• by Erik Sass  @eriksass1, January 2, 2007

Anyone who's interested in advertising in China should pay attention to the parliamentary proceedings that began Sunday, which are set to enact a new law leveling the playing field for taxation between domestic and foreign companies. The legislation doesn't address advertising or media agencies specifically, but its impact will be far-reaching. The tax law goes into effect in 2008.

Since the 1990s, tax laws have been deliberately skewed to favor foreign companies to attract investment. While successful, these laws are viewed as unfair by Chinese companies. According to China's official Xinhua News Agency, foreign companies pay about 14% tax on corporate profits; Chinese companies pay about 24%. The new law would create a "unified" tax of 25% on corporate profits across the board, with foreign and domestic companies assessed the same way.

Foreign-funded companies paid about $80 billion in taxes in 2005, representing just over one-fifth of China's total tax revenues. U.S. business is one of the biggest contributors.

In 2006, China was the fourth-largest export market for the United States--buying about $50 billion of U.S. goods and services--and U.S. firms are on course to turn about $4 billion profit in 2006. Under the current tax regime, that means U.S. firms will pay about $560 million; but if the new law were in effect, that number would jump to $1 billion.

Will the new tax law make it harder to do business in China?

Companies that look to China chiefly as a market are more likely to suffer, but that's not necessarily bad news for advertisers and media planners in China. U.S. exports to China tend to be divided into very high-tech merchandise, such as medical equipment and components for nuclear reactors--and very low-tech agricultural and industrial goods, such as beef, wheat, chemicals and steel. Because these companies don't make much use of advertising, higher taxes are unlikely to have a major impact on media planning in China.

The catch: new corporate tax law could put the squeeze on media planners' biggest clients in China--American companies with substantial retail operations that are usually supplied by in-country manufacturers. For example, Procter & Gamble not only relies on cheap Chinese labor but also has big sales in China, accounting for $2 billion or 3.5% of P&G's $57 billion in global sales in 2005. With companies like P&G, advertising and media agencies could be hit with a double whammy--they could be taxed at a higher rate themselves, and the profit margins of the companies they represent may shrink, too.

But the threat to consumer-goods companies also presents a major opportunity for advertisers and media planners. Middle-class Chinese are very brand-conscious, with a marked preference for foreign brands in categories including packaged-goods, consumer electronics, computers and automobiles. These brands are unlikely to abandon China's loyal consumers simply because of higher taxes. More likely, they will shift advertising into high gear to consolidate their position as quality leaders, compared to less prestigious domestic brands.

P&G has already proved to be tenacious in the face of adverse conditions that are far more capricious than tax law. Earlier this month, it resumed sales of SK II, a high-end cosmetics product, after the Chinese press publicized allegations that it contained toxic chemicals. Although P&G stands by the brand and the Chinese government has conceded that the products are harmless, it will almost certainly require a large-scale PR and advertising effort to repair the damage from these unsubstantiated rumors.

For retailers such as Wal-Mart, it's a twofold wallop. Wal-Mart uses Chinese manufacturers as a source of cheap goods, and also runs retail operations there. The first concern far outweighs the second. Wal-Mart's Chinese retail operation had sales of about $1 billion in 2005, while the company's Chinese imports to the U.S. were valued at $18 billion. And those goods were sold in the U.S. for over $150 billion, contributing to an operating profit of about $10.2 billion.