Tax Rashomon: It’s All in the Interpretation

Having grown up in Brooklyn, New York, I have fond memories of going with my father to the Bell Cinema, an art-house movie theater, to watch those few foreign-language films that made it to the States. One of those films was Rashomon, by the great Japanese filmmaker Akira Kurosawa.

Rashomon is the story of a crime and how it was witnessed by some. Those who saw the incident gave wildly varying interpretations of what they saw.

So what does this have to do with tax? Two articles, both published on June 17, one in the South China Morning Post, the other in China Daily, covered the same story but with completely different interpretations. Both articles discussed the ongoing tax threshold story in the P.R.C. that I’ve mentioned in recent articles.

“Govt Gets Earful of Tax Suggestions” was the headline of the article in China Daily. It was written by Zhao Yinan, and I consider it the more balanced of the two articles.
Only 15 percent of the 82,000 respondents to the National People’s Congress website solicitation for opinions expressed satisfaction with raising the tax threshold from CNY 2,000 to CNY 3,000 while reducing the number of tax brackets from nine to seven. Of the suggested alternatives, two were prominent: raising the threshold to CNY 5,000 or lowering the entry-level tax rate from 5 percent to 3 percent.
What I find interesting is that there were 82,000 respondents. Remember, this is a country where both the “Democracy Wall” and the Hundred Flowers Campaign were movements encouraging Chinese citizens to speak out and suggest alternatives – except that those who did were penalized. True, the overwhelming number of respondents were anonymous in their website comments, but some listed their names. (While I am limited to putting in my two cents worth to the English-language sites, I always list my full name.)

Li Daokui, an adviser to the People’s Bank of China and a professor at Tsinghua University, suggested that China implement different thresholds according to living standards in different areas. Gao Peiyong, a researcher at the Chinese Academy of Social Sciences, stated, “The amendment should not only focus on the threshold, but also have to make comprehensive changes on the structure of the tax, as well as pushing forward the reform of the country’s taxation system.”

The article also mentioned that more than 40 percent of the respondents to the poll came from Beijing, Shanghai, and Guangdong.

“80PC Oppose Proposed New Tax Threshold” was the headline in Cary Huang’s article in the South China Morning Post. The subhead stated: “Poll finds widespread resistance to setting 3,000 yuan a month as the limit for tax-free income.”

This is yet another example of why one cannot simply rely on only one source of information to objectively determine what is going on. Read the Financial Times and The Wall Street Journal articles about China and you will find vast differences on the same issues in them as well. The National People’s Congress is well aware of the impact that inflation is having on taxpayers and will change the personal income tax law to make taxpayers less unhappy than they currently are about inflation.

The government’s problem is that while it wants to increase social spending, a threshold increase to CNY 5,000 would bring the proportion of the tax-paying population down from the current 28 percent to 12 percent, with a revenue loss that would have to be made up in other areas.

Other Things China

Shenzhen’s Unenforceable New Law

The South China Morning Post reported on June 15 that beginning July 11, Shenzhen’s municipal government will impose a transaction tax on secondary market home sales that will be based on a reference price determined by market conditions. According to Samuel Wong, a director at Midland China’s Shenzhen branch, the new rule is meant to solve the problem of “yinyang contracts,” in which sellers and buyers sign two sales contracts, both a public one (to avoid taxes) and a private one, with the actual sales price. The resale of secondhand properties is subject to a 20 percent tax on gain, but sellers rarely, if ever, pay the tax. Starting July 11 there will be a 1 percent tax based on assessed value of “mass housing” and 1.5 percent of assessed value for upmarket flats.

I support something like this, not only in China but in Hong Kong, too. But without a municipal assessor’s office or bureaucracy in place to administer and enforce it, how will it be effective? Five years from now, this tax will be enforceable, but not now. Rampant real estate trading will continue with little or no tax collected – not just in Shenzhen but throughout China. The tax is a good idea, but good ideas alone won’t alleviate fraud and abuse.

Off to the Races

The Chinese are gamblers. Properly administered horse racing can be a revenue maker at the local level – and there will be ample gambling tax revenues if racing is properly administered, minimizing corruption. I believe shady activities will never be completely eliminated where horse racing exists: I owned a race horse in California during the 1970s, and I firmly believe that races were fixed. I am a Hong Kong Jockey Club member, and I believe that there are still activities going on in Hong Kong that are not quite kosher, although I can’t prove it. But it is sufficiently regulated and administered that I will not hesitate to gamble and thereby increase tax revenues and the coffers of charity.

Guangzhou’s horse racing efforts in the 1980s and early 1990s failed. Beijing had horse racing a few years ago; it never truly worked.

The General Administration of Sports of the P.R.C. has approved weekly horse racing in Wuhan, scheduled to start in August. There will be four to six races every Saturday, with 10-12 horses in each race. More than 200 horse owners have already signed up for this latest experiment in horse racing in China. Wuhan, during the 1920s, was the horse racing capital of China.

“People can win small prizes if they correctly guess which horse will win the race but they can’t bet on horses,” said Liu Hongqing, spokesperson of Wuhan Orient Lucky City, the Hong Kong-based organization that was awarded the concession to develop horse racing in China.

If Wuhan Orient Lucky City is able to control development, I expect that in another few years, fullfledged international-style horse racing will become a major fixture in China, with Wuhan’s tax revenues to substantially increase because of this. I am hopeful, but not quite optimistic because of China’s recent past in this area. But since I do love the ponies, I will watch this one closely.

Future Income — and Tax — Generation

The June 10 issue of China Daily reviewed a survey taken by MyCOS Institute, a Beijing-based consulting firm that looked at the Chinese university graduating classes of 2007 through 2010. The institute interviewed 227,000 2010 university graduates and 109,000 2007 graduates in Beijing, Shanghai, and Guangzhou. Results indicated that 22 percent of university graduates are choosing to leave their jobs and homes in Beijing, Shanghai, and Guangzhou within three years of graduation.

The graduates most likely to move were making either CNY 2,000 per month or less or CNY 9,000 per month, occupying both the low and high ends of the income scale—in other words, those who do not pay taxes because of a threshold higher than their income or those likely to be making substantially more in the future.

The average monthly income of those surveyed was CNY 3,272 during their first six months of employment. After three years of employment, that monthly income rose to an average of CNY 6,781. Why move? Cost of living, that’s why. “My friend and classmate earns 4,500 yuan a month in Wuhan [will he lose it all at the race track if horse racing in Wuhan works?] and he had a wedding ceremony in his house last month. I earn about 7,000 yuan a month (in Beijing), but am still far away from getting married because I can’t afford to buy a home,” said one of the respondents. Quality of life will definitely be a boon to the creation of new cities and will contribute to the growth of fourth-, fifth-, or sixth-tier cities in China. I think the central government is aware of this and is emphasizing development of a new bureaucracy in these areas – a bureaucracy without the culture of corruption and stodginess embedded in some of the more established municipalities. Don’t get me wrong: The State Administration of Taxation is as clean as you will find of any bureaucratic administration in China, but while China puts its increasing tax revenues into turning China from an export-driven economy to one of consumption, things will have to be quite above board to maintain the support of a growing middle class. And that will be easier to develop in growth areas than it will be to change already established areas. For those watching this develop over the next half-century, remember that you read it here first.

Dandong’s New Economic Zone
,br /> Go north, young men and women. Although I’ve lived in China for 21 years, I’ve only been to Liaoning Province two or three times, and those trips were brief. I anticipate going again soon. It is the northern rust belt of China. While the west is underpopulated and certainly underdeveloped, China’s rust belt used to be its industrial heartland, inefficiently mass-producing all things industrial.

The Binhai new development area out of Tianjin was China’s first stage in redevelopment of the north. Dandong is step two. On June 11 China and the Democratic People’s Republic of Korea reached agreement to jointly develop new economic zones in Dandong, Liaoning Province, and another zone in Jilin Province. Dandong has designated a 30-square kilometer parcel of land for development of a special economic zone with tax incentives not solely limited to high technology. This zone will “actively engage” (as per People’s Daily of June 18) in the development of the Hwanggumpyong andWihwa islands’ economic zones in the D.P.R.K., both located near the estuary of the Yalu River, which is the border between China and North Korea. Did anyone out there even realize that there were two D.P.R.K. economic zones in that area? I did not.

By 2020, according to Dandong Communist Party Secretary Dai Yulin, the Dandong new economic zone will have a 300,000-strong talent pool specializing in alternative energy, new technologies, new materials, biopharmaceuticals, and advanced equipment manufacturing. Let’s see, a 300,000-strong labor force in an area without a basic labor force – that means development of a new city of approximately 1 million people in nine years.

Between now and 2016, this zone will create 100,000 new jobs, primarily in the areas of financial services, information services, export-oriented processing, tourism, and recreation. This is not high tech. To lure new business, Dandong will have to offer the same 15 percent corporate tax rate (after initial incomeproducing tax holidays) found in China’s other new development and high tech zones. Dandong’s municipal government will allocate CNY 20 million a year over this period solely for human resource projects.

Dandong is 220 kilometers from Pyongyang and 420 kilometers from Seoul by rail. Its port is 245 nautical miles from South Korea’s port of Inchon.

A few years back, at a Chinese accounting conference in Hangzhou, sponsored by the Chinese Institute of Certified Public Accountants, I met the head of accounting for the D.P.R.K. and started negotiations to visit the D.P.R.K. to learn what its tax system was all about. I never followed through, primarily because I could not determine whether a D.P.R.K. tax system even existed. Perhaps it’s time to restart these negotiations with my friends from the P.R.C. Ministry of Finance acting as intermediaries.

As Long as We’re Talking Korea…
I don’t write that frequently about South Korea’s tax system because there’s not that much to write about. Its tax system is simple. You can read all you need to know in under 100 pages, in under 90 minutes. Try that with any set of IRS instructions: They may look like English and sound like English, but I defy anyone to tell me what they actually mean.

I summarize Korean tax law thusly: If an area is specifically covered in that (approximate) 100-page law, you can project your tax liabilities and come under the South Korean tax umbrella. If nothing can be found within those 100 pages, then good luck.

Case in point: Lone Star Funds’ 2003 acquisition of Korea Exchange Bank (KEB), during the 2003 Korean financial crisis. Lone Star turned KEB around but was neither able to repatriate profits nor unload the bank (which has become their albatross) to anyone else. And it still can’t unload it because of pending court cases regarding taxes due to South Korea that must be cleared before it can take any further action. Once again, Lone Star assumed that these tax matters were clear-cut. They were not because the issues involved simply were not covered in Korean tax law.

Lone Star wants to dump KEB on Hana Financial Group, South Korea’s number four bank. According to the June 14 edition of the Korea Herald, Lone Star’s alleged wrongdoing in its 2003 purchase of a credit card unit affiliated with KEB takes precedence over capital gains tax issues involved with the sale of KEB to Hana. This case will likely drag on for some time.

While I love all things Korean, I must advise anyone seeking to invest in South Korea to use extreme caution. Simply remember this: If you are going to be involved in Korean investments, make sure that you have reviewed Korean tax law. If the issues you anticipate are covered, confirm this through the Korean tax bureaucracy, rather than dodge them. They will be happy to speak with you and answer your questions. I know this from firsthand experience; I’ve talked with them on several occasions. If there are any areas that are not covered, be extremely careful, because you are walking on thin ice.