CHINA FOCUSNewsletter on business trends and corporate strategies

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CONTENT4 out of 5 Power Tools Made in

China

Uncovering Corporate Mysteries: Are Free Trade Zones Always the

Best Choice?

“China Eases Taxes for Foreign Companies” – Fact or Fiction?

Tough Stance on Visa Policy and The New Immigration Law

Contain Yourself in 5-Star Luxury

4 out of 5 Power Tools Made in China

CHINA FOCUS • Jul/Aug 2012 • 1 of 4of China Insight

The power tools industry in China has undergone substantial development over the past decade. However, the market situation is now at the tipping point of change and requires finely-tuned growth strategies in order to succeed in the next growth phase. This article provides an overview of the domes-tic market structure, demand and supply, future challenges and recommendations based on Fiducia’s consulting projects.

Tools of the trade In the past 5 years, the power tools market underwent an expansion boom. The number of manufacturers producing mainly hammers, saws and grinders doubled from 2006 to 2012. Production clusters are mainly situated in Zhejiang, Jiangsu and Guangdong provinces, which account for over 80% of the domestic output.

The market can be broken down into 3 segments:

Market Position Market Players Example

Tier 1 – International Companies <10

Bosch, Makita, Black & Decker, Hitachi, TTI

Tier 2 – Leading Chinese Companies ~20

Zhejiang Boda, Jiangsu, Jinding, Guoqiang

Tier 3 – Small Chinese Companies >100 Zhejiang Yinger,

Nanhai Lihao

In recent years, China has accelerated with the support of the government and has become the world’s largest exporter accounting for more than 80% of global production. To date, export of power tools from China is over RMB 60 billion, more than double the amount that Germany exports.

Concurrently, China’s domestic consumption of power tools has witnessed rapid expansion, reaching RMB 5.1 billion in 2011. This is primarily driven by the construction end market, followed by the demand from wood and metal processing

domestically. Particularly in the aftermath of the financial crisis in 2008, the RMB 4 trillion stimulus package clearly boosted the growth of domestic fixed asset investment (FAI), which alone constitutes 50% of China’s total GDP overall.

Do It Yourself? Not in China These demands boosted consumption in the industrial and professional sectors, mainly supplied by international manufacturers, but not in DIY (“Do-It-Yourself”). Chinese consumer behaviour differs from Western countries; DIY in the West is quite popular where home improvement is done as an enjoyable pastime. Quite the opposite, Chinese consumers view DIY as low-end manual work and tend to hire specialists to do the job.

Penetrating the marketIn spite of the rapid expanding domestic demand, manufactur-ers are facing increasing pressure from all sides: ► Externally: Shrinking demand from Eurozone and the U.S.;► Internally: The domestic overcapacity which accumulated over the previous years of robust growth;► Government: Beijing’s efforts to consolidate the industry, particularly for mid- to low-end companies.

Based on this situation and Fiducia’s recent project findings, we

Domestic consumption is projected to increase at a faster rate.

RMB billion

The common conception is that setting up in a Free Trade Zone (FTZ) is beneficial to all businesses and especially favourable to foreign investments. The main purpose of a FTZ is to promote export-oriented business through a designated bonded area with less government interferences and limitations. A bonded area is government space where goods can be stored or processed before being exported without payment of duty to the customs authorities. Despite the popularity, some business models may actually not benefit from locating in a FTZ.

Case Study: Waigaoqiao

Waigaoqiao was the first FTZ in China, established in 1990 and is the largest bonded zone in the country. Today, over 5,000 foreign companies warehouse high-end imports, sell across the Asia-Pacific region and/or coordinate exports for their OEM

CHINA FOCUS • Jul/Aug 2012 • 2 of 4of China Insight

Uncovering Corporate Mysteries: Are Free Trade Zones Always the Best Choice?

There are 15 FTZs in China, with 3 located in Shanghai alone.

operations. Waigaoqiao also provides facilities for software development and R&D.

Companies registered in Waigaoqiao can enjoy the following incentives: ► Customs duties and import tax exemption for goods transferring to overseas destinations.► Simpler customs clearance procedure – companies can declare imported goods collectively. Goods that need to be transferred can enjoy optimised clearance procedure.► Shorter inspection and quarantine time for pre-inspected and pre-quarantined imported commodities already on the entry record.► Tax rebate upon entry for domestic merchandise. ► Free deposit bank accounts.

Not always the right fitDespite the many advantages, some FTZs may have certain characteristics which are partly due to the incentives they offer: ► Smuggling – FTZs increase the chances of goods being sneaked out of bonded areas to avoid the payment of taxes.► Money Laundering – FTZs are misused to aid in money laundering due to the relaxed oversight by the domestic authorities and a lack of adequate coordination between the customs officials.► Customs Fraud – officials alter trade certificates to change the country of origin of goods.

Furthermore, the incentives FTZs offer only match export-oriented business models. In a specific case, an industrial components assembler initially set up in Waigaoqiao. Over the course of five years, their target market changed from Europe to South East Asia, and eventually they decided to concentrate solely on China. Now that they did not export anymore, the incentives Waigaoqiao offered became redundant, resulting in higher costs for the company.

Waigaoqiao in particular lags behind in developing an electronic customs clearance system, which is a key element of trade. Customs have to track imports piece-by-piece, with separate books for bonded and non-bonded imports, and check the physical books with each import and export. This is cumbersome, paper-intensive and time consuming.

The decision of where to locate in China highly depends on your business scope and future market expansions your company wants to pursue. Before jumping into a FTZ, here are some important factors to consider: ► What kind of products does my company handle? Small electronics may be more suitable than large, heavy machinery because available land is limited. ► Is the FTZ favourable towards my industry? Waigaoqiao has many technology residents such as Intel, HP, Philips and Lenovo. ► Is my business scope concentrated on export only or will my future target market be in China? China revenue comprises over 10% of global revenue for many European companies in China.► Perhaps an Export Processing Zone or a High-Technology Industrial Development Zone is more suitable? Different zones offer their own incentives depending on their specialties.

For advice on the most suitable location and structure for your China business, send an enquiry to contact@fiducia-china.com.

expect industry consolidation to further accelerate. In order for international players to enter or further expand in the Chinese market, organic growth will be challenging given increasing cut-throat competition from domestic manufacturers creating a bottleneck, particularly for the mass low-end market. This situation is further intensified by the government’s attempts to restrict the number of industry players.

Product quality and niche application focus are more impor-tant than ever in order to differentiate in a consolidating mar-ket. For a more aggressive approach, we recommend merging with or acquiring a Tier 2/Tier 3 company to take advantage of existing production capabilities and local networks. The con-trolling company should promote new technology, R&D and training to optimise processes in their Chinese operations.

Snapshot: AbrasivesAbrasives, used to give products a finish such as a polished look, are one of the most widely applied power tool accessories. The total abrasives market reached RMB7.7b in 2011. However, the value development of China’s overall abrasive market in past 5 years was flatter than the power tools market because of overcapacity and intense competition driving down single product price significantly.

it comes to applying or renewing their visas. The motto seems to be: “People get away with it all the time.” Many workers on China business trips hold tourist visas, and those who work full-time in China use business visas instead of legal working permits and just enter and exit to Hong Kong every once in a while.

Beijing is now cracking down on this care-free attitude – local police are swooping into bars popular among foreigners to check identification. Therefore, to avoid being on the wrong side of the law, all foreigners and foreign companies in China should adhere to these basic rules:► Never do business in China with a tourist visa;► Make sure no employees working in your office in China carry a tourist visa, may it be own staff, interns or business partners. Even if they are here for only one day, your company will be responsible in case of an investigation;► For any activities that are effectively paid employment in China, apply for a work permit.

Local spot checks in offices are rare, but may happen: cases have been reported in which disgruntled former employees or competitors tipped off the local police on a company that has not followed the visa rules.

Harsher penalties for illegal workersHow does this development fit in with the new immigration law? Major changes are that penalties for violations are now clearly specified and can reach up to RMB 100,000 per illegally employed person for the company. Furthermore, any gains from the illegal employment can be confiscated. Individuals face up to RMB 20,000 fine for working illegally, plus detention for up to 15 days. Additionally, they can be deported to their home countries and banned from entering China for 5 years.

Policies in favour of foreign workersApart from these provisions, the law also contains some interesting developments in favour of foreign companies. It includes a new visa category for “talented” individuals which is designed to make it easier for people with professional skills to obtain work permits for China. The specific requirements will be outlined later by the relevant authorities.

The new law was passed during a recent meeting of the People’s Congress but will only come into effect on July 1st 2013, thus allowing enough time to arrange for compliance. It is evident that China is trying to encourage certain categories of foreign investment; it can now identify areas with a lack of skill set in the local workforce and attract the right foreign workers with a policy of preferential treatment.

CHINA FOCUS • Jul/Aug 2012 • 3 of 4of China Insight

Tough Stance on Visa Policy and The New Immigration Law

“China Eases Taxes for Foreign Companies” – Fact or Fiction?

Major international newspapers have recently reported that China is easing withholding tax for foreign companies by up to 50% to encourage more investment from overseas. This will also apply to dividends Chinese listed companies pay to foreign shareholders through the

China has recently started a 100-day campaign against foreigners working illegally and overstaying on their visa. At the same time a new immigration law has been passed that imposes stricter sanctions on companies who employ foreign workers.

Zero tolerance on ALL Chinese VisasSome foreigners in China take a rather relaxed approach when

Having too many visa stamps on your passport may arouse suspicion.

Qualified Foreign Institutional Investor Scheme. By this, can companies potentially save billions of dollars’ worth of tax payments? Naturally more foreigners will invest in China and this could possibly boost an economy that has achieved lower growth than expected.

Due to the direct impact this could have on our clients, Fiducia has immediately investigated this situation with the State Ad-ministration of Taxation and uncovered the following updates:► There is no change to the PRC Corporate Income Tax (CIT) Law.► For holding companies of a WFOE, there is a reduced rate of 5% withholding tax on dividends for some jurisdictions with a DTA – in order to enjoy the beneficial rate, the holding companies need to prove to the Chinese tax authorities that they are “of substance”, meaning that they have real business operations.► For listed companies or holding companies that are directly held by a listed company, it is now automatically assumed that the company is of substance.► For listed companies and their subsidiaries, it is now easier to profit from the reduced rate.► China has signed several tax treaties which offer 5% withholding tax for dividends with Hong Kong, Macau, Singapore and the Republic of Seychelles only.► In order to enjoy the benefits of the tax treaty, companies should pay withholding tax of 10% prior to applying the tax treaty benefits – in practice, the procedures to execute this are still quite complicated.

In conclusion, “China eases taxes for foreign companies” does not apply to all foreign companies in China. There must be specific requirements, and companies may have to go through extensive approval procedures before this applies. To learn more about this topic or taxation in China in general, email contact@fiducia-china.com.

CHINA FOCUS • Jul/Aug2012 • 4 of 4

For previous issues and newsletter subscription: www.fiducia-china.comPublisher: Fiducia Management ConsultantsEditor & contact for press and article reprints: contact@fiducia-china.com

All liabilities excluded. This newsletter is based on information obtained from sources (govern-ment, business associates, companies, publications, etc.) we believe to be reliable. However, Fi-ducia Management Consultants does not take any responsibility as to its accuracy, completeness or correctness. Copyright © 2012 Fiducia Ltd. All rights reserved. Protected by copyright laws.

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of China Insight

UPCOMING EVENTS

18/19 September Nuremberg“Establishing Successful Companies in China and Hong Kong” and “Understanding Chinese VAT and Implications of the New Vat Pilot Reform”Chairman Jürgen Kracht and Project Manager Hannes Basten will advise on precautions to take to protect yourself when opening a new subsidiary in China. They will also present China’s sales tax laws and how you can work with the tax authorities efficiently and safely.

20 September SuzhouYangtze River Delta SME SummitThis DUSA European Association main event, in con-junction with the European Chamber of Commerce, will have high profile speakers from various business areas focus on emerging opportunities and threats for small- to mid-sized companies in the YRD region. Managing Director Stefan Kracht will cover “The Chinese Golden Era of Consumption”, how China is shifting to a consumption-driven economy and its implications.

21 September TianjinAustria ConnectAustria Connect is an annual 3-day conference that is not only a chance for Austrian companies in China and Hong Kong to implement new ideas, but also a plat-form to share current issues to help achieve goals, set priorities and solve problematic tasks related to China business. Managing Director Stefan Kracht is invited to speak about “China 2030: Strategic opportunities for Austrian Companies to best position themselves”.

26-27 September Munich“Hong Kong: The Dying Glamorous City”After the 1997 handover, the German newspaper Bild proclaimed the Hong Kong market will not perform well in the near future. 15 years later, this statement has been proven wrong. This full-day seminar held by InvestHK in partnership with Chinaforum Bayern and DCW discusses the successful development of Hong Kong as one of the world’s leading markets. Associate Director Thaddaeus Mueller will discuss about the chal-lenges that businesses face in order to become success-ful and his views on the HK/PRC market as it is today.

FIDUCIA 30TH ANNIVERSARY

Contain Yourself in 5-Star LuxuryLooking for a unique vacation experience? A revolutionary hotel called “Xiang Xiang Pray House”, located in Nan Dazhan Cun, a rural village on the outskirts of Changzhi city in Shanxi Province is a 5-star hotel made out of 35 new shipping containers – yes, shipping containers.

The hotel has 21 guest rooms in two different container sizes and a 2.59 metre high-ceiling with windows on the side and roof to ensure sufficient comfort lighting. Each room is also fitted with traditional Chinese decoration and high quality furniture. Main facilities include a lobby, restaurant, function rooms and patio areas where guests can enjoying tea ceremonies accompanied by live traditional Chinese music.

This one-of-a-kind luxury living is inspired by the containers imported from China as temporary houses for earthquake survivors during the 2011 tsunami disaster in Japan. Taking only three months to design and install, the container rooms can be easily transported to another location. The hotel is also eco-friendly – it uses environmental water paint; construction saved approximately 60% water and concrete consumption, and produced only 30% of normal construction waste.

We recently held 3 events in Hong Kong, Shanghai and Munich to celebrate our 30th anniversary milestone. We’d like to share with you some unforgettable moments – photos as well as videos are now available to view, please go to our main page www.fiducia-china.com where you can access the media site.

(Pictures: Tonghe Shanzhi Landscape Design)