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Tax Burdans Equalized for Chinese, Foreign Firms

“The unified tax rate is set at 25 percent, replacing the current 33 percent nominal rate that has been in place for 14 years. Under the tax regime to be replaced, foreign companies enjoyed many kinds of tax preferences, despite having the same nominal tax rate as Chinese firms, which made the foreign firms’ actual tax rate about 15 percent or less, while domestic firms paid an average tax of about 25 percent.  In the domestic banking, beverage and communications industries, the top three in terms of tax burdens, actual income tax payment rates were 35.59 percent, 31.51 percent and 31.06 percent.

But while putting an end to many preferential tax policies and incentives enjoyed by foreign firms, the new law retains some favourable terms for companies whose development is in line with the nation’s strategic priorities, such as the 20 percent preferential rate for small enterprises with small profit margins and also a 15 percent rate for high-tech companies.

“With further opening up of the domestic market after China’s entry into the World Trade Organization (WTO), domestic companies are gradually merging into the global economic system, facing ever fiercer competition. We will force local companies into an unequal playground if we stick to the differential tax policy; it would also hinder the formation of a regulated and fair market environment,” said Jin Renqing, minister of Finance, when explaining the need for the new law.

The direct effect of the new law will likely be a temporary decrease in tax revenues, by about 93 billion yuan (US$12.09 billion), a 134 billion yuan (US$17.42 billion) decline in revenues from domestic companies, which will be offset, to some extent, by a 41 billion yuan (US$5.33 billion) increase in revenues from foreign firms, according to statistics.

There are concerns about the effect the new law may have on foreign investment, but Jin said he was not overly concerned about this. He said preferential tax rates are becoming less important as an element in the Chinese economy than maintaining political stability, broadening markets, ensuring sufficient labour resources and optimizing efficiencies related to facilities and government services. Jin said that compared with the 28.6 percent average rate among the 159 countries that rely upon a corporate income tax, China has adopted a very reasonable policy.

Jin’s comments were echoed by Zhang Haiyu, director of the Financial Centre, Economic System and Management Institute of the National Development and Reform Commission. He believes foreign companies are more concerned about transparency in business and financial operations, the stability of relevant policies and the efficiency of the government than tax preferences at this time. They are also concerned about labour availability and the market environment, a clear message he said he has received from many foreign entrepreneurs.

The change didn’t stir much excitement or debate as both domestic and foreign companies have taken this quite calmly.

“Twenty-five percent is equal between foreign and domestic firms, and it’s reasonable,” says James M. Zimmerman, president of American Chamber of Commerce in China. “In general, these companies come to China mainly because of the market here. What they value most are the market opportunities; favourable policies in taxes and other aspects are just part of their consideration.”

Domestic companies are excited, because the new law establishes a fairer field of play with their foreign competitors.

Because of the lower tax rate, domestic companies will be able to invest more of their profits in production, research and development, thus enhancing their competitiveness, said Cai Hongsheng, chairman of Orient International Company, Limited.

Liu Yonghao, chairman of the New Hope Group and winner of the CCTV 2006 Magnificent Ten award, also expressed his expectations for the new tax system. He said the new law will set a new pattern for the Chinese economy, especially in the private sector.

Economic Zones to Lose Tax Privileges

Aside from unifying the rates for corporate income taxation, the new law also makes adjustments to the favourable treatment accorded to special regions, mostly economic zones.

The first national economic zones were set up in 14 coastal cities in 1984 as a way to attract and control foreign investment, but such zones have since proliferated as localities competed to lure overseas money. Fifty-four national economic zones and nearly 3,000 provincial and municipal economic zones have been established.

According to the old corporate tax regime, enterprises in economic zones could have preferential tax rates of as low as 15 percent. But the tax rate doesn’t tell the whole story. Other corporate benefits, incentives and rebates could result, in a net sense, of foreign corporations paying even less, if various subsidies are taken into consideration. Under such lucrative terms, economic zones flourished everywhere. But while creating jobs and contributing to fiscal revenues, this caused problems that could no longer be neglected, including reflecting poorly on the performances of even some of the best State-owned enterprises.

The main problems came with the process of land appropriation for building roads, factories, office buildings and industrial facilities. Farmers lost their lands almost overnight in some case and usually did not get just compensation. About 1.64 billion yuan (US$213 million) was embezzled, delayed or deducted from compensation owed to farmers for land appropriations in 2005 alone, according to an Audit Work Report on Budget Implementation in 2005. This resulted in a massive drain of State assets, but also tempted the corrupt, caused uneasiness and distress among farmers and threatened stability in the countryside and society as a whole.

The new Corporate Income Tax Law eliminates tax preferences for economic zones and diverts the preferences to industries in line with the long-term economic strategies of the nation. In addition to favourable rates for high-tech (15 percent) and low profit-margin small companies (20 percent), no matter where they are located, expenditures for environmentally friendly equipment, for research and development of advanced technologies, new products and crafts, for work-place safety and others can be exempted from companies’ taxable income.

Some officials are worried that the new law may affect investments in economic zones, but many remain optimistic. Preferential tax policies have lost their charm with the advancement of the economy, while resources, geographical advantages, transportation and other supportive facilities now constitute the new core competitiveness of economic zones, said an official in charge of a national economic zone in Xi’an, Shaanxi Province.

Fake Foreign Companies to Disappear  

Tax preferences and special treatment for certain businesses have resulted in strong foreign investment rates in China, which, in turn, have contributed a lot to the soaring Chinese economy in its early stage of development. In 2005, China became the third largest foreign direct investment (FDI) recipient just after Britain and the United States, attracting US$72.4 billion; in 2006, the same figure rose to US$691.9 billion.

However, not all the FDI was real foreign money. According to a report issued by the Asia Development Bank in 2004, about 40 percent of FDI is “returned capital,” that is, domestic capital that was cached in places like the British Virgin Islands, Cayman Islands and Samoa, where local firms registered companies so they could take advantage of preferential policies for foreign firms, especially the evasion of Chinese taxes.

With nearly nine months left before the adoption of the new law and because of the interim period for foreign enterprises, there are still many companies seeking to take one last low-cost ride. The new trend is toward Hong Kong since it still has a 17.5 percent rate under the new law.

New Law Encourages Charity

The new Corporate Income Tax Law is expected to spur charitable giving in China: a corporation may now write off as much as 12 percent of its corporate revenue if it is given to charities. Previous law allowed tax offsets for charitable giving that were no more than 3 percent of a company’s revenue.

 “The current rules have already affected the development of charity in our nation; the rather low offset rate was cooling the enthusiasm of corporations and individuals who were willing to do so,” said Ma Jialai, deputy director of the China Aid-the-Poor Development Commission.

In 2006, only 1 percent of the 10 million companies in China reported making charitable donations. They donated 3.5 billion yuan (US$455 million), compared with US$13.8 billion in corporate donations in the United States in 2005.

After nearly 30 years of development since reform and opening began in 1978, the problem of social inequality is becoming increasingly glaring and damaging. The government has tried to address this problem through various kinds of channels including personal income taxes and social assistance. The adjustment of the tax offset ratio in corporate income is believed to be another step in advancing China’s lagging charitable-giving system and allowing everyone in the Chinese society to share in the benefits of reform and opening.

“China will try hard to encourage charities societywide and it will set a goal of achieving 50 billion yuan (US$6.5 billion) in donations annually by 2010,” said Wang Zhenyao, director of the Department of Disaster and Social Relief of the Ministry of Civil Affairs.