Thursday, April 19, 2007

The New Chinese Tax Law and Its Ramifications to Foreign Companies

On March 16, 2007, President Hu Jintao signed into law the new Corporate Tax Law of the People’s Republic of China (“New Tax Law”). It will come into effect on January 1, 2008. In comparison with the old corporate tax laws, the new tax law ushers in a unified corporate tax regime and it could have significant impact on both Chinese and foreign companies in China.

I. Legislative History

A. The Old Tax Law

Ever since the beginning of the economic reforms in the late 1970s and early 1980s, China has had a dual taxing system, one for domestic companies, and the other for foreign enterprises. The Interim Corporate Tax Measures of the People’s Republic of China (“Domestic Corporate Tax Law”) governs the taxing of all Chinese companies, withholding a tax of about 33%; while the Foreign Invested Corporation and Foreign Corporation Tax Law (“Foreign Corporate Tax Law”) applies to all foreign corporations, enjoying a tax rate of about 15%. The purpose of the dual taxing regimes is plainly to attract foreign investments, and such a purpose has been well served as China has become one of the world’s top recipients of foreign direct investments. However, the large tax incentive to foreign companies means a large competitive disadvantage to local Chinese companies, and they have been pushing for a change in the “discriminatory” treatment in their own country since the mid 1990s.

B. The New Tax Law

After almost ten years of internal debates and political struggles, the new tax law was finally approved by the National People’s Congress in March 2007 and was signed into law by the President of China. According to Chinese commentators, the new law is meant to balance the country’s continued need for foreign investments and a unified comprehensive tax code under which domestic and foreign companies at least compete on a plain field in terms of taxes. And according to Anthony Fay, a tax lawyer at White & Case’s Beijing office, “this new tax law is timely, and China views the tax code in parallel with the overall direction of where it would like to see the county headed.”

II. Important Changes

The following summarizes the major changes in the new tax law:

a unified corporate tax rate of 25% for both foreign and domestic companies;
a decreased rate of 15% for key high tech industry;
a decreased rate of 20% for small, low profit companies;
a decreased rate for environmentally friendly companies;
a five-year grace period for foreign companies to transition gradually to the 25% tax rate; and
This law does not apply to sole proprietors and partnerships.

III. Impact on Foreign Companies

To many foreign companies in or ready to be in China, the “New Tax Law” might look like “shock and awe” because it requires a hike of a whooping 10% in taxes due to the People’ Republic. Depending on a foreign company’s perspective to the new tax code, however, the “New Tax Law” does not mean all bad news. Quite on the contrary, it might mean new opportunities that a company would not otherwise have.

For example, the “New Tax Law” might incentive a foreign company to expand into other areas of investment opportunities inside China. Since the “New Tax Law” provides a tax break on high tech and environmentally friendly industries, a foreign company may look into bringing in new environment-related technologies into China, thereby taking advantage of the tax break. Furthermore, a foreign company may examine the possibility of expanding its investments into interior China where the local government might provide additional tax incentives taken away by the New Tax Law (Of course, moving to interior China presents logistic challenges. It is the topic of another day.).

IV. Conclusion

Good or bad, the New Tax Law has arrived, and it is the time for foreign companies to strategize on ways to either cope with or take advantage of the new tax code. For most foreign companies with current or future interests in China, the “New Tax Law” does not really offer them with an option to back out of China simply because of the economic importance of the Chinese market itself. Therefore, the “New Tax Law” presents another wrinkle in the many folds of challenges in doing business in a more and more globalized world.

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