Beijing (AsiaNews) – At the end of July, the Chinese Ministry of Finance announced, effective immediately, that trusts established abroad by citizens of the People's Republic will be subject to taxation.
This is the first time that China has issued an official directive for these instruments, which have been used for years by wealthy families to protect their assets and plan their inheritances without tax.
From now on, anyone moving assets to an offshore trust will have to declare the income and pay the related taxes, even if they have not yet received it. At stake are hundreds of billions of dollars from mainland China, largely parked in Hong Kong, which recently surpassed Switzerland as the world's leading offshore wealth hub.
Viewed in isolation, the measure may seem like a routine fiscal grab, but seen in the context of recent months, it reveals a more ambitious agenda.
With empty public coffers, it is becoming increasingly hard to raise capital to finance the race for semiconductors and artificial intelligence (AI); for this reason, China has begun to look for financing in the wealth accumulated by ordinary Chinese.
For 20 years, local governments in the People’s Republic have funded themselves by selling land to developers, but the real estate crisis has dried up this source, and revenue generated by these types of transactions has nearly halved in five years.
Signs of distress are coming from every direction.
The National Audit Office reported that even the Bank of China, one of the four state-owned credit giants, evaded taxes amounting to approximately 2.4 billion yuan. The decision to make the news public was seen by many observers as a message.
When the state pillories its own banks in an attempt to recover revenue, it means money is truly in short supply. Meanwhile, after lifting COVID-19 restrictions, more than a million people left the country, often taking their capital with them.
Three fronts to plug the leaks
The state's response is three-pronged. The first is a crackdown on high-income earners.
In the first half of the year, personal income tax revenues grew by 13 per cent, almost eight percentage points more than income, a gap that economic performance alone cannot explain.
Driving the increase are taxpayers with at least ten million yuan in liquid assets, the growth of financial markets, and, above all, much more aggressive tax collection.
Local governments, strapped for funds, are scrutinising undeclared foreign income. Revenue from cross-border income is split between the central government and the provinces, and for struggling regions, that share is increasingly important.
The second front is the closure of capital flight routes. In May, the China Securities Regulatory Commission (CSRC) cracked down on brokerage platforms that allow mainland Chinese residents to trade US stocks.
Three companies based in Singapore and Hong Kong were fined a total of approximately US$ 330 million. One of them is Futu, a giant with millions of customers that offers account opening “in as fast as 3 minutes”.
The timing is surprising, given the strong yuan and the trade surplus, which has reached record levels. The crackdown, therefore, is not intended to defend the exchange rate, but rather has political motivations.
Beijing does not want Chinese nationals to bet on American technological dreams rather than Chinese ones, and considers capital flight damaging to the regime's image, as well as to its reserves.
The foreign investments regulation that came into force on 1 July is moving in the same direction, requiring authorisation not only for capital, but also for technology and personnel employed.
The measure came after AI startup Manus moved to Singapore and was subsequently sold to us giant Meta, a step that convinced the government to shut down exit routes.
From real estate to stocks
The third front is the most innovative and aims to channel household savings into strategic sectors.
For decades, Chinese wealth has been concentrated in real estate, which now accounts for about 70 per cent of household assets. Now that that engine has stalled, the state is offering technology company shares as an alternative.
The most emblematic case is the stock market debut of CXMT, a national memory chip leader.
Purchase requests from small savers exceeded the number of shares reserved for them by more than two hundred times, while the stock price jumped over 500 per cent on its debut.
For public funds from Hefei City, which had invested in the company before its listing, the increase translated into earnings on paper equal to 50 times the initial capital.
This is not an isolated incident, given that last year, state-backed investors provided over 90 per cent of the capital earmarked for unlisted Chinese companies.
Meanwhile, cities are racing to replicate the Hefei model, using public funds to finance strategic companies in their early stages, when prospects are still uncertain and the risk of losing money is highest.
“To compete in a capital-intensive industry, with long lead times and uncertain outcomes, China requires very patient capital willing to accept risk. This capital must be equity-based, because banks are not enough," explains Chen Li, an expert in Chinese economics at the Chinese University of Hong Kong.
Direct market financing is thus replacing bank credit as the main channel of support for emerging industries, in what some have called the shift from the real estate state to the technology shareholder state.
Risks
The system, however, already exhibits several flaws. The most enterprising investors have found a way to circumvent controls by purchasing derivative contracts that replicate the performance of CXMT shares on cryptocurrency platforms outside the reach of the authorities. Millions of dollars are thus traded in a single day.
This is a sign that capital continues to seek the most profitable investments, both within and outside the confines set by the government.
There is also a deeper risk. In fact, “The greatest danger is that industrial policy becomes speculative finance," warns economist Tan Kong Yam.
When a sector is declared strategic, investors tend to assume that the state will not let it fail and end up assigning companies much higher values than their performance justifies.
China has already gone down this path twice, first with photovoltaics and then with electric cars. The enormous influx of public money fuelled rapid expansion in both cases, followed, however, by excess production capacity, price wars, and bankruptcies.
The case of the carmaker Neta, which went bankrupt after raising billions of yuan from three different local governments, is the latest reminder of the potential consequences of bad investments financed with public money.
This time, however, the risk falls on different parties. In previous bubbles, losses fell primarily on local budgets and banks.
In the new system, designed to channel private savings toward chips and AI, households are at the forefront, as the state encourages them to shift their savings from real estate to stocks, while simultaneously limiting their ability to invest abroad.
However, the decline in stock prices is already highlighting the model's limitations. Since the start of the year, the Chinese stock market has lost nearly 10 per cent, despite Beijing ordering state-controlled funds and companies to buy shares to support prices.
Interventions of this kind do not erase losses – they merely temporarily hide them by passing them on to large state-controlled entities. If technology companies fail to generate returns commensurate with the capital they receive, the price will still rise.
The burden will be borne by families, forced to shift their savings from real estate to stocks, and the public sector, forced to buy securities to prevent the strategy's failure from becoming visible.
The new model thus risks transforming private losses into public losses, merely postponing the moment when they will have to be acknowledged.
RED LANTERNS IS THE ASIANEWS NEWSLETTER DEDICATED TO CHINA. WOULD YOU LIKE TO RECEIVE IT EVERY THURSDAY? TO SUBSCRIBE, CLICK HERE.
