 To improve the socialist market economy and to unify the income tax system for all kinds of enterprises, the State Administration of Taxation and the State Council Legislative Affairs Office worked together and drafted the Enterprise Income Tax Law of the People's Republic of China (hereinafter referred to as “the Law”) by taking into account the new developments of China's economy and society. China's parliament, the National People's Congress, adopted the Law on March 16th, 2007, with 2,826 votes for and 37 against, and 22 abstentions, a key signal of a phase-in end of superior treatments to foreign investors for two decades.
Ⅰ The Background to the Adoption of New Enterprise Income Tax Law
After China adopted its reform and opening-up policy in the early 1980s, the government offered favorable income tax rates to attract foreign investment and boost China's economy.
Domestic and foreign-funded enterprises in China are now governed by different laws on enterprise income tax. Foreign-funded enterprises are governed by the Income Tax Law of the People's Republic of China for Enterprises with Foreign Investment and Foreign Enterprises adopted at the 4th Session of the 7th NPC in 1991, whereas domestic enterprises are governed by the Provisional Regulations of the People's Republic of China on Enterprise Income Tax promulgated by the State Council in 1993.
Yang Yiqing, taxation professor with the Central University of Finance and Economics, pointed out that on the surface, the income tax rate of both Chinese and foreign-funded enterprises is the same at 33 percent. But in some special regions, a more favorable income tax of 24 percent or even 15 percent has been granted to foreign-funded enterprises. However, the majority of domestic companies are still taxed by 33 percent and only the least profitable ones can be entitled to a favorable tax rate of 18 to 27 percent. So generally speaking, the actual tax burden on domestic enterprises is twice that of foreign-funded companies.
With the development of a market economy, especially now that the transitional period of China's entry into the World Trade Organization (WTO) has come to an end, it would be quite unfair to apply different income tax rates to Chinese and foreign-funded enterprises. Moreover, it would be harmful to the establishment of a unified, regulated and fair competitive market.
As a matter of fact, those voices calling for a unified and fair taxation policy have gained strength in the past few years. Since the Second Session of the 10th National People's Congress (NPC), altogether 541 NPC deputies have offered 16 motions to enact an enterprise income tax law in an effort to unify the income tax of both Chinese and foreign-funded enterprises.
On December 29, 2006, the 25th meeting of the 10th NPC Standing Committee was closed in Beijing, with almost all the attendants agreeing to submit the draft income tax law to the deliberation of the Fifth Session of the 10th NPC in March, 2007.
Jin Renqing, Minister of Finance, pointed out that it is time to reform the enterprise income tax system to quickly unify the income tax on both domestic and foreign-funded enterprises.
"This round of tax reform is aimed at improving the quality and level of utilizing foreign capital," Jin said. "A favorable income tax policy will be granted to new and high-tech enterprises, which will help upgrade and optimize the foreign investment structure."
Ⅱ Main provisions of the draft enterprise income tax law
The Law highlights "four unifications":
(1) Unification of income tax law applicable to both domestic and foreign-funded enterprises;
(2) Unification and appropriate reduction of enterprise income tax rates;
(3) Unification and standardization of deduction; and
(4) Unification of preferential income tax policies to introduce a new preferential tax system of granting the industry-based incentives as the mainstay, while the region-based ones as the supplement.
1.Tax rate – 25%
The Law sets a new tax rate of 25 percent (Paragraph 1 of Article 4). It is mainly intended to ease the tax burden on domestic enterprises, and keep a rise as little as possible in tax burden on foreign-funded enterprises. The loss of revenues should be within an acceptable margin, and the level of enterprise income tax rates in the world, especially the neighboring countries (regions), has to be taken into account. The average enterprise income tax rate is 28.6 percent in 159 countries (regions) around the world in which an enterprise income tax is applied, while that in China's 18 neighboring countries (regions) is 26.7 percent. The rate of 25 percent set in the Law is relatively low in the world and will be conducive to enhancing enterprise competitiveness and attracting foreign investment.
2. Tax preference
To ease its impact, the Law develops some transitional preferential measures for the enterprises established before the promulgation of the new tax law which enjoy low tax rates or regular tax reduction and exemption treatment under current tax laws and administrative regulations. According to these transitional measures, the old enterprises entitled to enjoy an income tax rate of 15 percent or 24 percent under the current tax laws may, pursuant to the regulations of the State Council, continue to enjoy a gradually increasing transitional income tax rate within five years after the new Tax Law becomes effective. However, for enterprises that have not made any profits and thus not enjoyed such preferential treatment, the period for enjoying preferential treatment shall be calculated from the year in which the new Tax Law becomes effective.
3. Who's the Taxpayers
The Law defines a taxpayer as an enterprise or other organization that earns income. Such provision is basically in conformity with the relevant provisions of the current tax laws. To avoid double taxation, the Law does not apply to individual proprietorship enterprises and partnership enterprises.
4. Taxable Income
According to the Law, the taxable income of an enterprise is the amount remaining from its gross income in a tax year after the excluded income, exempted income, deductions, and carry-forward loss in previous years are deducted (Article 5).
(1) Income
In the Law, "gross income" is defined as "an enterprise's monetary and non-monetary income from various sources" (Article 6). "Excluded income" is defined as income from fiscal funds such as fiscal appropriations, administrative charges subject to fiscal administration and government funds (Article 7). "Exempted income" is defined as income from interests on treasury bonds and from equity investment such as dividends and bonus between eligible resident enterprises
(2) Deductions and taxation of assets
The Law unifies the policy for deducting various actual expenditures of enterprises, prescribes the standards for deducting expenditures for public welfare donations (Article 9) and defines the scope of nondeductible expenditures (Article 10). It also makes unified provisions for the deduction of expenditures related to an enterprise's fixed assets, intangibles, long-term prepaid expenses, and investment assets and inventory (Articles 11 to 16).
5. Tax collection
(1) Methods of tax payment
To unify the methods of tax payment and make tax payment easier, the Law provides that a resident enterprise establishing operational entities without legal person status shall calculate and pay enterprise income tax on a consolidated basis (Article 50).
(2) Special tax adjustment
Tax avoidance by some enterprises through various means is serious, and the struggle against tax avoidance is intense. Thus, on the basis of international practice, the Law provides rules for preventing tax avoidance through transfer pricing among associated enterprises. It also provides general anti-avoidance rules and articles against thin capitalization and avoidance through tax havens. Moreover, it sets forth provisions for assessment procedures and collection of interest from settling tax arrears as provided for by the State Council. This will help guard against and prevent tax avoidance and safeguard the interests of the state (Chapter VI).
Ⅲ The Impact of the New Law
Will the tax unification hurt the competitiveness of foreign-funded businesses? Will the new tax law kill their investment enthusiasm?
The answer is no. According to statistics from the Ministry of Finance, the average enterprise income tax rate of 159 countries is 28.64 percent. Jin Renqing stated that the 25 percent rate is relatively low in the world and will be conducive to maintaining China's tax competitiveness and attracting more foreign investment.
From an over-all stand point of view, the income tax rate for domestic enterprises would be reduced by 8 percentage points from the original 33 percent. As a result, the state tax revenue would come down accordingly. Yang Yiqing, taxation professor with the Central University of Finance and Economics, estimated that if the new tax rate takes effect in 2008, the annual tax revenue from domestic enterprises would drop by 134 billion yuan, while that from foreign-funded enterprises would increase by 41 billion. It means a total of 93 billion yuan would be deducted from the previous annual tax revenue.
"This round of tax readjustment is more beneficial to foreign-funded enterprises," said Yang Yiqing. "As for those who had enjoyed a lower tax rate than 25 percent, the tax burden is raised a little bit. However, as many of the foreign-invested enterprises in China are in high-tech industries supported by the government, they can also enjoy the 15 percent income tax rate. Meanwhile, according to the Law, the 15 percent favorable tax can be applied to all high-tech enterprises in all areas of the country. Therefore, the income tax rate readjustment won't pose a heavy burden for the majority of foreign-invested enterprises."
Liu Longheng, a tax professor with Peking University, noted that from a long- term point of view, the object of the Law is to establish a standard, transparent and fair tax collection environment, which is more conducive to attracting foreign investment in China. According to World Bank research, China's stable political situation, sound economic development, vast market, rich low-cost labor resources, enhanced commercial infrastructure and government services are the most important factors that attract foreign investment. Liu contended that favorable tax rate is a less important factor considered by foreign investors. Transparent tax policy and non-discriminative policies are more important, Liu said. (Source: Beijing review)
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