China investors face taxing challenge

By Wu Zhong

HONG KONG - Chinese citizens are not the only people falling victim to rampant abuse of power by local mainland officials; foreign investors also frequently have a hard time, particularly those involved with small and medium-sized businesses from countries or regions where there is strict rule of law and who are not used to developing good guanxi or connections with local officials.

Some have to close their businesses and pull out of China as harassment of local officials become unbearable. This is particularly true in less-developed regions where officials’ abuse of power runs more rampant.

Here is a recent example.

About eight years ago, a Singaporean businessman surnamed Wang began a 100-million-yuan investment project to build a hotel in Anxi county, in eastern Fujian province. His Mingyuan Hotel, the only four-star hotel in Anxi, started business in 2003.

In a small place like Anxi, when a new hotel or restaurant opens business, the chance is that local officials will come to wine and dine. They normally don't pay, instead asking the owner to keep their bills "on record", which often means no payment should be expected. If the owner is savvy he will waive the bill to build good guanxi and for potential exchange for other benefits.

Wang apparently had no knowledge about such a practice. From time to time, he would ask his staff to visit the officials concerned and demand payment of their debts. His boldness eventually offended officials with the local taxation authority - whose offices are only a five-minute walk from Mingyuan Hotel - and Wang’s nightmare began.

In China, there are national taxes and local taxes, somewhat similar to federal taxes and state or city taxes in the United States. The local taxation authority oversees the collection of local taxes.

"Officials with the county’s local taxation authority often come here to have 'free meals'. Once three of them ate a meal worth 1,400 yuan [US$193], but they refused to pay, saying one of them was the director of the county local taxation authority,'' the manager of the hotel restaurant told the Market News, a sister publication of the People’s Daily - the flagship newspaper of the Communist Party. "But in fact he was just the head of a branch of the authority. At another time, the director, Huang Zhiyuan, himself came to eat. When the bill was presented to him, he said he would let a subordinate come to pay. In the end no one has shown up to pay the bill."

Records of the hotel in the first three months of 2007 alone showed that the Anxi county local taxation authority owed the hotel 18,289 yuan. On March 15, director Huang alone ordered shark fin and two other dishes, worth 350 yuan - or close to a month's pay for a local farmer (402 yuan) or a third of the 1,146 per capita monthly income of Fujian urban residents, according to government data.

One has to pay to eat in a restaurant, and government officials must take the lead in behaving properly well, according to Wang. "In Singapore, an official who doesn’t pay for a meal in a restaurant would be sacked," he said. He blames his current predicament on his "rigid way of thinking" and ignorance of the local environment in Anxi.

Urged by Wang, hotel staff went to demand for repayment from time to time. "A year ago, my colleagues and I went there several times to demand payment, but they always refused to pay. At one time, we were told that our prices were too high and we should lower the prices if we wanted the payment. The next time we went, we were slammed as 'insensible'," the hotel restaurant manager told the Market News.

"Our staff came back to complain. I could never understand why we were 'insensible' by demanding payment of debts? But now I fully understand, after all that has happened," Wang said.

On September 25, 2006, a van blocked the front door of the Mingyuan Hotel, 13 people got out and rushed to the reception desk, the financial department and security department of the hotel. Without showing any official credentials, the intruders claimed they were from the taxation authority and had come to check the hotel’s accounts. The check lasted about half an hour. Only when the people were about to leave did they show the hotel a notice about the taxation inspection.

The next day, the Anxi local taxation authority paid the debts, about 20,000 yuan, it owed to the hotel. Then came a notice from the Quanzhou local taxation authority, the direct superior of the Anxi taxation authority, of heavy fines imposed on the hotel. The hotel was ordered to pay Anxi local taxation authority 1.87 million yuan in taxes and fines. After a later hearing later, the total sum was reduced to 1.2 million yuan.

According to Market News and follow-up reports by other Chinese media, some of the taxes and fines listed were ungrounded and maybe illegal. For instance, the Anxi taxman demand the hotel pay 656,159 yuan of "urban real estate tax", which is against national law and thus invalid, according to Chinese law experts.

Most absurd was that Anxi taxation authority even levied a 87,380 yuan "hostess tax" on the hotel - basically equivalent to a prostitution tax. The figure was calculated as follows: based on the number of beds, the number of karaoke TV rooms and the number of sauna and massage rooms in the hotel, the authority concluded that the hotel should pay tax for 18 hostesses with 340 yuan for each per month.

According to China’s taxation system, local governments are entitled to levy certain local taxes, which however must not violate any national law or regulation. While in reality, prostitution is widespread in China, the world's oldest trade however is still illegal there. To levy a "hostess tax" would effectively give legal status to to legalize prostitution, far beyond the authority of the Anxi local taxation authority.

Hence some law experts and media reports called the Anxi authority’s action as "punitive enforcement of law''.

After the exposure of the incident, the Anxi local taxation authority insisted it had done nothing wrong and that it had acted strictly according to the books. As for the "hostess tax", it said it was a "personal income tax on high-income persons working in the hotel industry".

The explanation was partially true. If the hotel did not chase after the Anxi authority for payment of their debts, the "books" might not have been strictly followed. In exchange, some taxes might have been waived for the hotel had the local tax collectors been treated well.

Wang filed a lawsuit against the Anxi local taxation authority and is now awaiting a court ruling. Whatever the outcome, he says he has lost his confidence and plans to sell the hotel and return to Singapore.

This is by no means an isolated case, though they happen more often happen in less-developed regions. So much so that it seems a vicious cycle has been developed in China.

In developed regions, particularly in eastern costal areas where the investment environment is much better than elsewhere, officials are more open-minded, enlightened and law biding. As such, funds from home and abroad tend to flow into these regions, boosting their economies.

By contrast, in less developed regions - which more desperately need investment from outside - the environment is less attractive and officials’ abuse of power tends to run wild. Overseas and domestic investors hold back from putting money into these regions out of fear of becoming prey to local bureaucrats.

This contributes to the widening wealth gap between regions. To narrow this gap, investment funds should be channeled to less-developed regions, but to attract such money the investment environment, including the quality of local officials, must be greatly improved.

The central government of China has offered preferential policies to help less-developed regions to attract investment from outside. Nevertheless, lessons from the Anxi case and similar ones clearly show it is equally important that Beijing find more effective ways to rein in local officials, if the central government's goal is to be attained.