Tax Break

John Fisher, international tax consultant

Archive for the tag “China”

Far East in deep water

Where’s the motto?

If the motto of the United States is “In God we trust”, the motto of Australia should be “No worries”. We northern hemisphere folk who, unlike our antipodean friends, have summer in the summer and winter in the winter believe that, come Christmas,  an Aussie’s problems boil down to finding room for another shrimp on the barbie while his guests luxuriate in the pool swigging cans of XXXX (a beer for illiterates, pronounced 4X).

Australian defences are ready

I was, therefore, shocked to the depths of my didgeridoo when, in the middle of last winter (real winter, that is) I was informed by a representative of one of the Australian State Governments that  her government invests an inordinate amount in defence. My first impulse was to ask whether they were expecting an airborne strike by New Zealand sheep, the idea being so ridiculous. When I was told that the concern was Chinese imperialism, I was still gobsmacked – China has never struck me as that way inclined. It occurred to me that they were probably just scaremongering  so that when Julia Gillard, the prime minister, travels abroad she has something more serious to talk about than Australia.

Well, as Harold Wilson once said, “A week is a long time in politics” and the last couple of months have shown that those Bruces and Sheilas are not as dangerously brainburned as they insist on making us think they are.

The South China Sea has been witness to a series of petty maritime incidents between various nations that are frankly reminiscent of what was happening in our northern neck of the woods exactly one hundred years ago.  With spats over lumps of rock with such unlikely names as Scarborough Shoal, Spratly and Paracel there have been faceoffs between China and Taiwan, China and Philipines, China and Vietnam, South Korea and Japan (the Chinese navy must have been on vacation that week) and, most recently, China and Japan. It seems that all the minnows have been tickling the dragon under its armpits (I don’t know whether dragons have armpits) to test how far they can go before being incinerated. Meanwhile, the Americans, bound to keep the peace in the region, follow developments closely and frighten the hell out of the rest of us with the threat of going in and really warming up the party. The overriding concern, of course,  is Chinese expansionism, but if World War III does break out in the Australian outback’s back-yard, the conflict’s roots will likely be traceable to a VAT hike. Read on.

Beware!

Earlier this month the Japanese government purchased two small islands in a private transaction (I can picture it now – “Have you met our new neighbours ? Delightful people . Very quiet. They are called Japan.”). This really narked the Chinese who think they own them and would have liked to move in themselves. There have been all sorts of demonstrations in China and one newspaper even suggested skipping diplomatic options and going straight for the nukes. Most surprising of all, Xi Jinping, the next leader of China, having forgotten to meet Hillary Clinton and various other fat cats over the previous two weeks,  came out of hibernation to berate his neighbours. The question everyone is asking is: “Why did the Japanese do it?”. The  question everyone should be asking is Why did Mr Yoshihiko Noda, the highly pragmatic Japanese leader, do it?”.

Rewind a couple of months. Faced with the impossible arithmetic of covering pension costs of an increasingly aging population (the Japanese are skilled at not dying), the effects of an earthquake and nuclear accident, and fearing a Europe-like crisis  Mr Noda announced that consumption tax (VAT to you and me) would be raised from 5% to 8% in April 2014 and 10% in October 2015. The Liberal Democratic (which means conservative) opposition could not object to this austere measure but, following defections from the governing Democratic Party, extracted a promise of early elections from Noda as the price for passing the legislation last month.  Noda, blatantly doing what he genuinely felt was necessary for Japan’s future, effectively committed Hara-Kiri and is expected to lose the election convincingly.

As this story was unfolding, the maverick Governor of Tokyo  – reputed to be something of a loose cannon – started moves for his administration to buy the abovementioned islands in an act of, what many have interpreted as nationalistic provocation. Hence, Noda stepped in to frustrate that gentleman’s plans and, ultimately, to try and defuse the situation with the Chinese by ensuring nobody actually set foot on the islands. Despite acute early reactions, there are indications that tensions are starting to wane.

It would be tempting to wrap up with “And they all (probably) lived happily ever after”. Had Noda not tampered with the consumption tax, they might have done. But he is now looking down the barrel of an election shotgun and is probably about to be blown away. And there’s the rub. One of the leading candidates in this week’s contest for Liberal Democratic Party leader, who would almost certainly become prime minister after the General Election, is Nobuteru Ishihara. His father, Shintaro Ishihara is a famous author who has lately made a name for himself as none other than…..the maverick Governor of Tokyo. Like father, like son? Interesting times. I am thinking of inviting my worried Australian friends to join us in the Middle East – even if we are a bit short on shrimps and XXXX beer, not to mention Christmas.

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.

Dead loss

Angry Talk (Comic Style)

Image via Wikipedia

Liu Zhuiheng was executed last Thursday.  Xinhua, the Chinese State News Agency,  reported that the 52 year old from Hunan Province had been convicted of the July 2010 bombing of his local tax office resulting in 4 dead and 17 wounded. The motive for the crime was  frustration over his business losses.

Now, if we are honest with ourselves, most of us – at one time or another – have dreamed about taking a match to the local tax office. But,  in my case, at least, there was always a good reason: because they insisted on reading a treaty upside down; because they were basing their decision on a non-existent law; or simply because they were getting up my nose.

What did not make sense was that Mr Zhuiheng was punishing the tax authorities  for something for which they were not to blame- his business losses. If he felt some need, as he clearly did, to let off steam it would  have been more appropriate to trot off to the local Party Headquarters  and harangue the Party over the absence of any mention of  business losses in  Das Kapital or the Little Red Book.

Then I got to thinking that, while Mr Zhuiheng got it tragically wrong, maybe tax authorities are not as innocent as they look. The basic principle of the carry forward of losses is a tried and tested one. Countries have differing approaches, some allowing carry back, some restricting the period of carry forward. A phenomenon that has been gaining momentum in recent years and, particularly, in 2011 has been the restriction on use of loss carry forwards in a particular year. Following Germany’s earlier lead, in 2011 countries including France, Japan, Spain, Portugal, Austria, Denmark and Hungary either enacted measures, or moved towards,ensuring  that companies that are profitable in a particular year pay a certain amount of tax despite sufficient brought forward losses – by only permitting a certain percentage of taxable income to be relieved.

Although this may appear unfair and will doubtless upset (although I hope without the same consequences as in China) the businessmen of the western world, it must be clearly viewed against the backdrop of the world financial situation, with governments desperately trying to balance their books and facing a multiyear delay in tax revenues as companies pull out of recession and utilize their losses. The OECD estimated in 2011 that in some countries loss carry forwards represent as much as 25% of GDP.

When added to the tightening of change of ownership rules as well as the expected effect of the OECD’s  2011 report “Corporate Loss Utilization through Aggressive Tax Planning”,  which identified key risk areas where governments should  clamp down as; corporate reorganizations; financial instruments; and non-arm’s length transfer pricing – it does not look like companies have a lot to smile about when it comes to their, already  painful, losses.

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