A REGULATORY MIGRAINE
New rules for business in China.
By Cesar Bacani

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 low-value 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 foreign-invested 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.