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Introduction of Circular

In the past few years, local governments have actively introduced more and more incentives to attract foreign investors to their locality. Incentive-shopping by foreign investors has become a popular practice, and one result has been that local governments have seen their local part of the tax revenues from a lot of local business decrease significantly.

On 27 November 2014, the PRC State Council released new policies that are designed to curb such practices. Guofa [2014] No. 62 (‘Circular’) launches a comprehensive reform of various taxes and other preferential policies, specifically prohibiting local incentives for new investment and ordering the cancellation of previously-confirmed incentives.

Tradition of providing incentives by local governments to attract foreign investment

In the first decades of China’s opening up, many foreign-invested companies could enjoy more favorable tax rates. When these were abolished in the last decade, local government throughout China started to introduce other local incentives to attract foreign investment. Common-seen examples of incentives and preferential policies include tax concessions, reductions and exemption of land royalties, counterpart funding, management services for foreign investment programs, financial guarantees and favorable interest rates. The establishment of special economic zones has helped local governments to market their incentives for specific industries.

Circular prohibits incentives

The new Circular specifically prohibits tax concessions, stipulating that ‘except for tax administration authority as prescribed in accordance with special tax laws and regulations, and the Law of the People’s Republic of China on Regional National Autonomy, no region may develop preferential tax policies without the approval of the State Council’. The Circular also prohibits reductions and exemptions of land royalties – land cannot be assigned at a preferential price. Other non-tax incentives such as waiving administrative fees and providing government funding are also prohibited, while state-owned assets may not be transferred at a preferential price. Reducing, exempting or postponing the collection of companies’ portion of social insurance premiums is specifically prohibited and no company is permitted to pay premiums at a rate lower than the uniform one without the approval of the State Council. Other preferential policies in violation of laws include refunds, expenditures from retained revenue, fiscal rewards and subsidies, which shall all be resolutely canceled.

The regulation on counterpart funding and management service is vague; the Circular refers to ‘other preferential policies shall be gradually regulated’ are ‘paying social insurance premiums and other operating costs on behalf of companies, granting preferential electricity price and water price, attracting companies from other regions to settle down in the regions or pay taxes in the regions by means of financial rewards or subsidies and the overall retainment or incremental refund of local fiscal revenues in some regions’. There is no also clear regulation related to monetary policies such as financial guarantee and favorable interest rates. Overall however, the message is clear: no more local incentives!

Previous incentives may be cancelled or curbed

Although the order from above clear establishes that past incentives must be cancelled, it remains to be seen whether local governments will so strictly execute and become compliant immediately. Currently for example, negotiations are ongoing between several large foreign investors and relevant local governments, on the continuation of preferential policies in direct conflict with the Circular. More than ever, companies should liaison regularly with their local government to inquire about the current status of incentives provided, and where possible negotiate for temporary relief. In any case there is pressure on local governments to act: The Circular calls for all regions and all relevant departments to carry out a special revise of contracts and agreements as concluded with companies, memorandums, minutes of meetings or talks as well as requests for instructions, reports and official replies in the form of ‘one case one meeting’.

What does this mean for your decision-making regarding new investments in China?

When considering on investment in China, foreign companies should be focusing less on specific incentives that are offered, and much more on other commercial facts such as convenience of location, transportation, labor costs, infrastructure, location of sub-suppliers and customers, nearby ports, industry parks, overall living environment, expansion options, regional headquarters, service providers, and so on.