China question: Where to invest?

An example is land. Assuming you want to have your own factory, you will need to acquire the so-called state-owned land use right for industrial use purposes against payment of land use right grant fees. As of 2007, the Chinese central government introduced a system under which the land use right must not be granted below a certain minimum price. Such minimum price varies depending on location of land. The hinterland regions are naturally cheaper.

Another cheaper aspect is labour, which has been a major factor in attracting foreign investment in the past decade. Local governments reveal statistics on average salaries every year. Take Shanghai and Chongqing as examples where the monthly average salaries in 2011 were around $680 and $530 respectively.

In addition, local governments in China tend to offer economic incentives to attract foreign investment. After years of rapid growth, the coastal areas – in particular those developed areas like Yangtze Delta and Pearl River Delta – are focusing more on quality of projects, while the inland regions are still eager to increase quantity and are therefore more generous in offering incentives such as subsidies to make your investment cheaper.

Hidden costs

Considering the speedy changes in China, the cheap picture above might have different kinds of implications, as can be observed from the constant development of legislation and local practice.

First, we have witnessed the trend of central government controlling price flexibilities at local levels. A typical example is the introduction of the land listing and bidding system in 2002, which now applies nationwide. If bidding procedures are triggered (more than one buyer), you will have to pay a higher price to secure the land even if your project is located in an inland region. The cheap labour in the western regions may also be affected by the trend of more stringent law enforcement, as can be seen from the recent launch of pro-labour legislation by Beijing including the PRC Employment Contract Law (中华人民共和国劳动合同法) on June 29 2007.

Secondly, the initial cheapness does not come without hidden costs. More bureaucracy and higher risks of corruption normally accompany the less developed status. You will see the differences in efficiency levels and mindset between authorities in Shanghai and in an inland city, which may substantially reduce the attractiveness of inland cheapness. Another concern comes from the HR perspective, as you may not find the senior and skilful staff you need in the hinterland and to second them there from coastal cities will be expensive.

On the other hand, if you look carefully, you may still find some cheap locations in the coastal areas. For example, compared with the investment-crowded cities like Shanghai, its slower neighbours like Jiangsu, Zhejiang and Anhui provinces may offer a cheaper and yet more suitable deal.

China adopts a centralised system that provides limited scope for local legislators to create regional differences. What matters in reality is local practice. It is strongly recommended for you to conduct a thorough check of all those parameters relevant to your intended investment project, in addition to cheapness. If possible, have them agreed in writing beforehand with the local government in question. You may also consider engaging an experienced consultant to guide you through this process, especially if it is your first adventure in this promising investment destination.

Michael Tan, Taylor Wessing, Shanghai

The domestic perspective

Since 2008, the Chinese government has focused its attention on developing inland cities, making them more attractive to foreign investors, especially those in manufacturing. In 2011, it was reported that Chongqing, the largest inland and western city, surpassed Beijing by attracting $10.8 billion in foreign investment.

In China, all urban and rural land is owned by the state. Rural land is owned by villages or farmers collectively, but can be acquired by the state and the land use rights then granted to foreign invested companies. The cost is usually cheaper than coastal cities. The Land Authority has created a minimum for the land pricing of all cities in China. Any cost to acquire the land for manufacturing purposes cannot be lower than the minimum set. For example, in Xuhui District, Shanghai, the cost cannot be lower than Rmb840 ($132)/ m², in Wuhu City, Anhui Province, the amount is Rmb336 ($52)/ m² and in Fuling District, Chongqing, the amount is Rmb144 ($22)/ m².

Typically, the manufacturing industry is more labour-intensive than service industries. Both the statutory minimum salary and the average salary of interior cities are lower than coastal cities. For example, the statutory minimum salary in Shanghai for 2012 is Rmb1,450 ($228) a month and the average salary in 2011 was Rmb4,331 ($682). While the statutory minimum salary in Chongqing for 2012 is Rmb1,050 ($165) (in developed areas) and Rmb950($150) (in rural areas), and the average salary in 2011 was Rmb2,187 ($344). Contributions to social benefits and compensation for worker's injury or death are calculated based on the local salary and consumption. Therefore, the compensation for death or injury accidents in an inland city is substantially different and low compared with a coastal city.

Interior cities also offer more attractive tax benefits. According to the Circular on Tax Policies for Development of Western Areas (关于深入实施西部大开发战略有关税收政策问题的通知)issued by the State Administration of Taxation on July 27 2011, if a company is established in one of the western areas and is mainly engaged in encouraged industries, the income tax rate is 15%. The normal rate in coastal cities increased to 25% under the PRC Enterprise Income Tax Law (中华人民共和国企业所得税法), which also applies to domestic companies. The interior cities include Chongqing, Sichuan, Guizhou, Yunnan, Tibet, Shaanxi, Gansu, Ningxia, Qinghai, Sinkiang, Inner Mongolia and Guangxi.

Furthermore, a foreign invested company may be entitled to partial exemption of the total income tax in the range of 25%-40% in some autonomous regions, such as Sinkiang Uyghur Autonomous Region and Inner Mongolia Autonomous Region. Many cities also offer other business or VAT tax reductions, tax refunds or financial subsidies. Sometimes there is a reduction in the individual income tax of senior management for a foreign invested company.

In practice, unlike coastal cities, local governments are more willing to offer additional investment benefits, including financing benefits, public utilities facilitation and accelerated government procedures. This happens on a case-by-case basis to foreign invested companies engaged in manufacturing and falls into the encouraged category.

There are many advantages and benefits when investing in China's interior, but smart investors need to consider the whole picture. They need to think about: transportation and raw material costs; whether there are experienced workers and technicians available in the local market; how corrupt the local law enforcement authorities are. Foreign investors should also consider if the local benefits offered have changed frequently in the past, helping them gage if the benefits are only short-term or long-term.

Haixiao (Helen) Zhang, Zhong Lun Law Firm, Shanghai