China’s Service Sector at a Glance

Investment opportunities for foreign-owned companies

Over the past four decades, China’s economic growth was driven mainly by the manufacturing sector, which benefitted from an enormous low-cost labour pool as the country opened to export markets. Now, as labour and land costs rise and its workforce becomes increasingly well-educated, China is transitioning from a manufacturing-heavy economic model to a services-led one. Ines Liu of Dezan Shira looks at the investment opportunities available as a result in Beijing for foreign-invested companies amid this transition.

A country’s gross domestic product (GDP) is contributed to by three main sectors; agriculture as the primary industry, construction and manufacturing as the secondary industry, and services as the tertiary industry. In China, according to government data, in 2013 the primary industry accounted for 10 per cent of GDP, the secondary industry 44 per cent and the tertiary industry 46 per cent. Looking at those same sectors in 2020, services now account for 54 per cent of GDP and contributes 60 per cent of China’s total economic growth.

China’s 14th Five-year Plan (2021–2025) is promoting the development of and access to the country’s service sector in general, which is a positive indicator for foreign investors. There is little doubt that, in 2021, China will continue to prioritise the service sector as a source for innovation and growth. New developments in this sector can give clues as to where investment opportunities lie. 

Beijing has been opening up its service sector for many years now. In February 2017, the local government launched financial incentives and investment to encourage high-value-added service exports. With added value in services contributing 83.5 per cent of provincial GDP in 2019, Beijing has steadily developed a reputation as China’s services hub. In 2020, the local government released reform measures aimed at furthering market access in key service industries, in order to develop a more friendly business climate for foreign investors.

Specific service industries with newly relaxed market assess measures

Beijing is now playing a critical role in spearheading and generating new momentum for China’s future market reform. Several sectors that are carrying out or have undergone market access reforms are as follows: 

1. Science and technology (S&T) services

Beijing is the unicorn[1] capital of China, with 93 registered there by the end of 2020, more than any other top tier city. Meanwhile, around 600 foreign companies have established research and development (R&D) centres in Beijing, including Apple, Tesla, Merck and Mercedes-Benz to name but a few. The Chinese Government also approved the creation of the Beijing Free Trade Zone in 2020, which will feature a S&T innovation centre intended to support the capital’s development as a high-tech, digital services hub.

One of China’s core innovation tax incentives is designed for high and new technology enterprises (HNTEs). Qualifying HNTEs can enjoy a preferential corporate income tax (CIT) rate of 15 per cent, as opposed to the standard 25 per cent. However, foreign companies have reported obtaining HNTE status challenging (due to the overall intellectual property (IP) structure) and many find the excessive documentation requirements in applying for the status burdensome. To enhance its attraction as a high-tech hub internationally, Beijing has stated the application process will be simplified for companies in high-tech service industries, such as integrated circuits, artificial intelligence, medicine and critical materials sectors. On top of that, IP ownership is not required if the company meets the following three criteria:  

  • It has operated in China for more than one year.
  • The company’s annual turnover is more than Chinese yuan (CNY) 20 million.
  • At least 50 per cent of its total R&D expenses were incurred in China.

2. The digital economy and trade sector

In 2019, China opened up market access in industries ranging from elderly care institutions to virtual private networks (VPNs). Foreign telecommunication companies are now permitted to own as much as 50 per cent of VPN provider joint ventures – which is seen as an important step towards improving the cross-border flow of information.

Beijing also announced plans to build a comprehensive demonstration zone to fulfill China’s drive for innovation-based development and further open up its services sector and digital economy. This will involve expanding existing industry clusters and parks, and implementing institutional and supply-side reform, while also promoting the expansion and opening of key industry parks to pull resources and centralise incentives for sectors the government deems a priority. 

In Zhongguancun Science Park (Z-Park), qualified VC corporations will be exempt from CIT on the profits attributable to individual shareholders. These corporations will be treated as a partnership for individual income tax (IIT) purposes; therefore, individual shareholders will be only subject to IIT on dividends from the corporations. The new pilot zone will be a testing ground for new innovative policies that can be replicated and scaled up nationwide.

3. Financial services

From the perspective of widening market access, an important milestone has been reached in the financial services sector: foreign companies can now establish wholly foreign-owned enterprise (WFOE) financial services companies in Beijing. Private equity can launch asset management activities and conduct equity investment; while foreign banks can act as custodians of portfolio investment funds, or as lead underwriter in the inter-bank bond market, and can also obtain gold import licences.

The central government is promoting the implementation of the pilot “separation of business licences from operating permits” programme in Beijing’s financial sector. Officials also called for support for private investors setting up and operating renminbi (RMB)-denominated international investment funds in Beijing, as well as for foreign investment institutions piloting overseas investment by qualified domestic limited partners.

4. Professional services 

Beijing now is open to foreign rating agencies, which can set up subsidiaries and conduct rating business in the inter-bank bond market and the exchange bond market.

Regulations on investment in the culture, tourism, education and healthcare sectors have also been relaxed. Running parallel to these measures, Beijing will also grant preferential IIT treatment to qualified high-end foreign staff working in designated fields, similar to IIT incentives in the Hainan Free Trade Port (FTP) and the Greater Bay Area (GBA) in South China

Institutional innovation and supply-side reform

The remainder of the measures introduced fall into two broad camps:

  • Institutional innovation: denoting measures for restructuring the systems in which businesses currently operate; and
  • Optimising supply factors: referring to supportive measures to boost production factors such as labour, land, capital and data. 

Most notably, Beijing will trial a cross-border service trade negative list management model in specific regions within the municipality, mirroring the national cross-border negative list. These lists specify the level of foreign access to specific markets.

In addition, Beijing will also test out the integration of domestic and foreign currencies – for example, encouraging foreign investors to use domestic foreign-exchange accounts and allowing foreign institutions to conduct foreign-exchange settlement and sales transactions.

Investment outlook of China’s services sector

The central government sees services as not only being key to sustainable economic growth, but also a way to increase competitiveness and cooperation on the international stage. The service industry is unique in that it is depends on many soft labour input factors (such as expertise and innovation) for production.

For this reason, it is widely understood that, for the service industry to grow, it needs an open and transparent business environment that allows cross-border connectivity of information, data, capital and personnel.

Beijing ranked 28th in the World Bank’s 2020 business environment assessment, and is becoming increasingly open, as it looks to establish itself as a favourable destination for foreign investors seeking business opportunities in the service sector. Beijing’s latest Comprehensive Demonstration Zone Work Plan aims to achieve this, and echoes many priorities of the central government – such as relaxing foreign investment restrictions, promoting more convenient cross-border flows of capital, attracting professional talent, securing IP and data protection, and digitalising business processes.

In 2021, with China’s further reduced 2020 Negative List, Beijing will provide an excellent example of how to achieve these goals, and provide the basis for a replicable and scalable model to accelerate reform at a national scale.

Ines Liu is a manager at Dezan Shira & Associates’ Beijing office and a member of the firm’s International Business Advisory team. She advises foreign investors on market entry strategy, corporate structuring, risk management issues, cross-border tax issues, and foreign direct investment-related legal and tax considerations in northern China. Prior to joining Dezan Shira & Associates, Ines acquired extensive auditing and assurance experience working at PwC, and managed investor relations for China-based US IPOs while working at Ogilvy Public Relations Worldwide. She has also practiced in specific areas of auditing, financial and corporate communications, and general accounting and management consulting.

[1] A unicorn is a private start-up company with a valuation over United States dollars (USD) 1 billion.