PUBLISHED : Thursday, 23 January, 2014, 1:13am
UPDATED : Thursday, 23 January, 2014, 2:20pm

The US$50b a year reason China's elite love tax havens

Taking the money out is just the first step; it's all about sending it back under the guise of foreign investment and enjoying the taxman’s largesse


As the writer of the South China Morning Post’s Monitor column, Tom Holland attempts each day to make sense of the latest developments in business, finance and economic affairs in Hong Kong and mainland China.

Yesterday an outfit called the International Consortium of Investigative Journalists published a story in several newspapers around the world alleging that close relatives of many of China's senior leaders own companies registered in offshore tax havens including the British Virgin Islands.

In terms of revelatory shock, this story has as much news value as the pope's catholicism.

Nonetheless, it is interesting - although scarcely surprising - to read that Xi Jinping's brother-in-law, Wen Jiabao's son, Li Peng's daughter and Deng Xiaoping's son-in-law, among others, all have ties to companies in jurisdictions like the BVI with minimal disclosure and no corporate taxes.

However, beyond saying that tax haven secrecy laws allow companies "to hide and facilitate all manner of crimes and abuses", and quoting vague estimates of massive illicit fund flows out of China, the article was unclear about exactly why China's princelings would want to set up offshore companies.

The explanation is not so much that they want to siphon money out of China, rather that they want to channel it in again.

Like the rich everywhere, China's wealthy dislike disclosing the value of their assets and handing over money to the taxman, especially if they made their fortunes trading on the influence of their high-ranking relations.

And the best way of evading tax is by pretending your money is really foreign investment.

Unlike Chinese-owned capital - say the proceeds of a Hong Kong initial public offering - foreign investment enters the country without paying capital gains or income taxes.

And once it's there, foreign capital enjoys all sorts of benefits, including a whole range of tax breaks and exemptions.

Alongside cheap land and discounted energy bills, some local governments allow foreign-invested enterprises to import capital goods without paying value-added tax. Others offer generous 50 per cent tax rebates to foreign companies buying locally made machinery.

That adds up to a big advantage. According to one study, the average Chinese company pays VAT bills equal to 8 per cent of their revenues. In contrast, foreign-owned companies pay just 3 per cent.

Clearly it pays to get your money classed as foreign investment. First, of course, you have to get your cash out of China. That's easy enough. As the owner of a mainland trading company, you simply understate the export revenues you declare to the authorities, allowing you to retain money offshore. Equally, you can overstate the cost of the goods you import. Either way, you accumulate a pot of money offshore, usually in the name of a BVI-domiciled company.

Alternatively, you set up a BVI company to hold the stake you own in your mainland business before floating it in Hong Kong, booking the proceeds of the offering in an offshore tax haven.

And then you route the capital back into China, either directly or through Hong Kong, labelling it as foreign investment in order to collect your low-tax jackpot.

The sums involved are huge. In 2012, the BVI, the Cayman Islands and Samoa - another tax haven - all made the top 10 list of the biggest sources of foreign direct investment into China.

Of course, Hong Kong was the biggest conduit for inward investment into China, channelling some US$66 billion of capital into the mainland, according to official figures.

But that money was only passing through, and most of it came from the same offshore centres favoured by China's wealthy businesspeople.

None of this is exactly news, but it does allow me to answer the reader who asked last week how much of China's record US$118 billion of foreign direct investment in 2013 was really mainland money.

Based on 2012's breakdown: at least US$50 billion, all routed through offshore tax havens by China's by well-connected rich.


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