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RR RUEHCN RUEHGH
DE RUEHGH #0065/01 0360155
ZNR UUUUU ZZH
R 050155Z FEB 09
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7608
INFO RUEHBJ/AMEMBASSY BEIJING 2488
RUEHCN/AMCONSUL CHENGDU 1727
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFIUU/DEPT OF JUSTICE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHGZ/AMCONSUL GUANGZHOU 0183
RUEHHK/AMCONSUL HONG KONG 1894
RUEHML/AMEMBASSY MANILA 0050
RUEHUL/AMEMBASSY SEOUL 0362
RUEHGH/AMCONSUL SHANGHAI 8238
RUEHSH/AMCONSUL SHENYANG 1716
RUEHGP/AMEMBASSY SINGAPORE 0224
RUEHIN/AIT TAIPEI 1517
RUEHKO/AMEMBASSY TOKYO 0532

UNCLAS SECTION 01 OF 02 SHANGHAI 000065 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM, DAS DAVIES 
TREASURY FOR AMB HOLMER/WRIGHT/TSMITH 
TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP/CUSHMAN 
TREASURY FOR IMFP -- SOBEL/MOGHTADER 
USDOC FOR ITA DAS KASOFF, MELCHER, MAC/OCEA 
NSC FOR WILDER/LOI 
STATE PASS CEA FOR BLOCK 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN 
STATE PASS CFTC FOR OIA/GORLICK 
 
E.O. 12958: N/A 
TAGS: CH ECON EFIN KTIA PREL
SUBJECT: (SBU) NEW TAXES HIT FOREIGN FINANCIAL FIRMS 
 
¶1.  (SBU) Summary.  Foreign banks based in China could see their 
cost of foreign funding rise by 15 percent this year as a result 
of recent Chinese tax changes, said a partner in a leading tax 
accountancy firm's Shanghai office.  Foreign banks have lobbied 
for exemptions, but so far have not been successful.  The new 
tax regulations most likely will put foreign financial 
institutions at a competitive disadvantage, said our contact, 
but they are unlikely to sour on the China market and instead 
will attempt to pass the new costs on to their customers.  In 
addition, Shanghai is quietly offering incentives to attract 
financial firms to boost Shanghai as China's financial center. 
Shanghai's tax collectors are more "open minded" than those in 
second-tier cities, said our contact.  End summary. 
 
============================ 
Beijing Closing Foreign Banks' Tax Loopholes 
============================ 
 
¶2.  (SBU) Foreign banks based in China could see their cost of 
foreign funding rise by 15 percent this year as a result of 
recent Chinese tax changes, Deloitte partner Johnny Foon (please 
protect) told Econoff on February 4, 2009.  First, China-based 
financial institutions now owe a 10 percent withholding tax on 
the interest paid to overseas lenders.  Second, although less 
certain, China-based financial institutions may be required to 
pay a 5 percent business tax on the full interest paid to 
overseas lenders. 
 
¶3.  (SBU) Foreign banks over the past year have lobbied Chinese 
tax authorities to be exempted from the 10 percent withholding 
tax on interest, but in November 2008 were turned down, said 
Foon.  The withholding tax became a problem for foreign banks 
with the unification of the corporate income tax code last year, 
when a previous loophole was closed.  (Note:  Before January 1, 
2008, the average applied corporate income tax rate for 
foreign-invested companies was 15 percent, and that for domestic 
firms was 25 percent, according to a People's Daily article. 
These rates are now unified at 25 percent.  The withholding tax 
of 10 percent is imposed on cross-border transactions that 
otherwise would not be subject to corporate income tax.  End 
note.)  Following the November decision, corporate taxpayers are 
liable to pay the withholding tax retroactively to January 1, 
¶2008.  Localities are currently negotiating with foreign banks 
and other companies that owe this tax -- Shanghai, for instance, 
is considering delaying payments until February 19. 
 
¶4.  (SBU) As for the 5 percent business tax on interest, to date 
Chinese tax authorities have not clarified whether China-based 
financial institutions are liable for the full amount, said 
Foon.  The new business tax implementing regulations were issued 
in November 2008 and became effective on January 1, 2009, he 
explained.  Under them, foreign banks are probably liable for 
business tax not just on the net interest (the difference 
between the lenders' cost of funds and the interest charged to 
borrowers in China), but on the gross interest, said Foon. 
Chinese officials will not accept calculations of net interest, 
because they do not have access to the lenders' accounts to 
verify the original cost of funds, said Foon. 
 
¶5.   (SBU)  However, to date, Foon knows of no local tax 
authorities that are attempting to collect the business tax on a 
gross interest basis.  One bank client informed him that on 
February 3, the Shanghai tax bureau called informally to ask the 
bank to pay the business tax; calls by Deloitte to other bank 
clients revealed that no other banks have yet been contacted to 
do so, said Foon.  Since banks pay business tax on a quarterly 
basis, it could be that local tax authorities are biding their 
time on the issue, said Foon. 
 
 
SHANGHAI 00000065  002 OF 002 
 
 
============================ 
New Taxes Disadvantage Foreign Banks . . . 
============================ 
 
¶6.  (SBU) The new tax regulations most likely will put foreign 
financial institutions at a competitive disadvantage, said Foon. 
 China-based foreign banks depend heavily on funding from their 
overseas affiliates, so any increase in the tax rates on funding 
from overseas will hit foreign banks harder.  In Foon's opinion, 
the 15 percent tax rate (if both taxes are implemented) that 
foreign banks would pay on the gross interest rate for foreign 
funds would outweigh the 25 percent corporate income tax that 
local banks pay on the net interest rate for local funds.  In 
addition, the margins for interbank lending are very tight, so 
the new taxes could easily outweigh the profits an overseas 
lender would earn from the transaction. 
 
============================ 
. . . But Beijing Calculates Foreign Banks Will Absorb the Costs 
============================ 
 
¶9.  (SBU) Foon said that Chinese officials have determined that 
the new taxes will not deter foreign banks from expanding in the 
China market.  In the process of unifying the foreign and 
domestic corporate income tax rates, Chinese economic officials 
had studied the issue of how much tax increases foreign firms 
could bear.  They concluded that tax advantages were not the 
major draw for foreign firms, but rather the promise of the 
large, rapidly growing domestic market.  Foon said that his 
foreign bank clients intend to defray the burden of the new 
taxes by passing them on to customers.  In addition, foreign 
lenders may be able to offset the 10 percent withholding tax by 
claiming it as a deduction in their home tax jurisdiction under 
double-taxation treaties. 
 
============================ 
Tax Incentives under Shanghai's Plan to Become a Financial Center 
============================ 
 
¶10.  (SBU) Another mitigating factor for foreign financial firms 
may be incentives offered by Shanghai as it seeks to solidify 
its position as China's international financial center. 
However, Foon explained that Shanghai's plan to offer tax and 
other incentives to financial firms in order to build up 
Shanghai as a financial center is complicated by the city's 
taxation system.  Shanghai centralizes all taxation by sector at 
the municipal level.  Therefore, Pudong, where Shanghai's famed 
Lujiazui financial area is located, does not have the authority 
to offer tax breaks to financial firms, despite making offers to 
do so.  Financial firms complained about this to the Shanghai 
Municipal Financial Affairs Office, and this past fall that 
office quietly began negotiating various incentives on an 
individual firm basis, said Foon. 
 
============================ 
Observations on Shanghai's Tax Authorities 
============================ 
 
¶11.  (SBU) Shanghai's tax collectors are more "open minded" than 
those in second-tier cities, said Foon.  For instance, Shanghai 
officials will actively consider the arguments made by Deloitte 
tax consultants regarding interpretations of the tax code.  In 
the smaller cities, officials are much more focused on revenue 
targets: if revenues are running above target, companies will be 
asked to delay tax payments until the following year; if behind 
target, companies will be subject to hostile audits and large 
fines. 
CAMP