While increasing numbers of international investors are attracted to China's huge market of 1.2 billion people and its continuous economic growth, they need more knowledge about changes in the Chinese tax system and what taxes they need to pay.

Double standard abolished for JV and WFOC

When China opened its doors to the outside world in the early 1980s, the Chinese government issued two tax laws to encourage foreign investors to develop joint ventures with Chinese companies. The income tax rate for a joint venture (JV) with a Chinese partner was 33% (including both corporate income tax and local income tax), whereas the rate for a wholly foreign-owned company (WFOC) was a basic marginal rate of 50% with a five-level progressive rate for surplus income. Foreign companies selling products or services in China had to pay a consolidated industrial and commercial tax (CICT) which ranged from 1.5% up to 66% based on the product classification.

Since 1984, foreign companies investing in Special Economic Development Zones and the coastal cities had their income tax rate reduced to 24% or 15% and also a reduced CICT.

In the early 1990s, China dropped its double tax standard for joint ventures and wholly foreign owned companies. A unified income tax law related to international investments was issued to give foreign investors more freedom. Since then, all foreign companies operating in China have had the same income tax rate of 33% regardless of the level of participation by Chinese partners. The tax system was also modified to provide differentiated tax treatments for various industries instead of locations.

Unified tax rate for domestic and foreign companies

In 1994, with completion of a tax reform in state-owned enterprises, the Chinese government initiated a value-added tax, consumption tax and business tax on both Chinese and foreign companies in manufacture and service industries, and discontinued the CICT on foreign companies. Thus, the 14-year-old dual-tax system on Chinese and foreign enterprises was abolished. The corporate income tax stood at 33% for both Chinese and foreign companies. These

changes and developments showed the Chinese government's efforts to standardize its tax laws and integrate them with international practice.

The 1994 tax system includes 24 taxes, with 14 of them applicable to wholly foreign-owned companies and joint ventures. This does not mean that each company has to pay all 14 taxes. The following lists the major taxes and their applications.

Applicable taxes on foreign companies

Value-Added Tax (VAT)

Usually, a foreign company doing business in import, sales, product processing or repair services needs to pay VAT at a standard rate of 17%. Generally speaking, the taxing base of VAT is the gross profit of a company. Taxes paid on cost of labor and material can be deducted from VAT. However, there is a significant difference in the taxing base of companies that use imported materials and those that do not, as these materials will be counted into the taxing base of VAT.

A liability to VAT arises whenever goods and certain services are sold in China or imported into China. Exports are exempted from VAT, as well as other items including agricultural products, contraceptives, antique books and imported equipment required for processing and compensation trade.

Business Tax (BT)

A foreign company engaged in transportation, finance, insurance, construction and remodeling in China only pays 3% or 5% of its sales revenue as BT and does notpay VAT.

BT, an indirect tax on services, also applies to the transfer of real estate and intangible assets. Unlike VAT, no credit is given for BT paid on purchases. An entertainment business pays BT from 5% to 20%. Exemptions for BT only apply to hospitals, schools, colleges and agricultural organizations.

Consumption Tax (CT)

If a foreign company produces or imports any of 12 luxury commodities including alcohol, cosmetics, jewelry, cigarettes, wine, cosmetics, vehicles, petroleum and diesel, it has to pay CT at rates from 3% to 45%. This is similar to the consumption tax in the United States.

CT is calculated either as a percentage of sales or as a fixed amount based on the volume of transactions before VAT. Exports are exempted.

Natural Resources Consumption Tax (NRCT)

In addition to VAT, a foreign company which invests in exploration and production of petroleum, natural gas, coal, metals or non-metal resources has to pay NRCT based on the amount, type and quality of consumed resources (including the amount of self consumption). For instance, the NRCT is RMB 8 to 20 (about US$ l to 2.5) per ton of coarse petroleum and RMB 2 to 15 (about US$ 0.25 to 1.85) per 1,000 cubic meters of natural gas.

Land Appreciation Tax (LAT)

A foreign company involved in real estate is required to follow the four-level progressive rates and pay LAT from 30% to 60%, based on the profit made from transferred land-use loyalty and from owned buildings and their attachments.

Corporate Income Tax (CIT) and Local Income Tax (LIT)

All foreign companies pay CIT and LIT for profit-making years for a total of 33%. Those in the Special Economic Zones and Development Zones pay a reduced rate of 15% or 24%.

For foreign companies receiving earnings without establishment in China, a 20% income tax is withheld.

Stamp Tax (ST), Real Estate Tax (RET), Land Usage Tax (LUT), Vehicle and Vessel Usage Tax (VVUT)

All foreign companies have to pay:

• ST when involving signing or holding business contracts and property transfers,
• RET when owning real estate,
• LUT when using land,
• VVUT when owning vehicles or vessels.

Personal Income Tax (PIT)

All foreign employees in China and all foreigners receiving earnings from China must pay PIT.

Import Tax

Import tax is the area that is changing the most in recent years, especially after China joins the WTO. Details of the import tax should be discussed separately.