Tax Break

Who said tax is boring?

Bo Peep

The human face of terrorism?

Ever since a BBC newsreader put me right about the difference in pronunciation between Gorilla, a type of ape,  and Guerrilla, a type of freedom fighter, I have been a bit of a stickler for getting the sounds of words on target. While a gorilla may be anthropomorphically protrayed as a guerrilla, articulation of the latter involves a painfully rolled ‘r’ (two to be precise) which sounds like a cross between a flamenco guitar roll and an onomatopoeic machine-gun burst.

"What do you mean your agent said you were going to be in the entire movie?"

I was therefore once again indebted to the Beeb when they recently started serious coverage of a story, like the best of John Le Carre’s spy novels, that has been gradually unfolding for months in the quality press. As the world now knows, Bo Xilai has been removed from his senior position in the Chinese Communist Party amidst allegations that his lawyer wife, Gu Kailai, was involved in the murder of a shady British businessman. The source appears to have been his local police chief, Wang Lijun, who took refuge for two days at the US Consulate in Chengdu and, according to reports, spilt a few too many beans during his stay. The unfortunate Brit, Neil Heywood, who has the only name I can pronounce without audio assistance, was even out of spy novel central casting (although Le Carre would have insisted on calling him Nick ) and sticks in my mind as one of those hapless extras in early Bond films always sweating in tropical suits and dead in the first five minutes.

His dancing was a lot better than his accent

According to Auntie – Britons’ affectionate term for the BBC – Bo Xilai and Beaujolais (as Le Bon Vin Rouge would have been pronounced by Dick Van Dyke in Mary Poppins – “lais” morphing to “lie”) are homophones. Hence, one might expect a Cockney to walk into a pub and announce: ” A pint o’ Beaujolais and a packet of crisps, darlin’ ” and, if one was not listening carefully, one might think he was talking about the Chinese crisis.

It appears that the less-than-free Chinese press is now concentrating on the antics of the prodigal son of Bo Xilai and Gu Kailai – Bo Guagua (not to be confused with Lady Gaga) – who appears to have bombed busily around Chongqing, his father’s fiefdom, in a Ferrari when not busy bombing exams at Oxford.

This banal coverage is giving the Chinese leadership some respite from discussion of the real issues that could affect the future of that great country including the taxation of outbound investments, which is what most interests readers of this blog.

The final chapter?

Until his fall, Bo Xilai was widely tipped to become a member of the nine member Standing Committee of the Politburo, which effectively runs China, in the much anticipated generational handover of power later this year. Although from one of the most prominent communist families (his father was vice-premier and the whole family suffered in the Cultural Revolution) he was not universally liked and the situation that is unfolding smacks of an old-style purge. While China continued its long march to a more Free Market economy – as was clear from the 12th Five Year Plan last year and the anticipated appointment of Xi Jinping as next president – Bo Xilai was from the left wing of the party and advocated partial return to Maoist policies. Perhaps most significantly, he was a Statist – advocating central control of the economy particularly through the promotion of state-owned industries as opposed to a free market.

China today is still predominantly statist but various pronouncements including a co-authored report with the World  Bank (which is also now headed by American Jim Yong Kim whose name I can, at least, pronounce) show that the country is ripe for further reform.

China’s growth in recent years has been built on foreign investment, exports, exchange controls and cheap finance from the masses. Put into other words, the Chinese have been encouraged to save rather than consume investing their savings in the limited ways available to them, hence freeing up cheap capital to be pumped into inefficient state industries. In the meantime control of the Yuan involves resorting to the printing press in transactions with foreigners to maintain an artificially low exchange rate and continue to encourage exports.

It is now recognized that the Yuan policy will eventually lead to inflation and, if high growth is to continue to be achieved, it is necessary to slowly free up the markets. This involves encouraging consumer spending, allowing interest rates to rise, reducing the prominence of state owned industries which guzzle available credit thus crowding out private enterprise, continuing to encourage foreign investment and, very importantly, putting more emphasis on encouraging outbound investment.

With the charismatic Bo Xilai safely out of the way the road ahead seems much clearer. In the field of outbound investments, from conversations I have had with Chinese experts over the last few weeks (don’t ask me  how to pronounce their names) things look ripe for a further liberalization of the outbound tax rules – further reinforced by the exponential increase in tax revenue from inbound investors in recent years.

Currently, the cornerstones of Chinese outbound tax legislation are the direct and indirect foreign tax credit rules and CFC rules. Both have serious shortcomings. The FTC rules allow credit for foreign tax paid but, in the case of indirect credit, this is restricted to three foreign tiers – precluding complex multi-national structures which the Chinese are likely to invest in going forward, as well as a same country limitation – restricting credits to tax paid on income from the same country; 5 year carry forward of unutilized credits is permitted. As regards CFC, the rules apply to all profits in a country with a tax rate of less than 12.5% unless it can be shown that the profits are left in the company for valid business reasons.

In a country that wants to substantially increase its investment abroad these rules are not good enough. At minimum, China needs to permit tiers all the way down (above a certain indirect holding percentage) and remove the same country rule. Ideally, it should consider a territorial basis of taxation for this income. As regards CFC, the rule is too vague as regards what constitutes valid business reasons and the cut-off rate is too high – 12.5% is no longer a tax haven rate of tax.

The human face of the free market?

In  modern China,  Bo Guagua and his parents might be listening to Lady Gaga’s  hit song Paparazzi and longing for the good old days when senior Party officials who fell from grace simply disappeared from the podium at the next National Day parade.

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