Risk & Compliance

A Regulatory Migraine

More than 200 new laws slated to take effect in China this year create an assortment of issues for businesses.
Cesar BacaniFebruary 28, 2008

Ng Wailun should be one happy CFO. This year, his company, Shanghai-based
pharmaceuticals and skin-care products distributor Profex, will see its
corporate income tax rate
slashed from 33 percent to 25 percent. “This is good news for us,” Ng
concedes. At the same time,
however, a new labor contract law came into effect on January 1, and Profex
is unsure how it will affect
its army of beauty advisers, cosmetics ladies, and product promoters.

While these workers are technically the employees of third-party agencies,
it is in Profex’s interest
to make sure its outsourcing providers follow the new rules. “We spent time
and money to groom
and train these workers, so we want them to stay with us,” says Ng. The
agencies are waiting for the
government to issue model contracts to find out how much their labor costs
will rise — and how much
of it they can pass on to Profex.

China has been churning out new laws, and more than 200 of them come into
effect all at once this
year. They include the Corporate Income Tax Law and Labor Contract Law,
which took effect on January
1, and the Anti-Monopoly Law, which
comes into force in August. These follow
last October’s Property Law and new regulations
that abolished or trimmed certain
export rebates.

No wonder companies like Profex
are in a tizzy. At least it doesn’t export
toys, garments, shoes, or other low-value
products. Those mainly foreign-invested
companies are already reeling from a
strong renminbi and the scrapping of
export rebates. Like other enterprises in
China that currently enjoy concessionary
tax rates of 15 percent or lower, they
will now be assessed at 18 percent this
year. The tax rate will rise progressively
until it reaches 25 percent in 2012.

The new labor law could also place heavier burdens on many companies. One
Hong Kong businessman told
reporters that the regulation could raise labor costs in his Chinese shoe
factories by 40 percent. The law entitles employees who have been with a company
for at least 10 years to a contract protecting them from dismissal without
cause, and sets pay standards for probation and overtime hours.

The worry is the timing. The appreciating renminbi is cutting into
profit margins even as recession fears grip the United States and China’s
other export markets. “You’d think they’d do it in stages and see how it
went, instead of doing it all in one blow,” says Steven Dickinson, a
Shanghai-based lawyer with U.S. law firm Harris & Moure.

Already, Hong Kong and Taiwan business associations in various Chinese
cities warn that many of their members will be forced to close. But the
calculation in Beijing seems to be that any exodus will be limited to
lowvalue firms that are in China only because of tax breaks and ultra-low labor
costs. The theory is that the productive and well-run factories that treat
their workers well will pick up the slack, especially in coastal cities where
foreigninvested firms congregate and which are suffering from a labor shortage.

The new tax rules are also designed to encourage high-value, technology-oriented companies, which will be taxed at 15 percent. The government
will grant tax exemptions and other perks to enterprises investing
in qualified infrastructure projects, environmental protection, and
energy and water conservation. “Beijing has decided that the old model of
export-oriented foreign investment is no longer needed,” says Dickinson.

It’s a big gamble. Has China reached the point where local capital
can keep the export machine running? Will foreign investors participate in
China’s technology push? The new tax law grants preferential treatment
only to “enterprises that own core proprietary intellectual property
rights.” But even with a tax break, foreigners are unlikely to transfer
whole proprietary technologies to their Chinese subsidiaries. If China is not careful, its Big Bang can turn out to be a big bust.

New tax rates for companies in special economic zones