An update on the specifics & the un-resolved Issues
On March 16, 2007 Chinese lawmakers passed the much talked about corporate income tax law, unifying the tax rates for foreign and domestic enterprises. The new law, which passed 2,826 votes for and 37 against with 22 abstentions, will bring China’s tax laws more in line with international standards. It has unified the two existing tax codes; one for domestic enterprises, the other for foreign invested enterprises (FIEs), into one and represents a fundamental change in China’s tax policy. Many of the tax incentives and tax holidays that existed in the old code for foreign investors have been changed or eliminated.
Set to take effect January 1, 2008, the Enterprise Income Tax Law of the People’s Republic of China contains general provisions on the law as well as chapters on what constitutes taxable income, taxes payable, tax incentives, withholding tax at the source, special tax adjustments, administration of the levy and collection of taxes, as well as some supplementary provisions. As is common in China, the details of those provisions, as well as their interpretation and application will be left to further regulations and supplementary circulars. The law has been written, but it remains to be seen how it is to be fully implemented. Some clarifications concerning qualifying for preferential treatment and deadlines for implementation have still to be issued.
Tax unification
The income tax rate for all companies in China, both foreign and domestic, will be 25 percent. This means that most foreign invested companies in China will see their taxes increase, while most domestic enterprises will pay less to the tax authority. Both international and domestic companies will now compete based on only quality and service but not preferential income tax rate. Domestic companies in the past have been notorious for under-reporting their profits and the government will have to properly administer tax collection from domestic companies under the new system lest they be seen as deliberately collecting less money from domestic businesses to help their competitiveness. This could be used as a stick to beat China with concerning trade imbalances as being effectively a ‘tax subsidy’ for Chinese businesses should the collection base remain ineffective.
While the new unified rate of 25% is an increase from the preferential tax rates of the past for FIEs, the change will likely have more of an affect on small to medium enterprises at the low end that, being typically undercapitalized, may look elsewhere to invest. The new rate is also designed, in some part, to discourage foreign investors of such types to invest here on the grounds that they are not tax productive in any event. Additionally, in order to deal with the massive trade imbalance China possesses, and in particular with the US, an increase in tax affects a large portion of the process manufacturing trade that is responsible for much of this. China intends to further clamp down on such activities, and a migration of this type of business may take place, probably to India. Additionally, industries that are inefficient in terms of energy use, polluting, not adding value or are tax inefficient will all feel the impact of this measure.
