Increasing the Cost of Doing Business

All this means is that foreign companies will be taxed at a higher rate. Chinese companies don't pay taxes, so it is absurd to whine about how the tax laws penalize the Chinese.

China has drafted executive regulations for a new corporate income tax law that will harmonize the domestic and foreign rates, and the final draft has been submitted to the State Council for approval, the China Securities Journal reported on Wednesday, citing an expert close to the issue.

The income tax rate for foreign companies in special bonded zones, which previously enjoyed a preferential rate of 15 percent, will rise in stages to 18 percent, 20 percent, 22 percent, 24 percent and finally 25 percent, the same as domestic companies, over five years, according to the draft.

One critical factor to consider when deciding whether to locate to China is the cost structure of the typical Chinese company vs. the typical western company. Should you buy a plant or continue to source?

Chinese manufacturers don't pay taxes (assuming they aren't massive and can fly slightly under the radar); they don't pay for software (at least 80% of software in China is pirated); they don't pay social insurance and taxes on their employees; they don't have an environmental compliance program; they don't pay for IP; and their factories probably aren't safe (meaning that if there is a fire, everyone will go down with the ship).

What does that mean for you, the western company who has to comply with all these requirements? From the outset, the Chinese company has a cost advantage and is operating under a different cost structure. If you are selling a commodity product, you're dead. They will win.

You have to provide quality and/or service that isn't yet available in the Chinese market place (and you have to know that the service is considered valuable enough to the consumer to cover the cost differential). You have be to innovative: the Chinese are smart folks, and they can modernize quickly.

Considering acquiring your Chinese supplier? Understand that the initial period following acquisition will be expensive as you move to remedy these irregularities. The Chinese management team, assuming you've kept them, will strongly resist your attempts. It will be beyond their comprehension that you'd be looking for ways to drive up costs.

If you're sourcing sufficient volume from China, consider establishing or acquiring a manufacturing facility that can fulfill a faction of your production requirements. This (a) gives you legitimacy with your clients (if Wal-Mart or Coke discovers you're a third party middleman with no production capabilities, they will cut you out of the chain); and (b) provides leverage against other suppliers to keep costs down. If you have multiple suppliers including your own plant, you can assert greater pressure on your suppliers.

As an aside, you should have a noncompete agreement with your suppliers that prohibits them from selling directly to your customers for a period of years. Understand that there are often practical difficulties to enforcement. If you have a larger relationship with Wal-Mart in a different location (US), you might be reluctant to enforce the noncompete against your supplier in China and cloud your larger relationship with Wal-Mart.