receive dividends China Dividends not taxed in Hong Kong THL can sell, contribute, or license lp to other future operations Offshore royalties not taxed in Hong Kong No tax treaties available, however. 13
Entering China Hong Kong Sales Company Asia Sales, Ltd. Hong Kong Product Enterprise, Inc. Technology Holdings, Inc. Hong Kong Manufacturing Company China Asia Sales Ltd. Employees, business, and assets transferred to Asia Sales, Ltd., located in Hong Kong. Provides marketing, billing, and collection functions May act as a buy-sell distributor for the sale of Manufacturing Company products in China. May provide procurement services and/or small assembly Special sourcing rules in Hong Kong minimize Hong Kong taxable income Income tax rate yet is only 16% Customer China/Other 14
Offshore Holding Co. Structure 1) Contract R&D Agreement 2) License Agreement Offshore Holding Co. (ETR: 0%) Contract Manufacturing Agreement Marketing & Sales Agreement US Operating Co. (ETR: 40.8%) China Operating Co. (ETR: 0%-33%) Hong Kong Operating Co. (ETR: 0%-16%) 15
Our China Offices Over 2,700 people in 9 cities Audit, ERS, Tax, Corp. Finance, Human Capital, Mgt. Solutions Advisor to MOF, SAT, PBOC Client portfolio of multinationals and locally listed companies * Dalian * Tianjin * Beijing * Nanjing * Shanghai * Guangzhou * Shenzhen *Hong Kong * Macau 16
National Chinese Services Group New York San Francisco Silicon Valley 17
Tax Considerations for Growing in China Chris Wang, Senior Manager Deloitte & Touche LLP March 2, 2003 18
Tax Incentive Policies for FIEs Investment Zones Tax Holidays US Co. Tax Incentives FIE 19
Special Tax Incentive Zone Special Economic Zones Economic and Technological Development Zones Coastal Open Economic Zones and Old Urban Districts Hi & New Tech Development Zones Middle & Western Areas 20
Special Economic Zones (SEZs) Five SEZs in China Shenzhen Zhuhai Shantou Xiamen Hainan 15% Foreign Investment Enterprises (FIEs) established in the SEZs 24% production-oriented FIEs established in the old urban districts of cities in which SEZs are located Regular rate is 33% 21
Economic & Technological Development Zones (ETDZs( ETDZs) 15% production-oriented oriented FIEs established in ETDZs 24% production-oriented oriented FIEs established in the old urban districts of cities in which ETDZs are located 22
Coastal Open Economic Zones (COEZs( COEZs) ) and Old Urban Districts 24% production-oriented oriented FIEs established in COEZs 15% production-oriented oriented FIEs (established in COEZs and old urban districts of cities in which SEZs and ETDZs are located) for the following projects: Technology-intensive or knowledge intensive projects; Projects with total foreign investment of at least US$30 million with a long return period; or Energy, transportation or harbor construction projects 23
Hi & New Tech Industrial Development Zones (HNIDZs( HNIDZs) & Western Areas 15% High & New Tech FIEs established in HNIDZs 15% Production-oriented oriented FIEs established in the Western Areas for 3 years after 2 years of tax exemption and 3 years of 50% tax reduction 24
Income Tax Holidays A typical 5-year 5 tax holiday for all production-oriented oriented FIEs with a scheduled operation period of at least 10 years 2 years income tax exemption + 3 years 50% tax reduction Begins from the first profit making year (after absorbing the previous years losses Loss are carried forward for 5 years Export-oriented oriented enterprises with export of at least 70% of their total output 50% tax reduction (but not lower than 10%) for each qualifying year Technologically Advanced Enterprises 3 more years of 50% tax reduction (not lower than 10%) 25
Other Tax Incentives Industrial incentive: Energy, transportation, & agriculture High tech, software, & semiconductor Technologically-advanced enterprise VAT: reduce to 3% from 17% Business Tax free on transferring technology Cost sharing: avoid withholding tax Qualification for High-tech Enterprise and government approval Tax incentives for High-tech Enterprise 2-year exemption and 3-yr half rate Reduced 15% income tax rate Exemption on imported equipment and testing samples 26
Other Tax Preferential Treatments Super Tax Deduction for R&D Additional 50% deduction for qualified R&D Income tax refund on domestically purchased equipment 40% of the purchase price can be used as tax credit Limited to the incremental tax of the current year over the preceding year Unused tax credit can be carried forward 27
Tax Incentives Policies for Foreign Enterprises ( FE( FE ) Tax exemption 0% on dividend repatriation Reduced tax rates 10% on royalty and interest 20% regular rate Income tax refund 40% or 100% refund of income tax paid on reinvested profits 100% if invested in high tech or export oriented enterprises US Co. FIE 28
Transfer of Technology As Capital contribution Advantage No tax at the time of transfer Minimize up front cash Disadvantage No income stream other than dividends Valuation is required IP protection issues As a Royalty Advantage Future Income stream tax deduction in China (0% ~ 24% tax benefit) Disadvantages 10% withholding tax Royalty rate is generally subject to approval 29
VAT Imposed on the sale of goods, provision of processing, repairs and replacement services, and the importation of goods. Input tax is permitted to be credited against or deducted from output tax Only the VAT paid on purchased materials used in production can be used on input credit. VAT paid on fixed asset can not be refunded (domestically made equipment exception). Cash flow impact Major tax revenue Substantial compliance requirements and severe non- compliance penalty 30
Business Tax Imposed on the gross amount received from the following: Provision of taxable labor services Assignment of intangible assets Sale of immovable properties Gross amount can be reduced by costs incurred by taxpayers only in certain circumstance Tax rate: 5% on most activities, up to 20% BT exemption No BT on revenue of technology transfer or development No BT on software fee paid to foreign enterprises 31
Individual Income Tax IIT IT rate range from 5% to 45% Stock option gain is taxes when exercised Expatriate taxed as follows Duration with China Income sourced from China $ borne by PRC employer Income sourced from China & borne by non- resident employer Income sourced from outside of China & borne by PRC employer Income sourced form outside of China & borne by non-resident employer <183 days Taxable - - - 183 days=< Taxable Taxable - - &< 1 year 1 year <& Taxable Taxable Taxable - =< 5 years > 5 years Taxable Taxable Taxable Taxable 32
Repatriation Strategies Dividend Management fee Royalty Loans and interest Overall US and international tax planning plan your exit before you enter 33
Any Questions? Lili Zheng 408-704-4788 4788 lzheng@deloitte.com Chris Wang 408-704-4218 4218 chriswang@deloitte.com Chinese Service Group 34