BEIJING -
Preferential taxes have been a major attraction
for foreign companies investing in China for
years, but that could all be about to change. With
the recent drafting of a new corporate income tax
law, to be reviewed by China's top legislature in
August, the unification of tax rates for
foreign-funded and domestic companies seems just a
matter of time.
According to the draft,
companies in China will no longer see two sets of
tax rates - more favorable ones for foreign-funded
ones and almost double the rate for their local
counterparts. Instead, the
corporate income tax paid
will be the same, regardless of the ownership of
the firm.
This would effectively scrap the
privilege foreign investors have enjoyed for more
than 15 years and lower the tax burden for
domestic businesses, enabling them to compete on
an equal footing.
"Such an adjustment is
in line with the overall strategic development of
the Chinese economy," said Ni Hongri, a tax expert
and researcher with the Development Research
Center under the State Council, a government
think-tank. "The trend is unavoidable; what
matters more is the new tax rate and the period of
grace."
The current corporate income tax
rate for Chinese companies stands at 33%, compared
to a maximum of 24% for foreign-funded
enterprises. However, foreign-funded firms in the
service industry are taxed at 33% and those in
economic zones pay 15%. There are also numerous
exemptions by local governments.
Alfred
Shum, executive partner and deputy chairman for
taxation of Ernst & Young in Shanghai,
predicted the unified tax rate would be somewhere
around 25-27%, and a three to five year grace
period would help companies adjust to the new tax
rate.
The issue has been discussed for
years, but resistance, for example from foreign
companies in China and administrators of economic
zones, pushed it off the agenda of lawmakers. Ma
Xiuhong, China's vice-minister of commerce, said
last week that the time was ripe to introduce a
unified tax system but a grace period would be
allowed for the transition.
Wang Jianfan,
deputy director of the tax policy department of
the Ministry of Finance, said earlier this month
that the unification of the corporate income tax
was a top priority for tax reform in China.
Instead of allowing general and regional
preferential taxes, the new system will give more
incentives to companies in industries that
encourage more investment, Wang said. The Chinese
authorities amend the industrial investment
guidebook every year.
The new tax law,
drafted by the Ministry of Finance, will be
submitted to the Standing Committee of the
National People's Congress (NPC) for initial
review in August. If approved by the committee,
the draft will be voted on at the NPC meeting in
March. The earliest timetable for implementation
is 2008, according to Shum.
It is wise to
base tax adjustments on the needs of industrial
restructuring, he said, noting that China's
reliance on foreign investment has decreased
compared with more than two decades ago, when the
country had just opened up. Now it has its
preferences and favors investment in high-tech and
industries with high-added value, said Shum.
China's actual foreign direct investment
was US$72.4 billion in 2005, up nearly 20% from
the previous year, with a strong growth in
investment in the financial sector, according to
statistics from the Ministry of Commerce.
A general concern over tax reform has been
that high taxes might drive away some foreign
investors, but as Shum sees it, the impact on
foreign investment should be limited if the
transitional period is carefully handled.
Many foreign-funded companies are eying
the growth potential of the Chinese market and
strong domestic demand. Higher taxes will not add
too much of a financial burden and are acceptable
compared to the profit generated and the overall
strategic importance of the market, he said. For
companies in the service sector, such as finance,
which has become a new focus for foreign
investors, their income tax, currently at 33%,
will actually be lowered.
For the Chinese
government, now is a good time to conduct tax
reform, given its smaller deficits and stronger
fiscal strength, said researcher Ni Hongri.
China's deficit has dropped considerably over the
past two years, so it is the right time to solve
old problems and upgrade the tax system, she said.
"More favorable taxes in neighboring
countries and regions may lure some investors away
from China," said Ni. "But you have to pay a price
for every reform. And it is worthwhile for
long-term development," she said, adding: "The
biggest attraction of a country to foreign
investors should not just be preferential taxes
... a simplified tax system and administrative
procedures, transparency and an environment of
'fair play' are more attractive."
For
Chinese companies, such factors would also
encourage them to be more innovative and enhance
their competitiveness on a level playing field;
they will soon no longer enjoy government
subsidies and preferential treatment, as China is
shortly to finish its five-year grace period after
joining the World Trade Organization.
