Nicole Zhang, Eric Zhou and Bin Yang of KPMG China take a deeper look at Hainan’s attractive tax programme to entice investors.
China’s central government released a master plan on June 1 2020, setting out policies to support the construction of the Hainan Free Trade Port (Hainan FTP). This has the aim of building Hainan island, on the southern coast of China, into a globally-significant free trade port by 2050.
The policies will be rolled out in several stages and is supported by a series of tax and legal system changes. The tax policy element is summarised in the master plan as consisting of “zero-tariffs, low tax rates, a simplified tax system, and an enhanced legal system”.
In this article, the authors look at the building blocks of Hainan’s innovative tax regime and the attractions for investing businesses.
Zero-tariff regime to build up a base for free trade
The zero-tariff regime will be established by 2025 across two stages. In the first stage (pre-2025), certain categories of imports are entitled to zero-tariff treatment to support the development of the tourism, e-commerce and logistics industries in Hainan FTP. Zero-tariff treatment covers equipment imports made by Hainan enterprises for their own use (subject to a negative list), and imports of vehicles, vessels and aircraft used for transportation and tourism in Hainan (with reference to a positive list). A duty-free shopping regime will also be in place.
In the second stage (from 2025), a separate tariff regime will be developed for Hainan FTP, meaning that zero-tariffs will apply to a wide range of imports based on a catalogue system. Import VAT and consumption tax (CT) exclusions may also apply.
Integration of Hainan FTP into global value chains
One notable difference between the Hainan FTP and other customs special supervision zones in China is its special import processing policy. Under this, goods can be imported zero-tariff to Hainan, processed in Hainan, and then sold to elsewhere in China at zero-tariff. This provides significant access to the Chinese market and opportunities for supply chain optimisation.
A key requirement is that the processing conducted in Hainan needs to meet a 30% value-added threshold and that a ‘Hainan Origin Certificate’ is obtained for goods. The government intent with this policy is to support the establishment of high-end industries in Hainan, fully integrated into global value chains.
Low tax, simplified tax system to attract investment and highly skilled people
One of the highlights of the Hainan FTP plan is the low corporate income tax (CIT) and individual income tax (IIT) rates. Specifically, for the period to 2025, a reduced 15% CIT rate applies to enterprises registered in Hainan FTP, engaged in listed “encouraged industries” and conducting substantive business activities; for reference the standard China CIT rate is 25%.
Moreover, the foreign dividend income received by in-scope Hainan FTP enterprises, and their foreign branch income, will be exempt from CIT – a significant attraction for setting up hubs for global and regional operations in the Hainan FTP. Alongside this, the IIT exemption is designed to produce a maximum 15% IIT rate for income of personnel with high-end and urgently-needed skills, working in the Hainan FTP; for reference China’s marginal IIT rate is 45%.
The tax reform will be widened from 2035 so that the 15% reduced CIT rate will cover all Hainan FTP enterprises which are not in a ‘negative list’ sector, i.e. the incentive will move beyond encouraged industries. The IIT regime will also be expanded to all individuals residing in Hainan for more than 183 days in a tax year levied at 3%, 10% or 15% rates. That is, the IIT incentive scope will go beyond those with particular skillsets.
International benchmarking
Compared with the existing mature free trade ports around the world (see Table 1), it can be seen that the 15% income tax rate makes the Hainan FTP internationally competitive.
It is expected that this will attract foreign investors and highly skilled foreign individuals. Furthermore, as the Hainan FTP tax policies are innovative and go well beyond those on offer in China’s existing pilot free trade zones (FTZs), a large number of Chinese enterprises and high-end staff will likely flock to Hainan as well.
| Table 1: Tax policies in the Hainan FTP and other international FTZs | |||||
| Hainan FTP (Overall plan) | China Mainland (non-FTZs) | Hong Kong SAR | Singapore | Dubai | |
| Corporate income tax (CIT) | (1) Before 2025: 15% for encouraged industries; CIT exemption for foreign-sourced income received by enterprises in the tourism, modern services and high-tech industries (2) Before 2035: 15% | 0-25% | 0-16.5% | 0-17% | (1) Within FTZ: CIT exemption for 50 years (2) Outside FTZ: 20% for foreign-invested banks, 55% for oil and petrochemical companies, and exemption for others |
| Individual income tax (IIT) | (1) Before 2025: 15% for personnel with high-end and urgently-needed skills (2) Before 2035: 3%, 10% and 15% excess progressive tax rates for individuals who resident in Hainan FTP for more than 183 days in a tax year | 0-45% | 0-17% (progressive tax rates) | 0-22% (progressive tax rates) | (1) No IIT; (2) 5% social security tax for Dubai residents who have UAE citizenship |
| Tariff | (1) Zero-tariffs for certain equipment, vessels, and duty-free shopping (first stage to 2025); (2) At the second stage (after 2025) the new Hainan FTP customs system will provide for wide zero-tariff treatment and turnover taxes will also be simplified | Majority of imports are subject to tariff at different rates | Tariff exemption for goods except for alcohol, tobacco, hydrocarbon oil and methanol | (1) Within FTZ: tariff exemption for all goods (2) Outside FTZ: tariff exemption for goods except for alcohol, tobacco products, motor vehicles and petroleum products | (1) Within FTZ: tariff exemption for all goods (2) Outside FTZ: 50% for alcohol, 100% for tobacco products, and 5% for others |
| Consumption tax (CT) and excise taxes | Tobacco, alcohol, cosmetics, jewellery, petrol and auto products subject to CT | N/A | (1) Within FTZ: CT exemption for all goods (2) Outside FTZ: CT exemption for goods except for alcohol, tobacco products, motor vehicles and petroleum products | (1) Within FTZ: CT exemption for all goods (2) Outside FTZ: 1) 100% for cigarettes and tobacco, 2) 30% for alcohol | |
| VAT | 9% for some consumer goods; 13% for others | N/A | (1) Within FTZ: VAT exemption for all goods (2) Outside FTZ: 7% | (1) Within FTZ: VAT exemption for all goods (2) Outside FTZ: VAT exemption for crude oil and natural gas, transportation sector and certain segments in education, healthcare and real estate sectors; 5% for others | |
| Source: Public information collated by KPMG | |||||
The ‘encouraged’ industries enjoying the 15% CIT rate have recently been clarified by the Chinese Ministry of Finance (MOF) and State Taxation Administration (STA). This refers to sectors listed in the ‘Guiding Catalogue for Industrial Structure Adjustment’ (2019 edition), the ‘Catalogue of Encouraged Industries for Foreign Investment’ (2019 edition) and a new Hainan-specific list.
At present, Hainan’s economy is dominated by traditional services industries. Sectors such as finance, insurance, logistics, legal service, tourism have further potential for expansion. To push these along the Hainan-specific list is expected to include various ‘modern service’ sectors, tourism, and healthcare, etc. The Hainan government recently clarified the scope of personnel with high-end and urgently needed skills. This covers a wide range of skills relevant to building up the encouraged industries in Hainan FTP, including high-tech, agriculture, medical, education, telecommunication sectors.
Although a simplified tax system is a common feature of international FTPs, the plan points out that the simplification is in line with the trend of general tax reform in China, i.e. reducing the proportion of indirect taxes. Therefore, it is safe to say that the simplified tax system may also be the direction for future tax reform in mainland China.
Legal system improvements and substance requirements
The roll out of the reduced tax rates does not imply that Hainan island is to be made into a tax haven. Access to the preferential tax treatments requires that substantive economic activities occur in Hainan and that significant value is created there.
A recent MOF and STA circular has set out detailed rules defining substantive operations. The enterprise’s management body must be established in the Hainan FTP and exercise real control over business operations, staff, accounting, assets, etc. These requirements prevent the use of shell companies to access preferential policies and will be accompanied by a tax administration risk monitoring system, and paralleled by Chinese authorities proactively participating in international tax cooperation and information exchange.
Looking ahead
China’s Hainan FTP construction has kicked off. The preferential tax policies introduced are in line with international FTP practice. The zero-tariff regime also marks a milestone in China’s tax reform and innovation, which is conducive to China’s participating in global trade and attracting foreign investment. The Hainan FTP is also a testing ground for tax policies that may be adopted in other China FTZs and more generally; precisely how this proceeds remains to be seen.
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