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Investors In Chinese Real Estate Continue To Face Tax And Accounting Challenges

by Mary Swire,, Hong Kong

02 August 2007

Despite measures by the Chinese government to temper the market, the China real estate market continues to be a significant investment opportunity for both domestic and foreign investors. However, amid the vast business and investment opportunities, the special characteristics governing the accounting and taxation of China's real estate market pose a number of challenges to investors, according to business and tax advisors, Deloitte.

Speaking at a press conference to launch Deloitte China's Real Estate Investment Handbook last month, Deloitte China's Southern China Regional Managing Partner, Mr. Kester Yuen said: "Driven by the continuous growth of the Chinese economy, rapid pace of urbanization, the upcoming 2008 Olympic Games and 2010 Shanghai World Exposition, the China real estate market is proving to be a significant investment opportunity for both domestic and foreign investors. In fact, the biggest and quickest price growth in China is currently being seen in the Southern region, where prices in Shenzhen jumped 14.2% in May following a 12.8% increase in April. Beijing and Shanghai on the other hand recorded increases of 9.6% and 0.6% respectively in May."

Deloitte noted that domestic demand has been spurred by rising incomes and the influx of an estimated eight million people to the cities. Although domestic and Asia-based investors traditionally have been the dominant investors in China real estate, US, European and, most recently Middle Eastern, investors are emerging as active buyers.

Mr. Yuen said: "The Handbook has been prepared as a resource for investors, investment advisors, fund managers and others participating in the real estate industry to provide guidance to assist the planning or maintaining of real estate investments."

Deloitte China's Real Estate Industry Practice Leader, Mr. Richard Ho cautioned: "There are many issues which investors in the China real estate market must consider and plan for, especially in the areas of accounting and taxation, which can make a significant difference in the net return on their China real estate investment. That is why we have subtitled our Handbook The details that make a difference."

The Handbook highlights the main issues faced by institutional investors, namely transparency, the legal system, the transaction process, valuation criteria, repatriation of capital and profits, and limited liquidity.

Mr. Ho said: "Most existing and prospective investors know or at least have an idea that the regulatory framework of China's real estate market, while developing rapidly, is still very young compared to other developed markets such as North America or Western Europe. However, understandably, there are many compelling reasons to invest in China’s real estate market and thus the challenge is to understand, anticipate and be able to navigate through the complexities. These really can be the "make or break" for foreign investors in China real estate. "

Challenges faced by foreign institutional investors include the latest tightening measures and recent developments in the new Partnership Law, the new China Generally Accepted Accounting Principles (GAAP), and tax reform.

Ms. Nancy Marsh, Deloitte China's Real Estate Tax Leader, said: "Taxation certainly ranks as one of the major challenges facing institutional investors. There are various taxes of which China’s real estate investors must be aware, such as Business Tax, Deed Tax, Urban Real Estate Tax, Urban and Township Land Use Tax, Stamp Duty and Enterprise Income Tax. However, the biggest challenge is presented by the Land Value Appreciation Tax (LAT) which is imposed on the taxable gain derived by companies and individuals from the transfer of real properties in China. The LAT is the most controversial tax in the real estate industry, not only because of its high rate, but also due to inconsistencies in local enforcement and calculation methodology. However, the challenges for real estate investors are counterbalanced by other measures. Currently the applicable income tax rate is 33% for most real estate companies, but this is expected to be reduced to 25% from January 1, 2008 including possible changes in withholding tax rates."

Mr. Anthony Tam, Deloitte's Southern China Deputy Managing Partner for Tax, said: "With the growing trend for mergers and acquisitions in China, it is also important for foreign investors to recognize that Chinese financial statements usually do not provide as much information as they might be used to receiving. There may not be enough detail to measure business performance or to form a basis for valuation and price determination in an acquisition. Therefore it is important that buyers perform their own financial and tax due diligence review before acquiring a Chinese target."

In conclusion, Deloitte advises that careful accounting and tax planning is critical in avoiding the unexpected traps that could wipe out an otherwise high return. Tax planning must also continue throughout the lifecycle of a real estate investment project as circumstances and tax rules have a habit of changing over time.

Deloitte China has a strong track record as a professional services provider to foreign and domestic clients in China's real estate sector. It audits more than one third of the property development and construction companies listed on the Stock Exchange of Hong Kong. In closing, Mr Ho said: "This Handbook draws on the insights that we have gained from our annual surveys of Hong Kong developers' real estate investment strategies as well as our professional experience of serving real estate sector clients. We will issue updates to this Handbook as and when necessary."

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