For decades, it has been common practice that local governments attract investors by offering them various financial incentives mostly in the form of subsidies. Such incentives include reduced prices for land use rights and return of parts of the granting fees paid, return of such parts of taxes which stay on the local level, etc. They are usually agreed in investment agreements concluded between the local government and the investor. Legally speaking, such arrangements were always in a grey area.

Already in 2000 the PRC State Council (“State Council”) had issued the Circular on Rectification of Policies of Tax Rebates Privately Formulated by Local Governments stating that tax rebates by local governments are not allowed. However, in order to attract new investment, all local governments ignored such attempts of the Central Government to rule them in and continued their practice. What was changed was only the name, i.e. calling the payments not “pay back” or “return”, but “subsidy”. It seems that with the arrival of the policy of “New Normal”, this practice is about to end.

  1. On 24 March 2015, the PRC Ministry of Finance suggested in its statistics report on revenues of national-wide land granting for the year 2014 that all preferential policies related to land granting, including but not limited to “payment in full amount first and then getting return”, shall be cancelled.
  2. On November 27, the State Council issued the Circular on Cleaning up and Standardizing Preferential Policies on Tax and Other Aspects (“Circular No. 62”). Circular No.62 aims at comprehensively standardizing the preferential policies on tax and other aspects and creating a fair market competition environment. According to Circular No. 62, all preferential policies in violation of the laws and regulations or affecting fair competition shall be either abolished or revised. Affected shall not only be preferential policies on tax, non-tax and other income, but also preferential policies on fiscal expenditure linked to tax payments by enterprises and non-tax revenues of local governments.

After issuance of Circular No. 62, it was reported that a number of large-scale investment projects, especially in central and western regions of China, had to be stopped due to lack of certainty on the implementation of agreed preferential policies. There was great uncertainty what will happen with agreements promising financial incentives which were concluded in the past and calls for clarification and transitional arrangements.

  1. In response to this, the State Council issued the Circular on Matters Relating to Preferential Policies for Tax and Other Aspects (“Circular No. 25”) on 10 May 2015, which took effect on the same day. We highlight below the key contents of Circular No. 25.

(1) Preferential Policies agreed before effectiveness of Circular No. 25

  • For preferential policies that have been agreed by local governments before 10 May 2015, if there is a validity period for such preferential policies, such preferential policies shall be implemented within the validity period. In case no validity period has been stated, and it is indeed necessary to adjust such preferential policies, the local governments shall set a transitional period and continue to implement such preferential policies within the transitional period.
  • Preferential policies contained in agreements concluded between local governments and investors before 10 May 2015 shall remain in force and already granted incentives will not be claimed back, i.e. Circular No. 62 does not have retroactive effect.

(2) Direction on New Preferential Policies which can be agreed after effectiveness of Circular No. 25

  • Any new preferential policies that will be granted by local governments involving taxation or non-tax income are subject to the approval by the State Council before implementation, unless otherwise provided in laws and administrative regulations.
  • Other preferential policies, including incentives which are not liked to taxes paid by an enterprise or non-tax income of the local government are subject to the approval by the local government.

(3) Arrangement on Cleaning Up under Circular No. 62

  • Ceasing and adjustment of preferential policies as stipulated under Circular No. 62 were suspended and will be resumed subject to later arrangements. Circular No. 25 does not provide for a specific timeline for implementation of the later arrangements.

In summary, Circular No. 25 provides for a grace period for local governments and investors to gradually adjust to the stipulations of Circular No. 62. Preferential policies agreed before 10 May 2015 can continue to be implemented and already granted incentives will not be claimed back. I.e. Circular No. 62 does not have retroactive effect. However, in the future local governments are no longer allowed to provide financial incentives which are financed by taxes or nontax income. Strictly speaking, this should mean the end of agreements with local governments promising refund of part of the taxes paid or part of land use right granting fees.

However, it remains to be seen whether and how local governments will indeed comply with these new Circulars. The fact that implementation of Circular No. 62 has been suspended for the time being indicates some level of resistance of local governments.

In any case, foreign investors are well advised not to rely on the payment of financial incentives promised under agreements concluded with local governments without clear legal basis and not in line with the guidelines set by Circular 25 after 10 May 2015 when doing their financial planning and budgeting.