Leveling the Playing Field

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Published on Tuesday, 29 March 2011 01:00

No longer capital starved as it was in its emerging early years, China revokes tax privileges for foreign investors, confident that fair competition and a mature market is appealing enough.

By Jiao Feng, China Today

On Oct. 18, 2010, the State Council promulgated the Circular on Applying a Unified System for Urban Maintenance and Construction Tax and Education Surcharge to Both Domestic and Foreign-funded Enterprises and Chinese and Foreign Nationals. This is another important measure since China unified the corporate income tax for domestic and foreign-funded enterprises in 2008, and signals a total unification of taxation on domestic and foreign-funded enterprises.

Taxation on Domestic and Foreign-funded Enterprises Unified

No longer capital starved as it was in its emerging early years, China revokes tax privileges for foreign investors, confident that fair competition and a mature market is appealing enough.

By Jiao Feng, China Today

On Oct. 18, 2010, the State Council promulgated the Circular on Applying a Unified System for Urban Maintenance and Construction Tax and Education Surcharge to Both Domestic and Foreign-funded Enterprises and Chinese and Foreign Nationals. This is another important measure since China unified the corporate income tax for domestic and foreign-funded enterprises in 2008, and signals a total unification of taxation on domestic and foreign-funded enterprises.

Preferential Treatment

Since adopting the policy of reform and opening-up and in order to attract foreign investment, promote domestic employment and introduce advanced technologies and management expertise, the Chinese government conducted a series of reforms on the system of corporate taxation, giving various forms of preferential treatment to foreign-funded enterprises. China adopted the Income Tax Law Concerning Chinese-Foreign Equity Joint Ventures in 1980 and the Income Tax Law Concerning Foreign Enterprises in 1981. In 1991 the two laws were merged into the Income Tax Law for Enterprises with Foreign Investment and Foreign Enterprises.

Under relevant articles of the law, foreign-funded enterprises enjoy a great many preferential policies. For instance, the profit derived by a foreign investor from an enterprise with foreign investment shall be exempted from income tax. Any enterprise with foreign investment of a production nature scheduled to operate for a period of no less than 10 years shall, from the year beginning to make profit, be exempted from income tax in the first and second years and allowed a 50 percent reduction in the third to fifth years. Those operating in Special Economic Zones and economic development parks enjoyed further incentives. In addition, to encourage foreign investment, various local governments have promulgated preferential policies regarding land use and local taxation.

So for a long period the tax burden on foreign-funded enterprises has been much lighter than on domestic enterprises. In 2005, for instance, the average tax rate for domestic enterprises was 24.53 percent, while the figure for foreign-funded enterprises was 14.89 percent. In 2008, the Chinese government promulgated the new corporate income tax law – the Corporate Income Tax Law of the People's Republic of China, which unified the tax rate for both domestic and foreign-funded enterprises to 25 percent.

The new tax law allows a five-year grace period, during which the old policy is still valid. And in fact, it still extends certain preferential treatment to foreign-funded enterprises. For instance, the preferential tax rate of 15 percent is levied on foreign-funded enterprises engaged in new and high technologies.

Zheng Yibing, chief executive officer of Henan ADD Electric Power Equipment Co., Ltd., confirms their foreign-funded company is still within the grace period and enjoys preferential tax treatment. In 2008 and 2009 the enterprise was exempted from income tax, and from 2010 to 2012 its income tax rate is reduced by half. In addition, the local government also gives it preferential treatment in land use and return of local taxes.

Chen Deming, Minister of Commerce, has reiterated that China pays attention to the important roles played by foreign-funded enterprises in promoting economic development and increasing employment. While encouraging domestic enterprises to expand investment abroad, China will continue to welcome foreign enterprises to invest in China, and is actively creating a good investment environment for foreign investors.

Non-fiscal Attractions

China's preferential taxation climate for foreign-funded enterprises has indeed played a positive role in attracting foreign investment and in promoting rapid economic growth. However, preferential treatment is not the decisive factor in a country's investment environment. As an incentive system, its role is limited, since a foreign investor has more factors to consider when deciding whether to invest in a country.

Political stability, consistent policies and sound legislation are the most solid protection for the rights and interests of investors, and are preconditions for the investment decision. In addition, an assessment of the investment environment looks at factors such as raw materials, labor force, market, work efficiency, transportation, power supply and telecommunications. Since it adopted the policy of reform and opening-up, China has maintained a stable political situation and provided a safe environment for investors. China has established a relatively complete legal system with respect to foreign investment and has continued to perfect it, providing reliable legal guarantees for foreign investment. The rapidly growing Chinese economy is also providing a fine economic foundation. China's relatively cheap labor and vast market are also important factors attracting foreign investors.

Zheng Yibing said, "Although our company's preferential period will expire in two years' time, we are optimistic about future development. Compared with developed countries, labor in China is inexpensive, and the rapid growth of the Chinese economy provides a huge market for our products. Therefore, the ending of preferential treatment in taxation will not affect our development plan."

Although there is a transition period of five years, preferential taxation treatment for foreign-funded enterprises is being phased out. Even so, foreign investment in China is not in decline. According to statistics released by the Ministry of Commerce, the amount of foreign investment actually used was US$82.658 billion in 2007 and US$92.395 billion in 2008. In 2009, despite the global financial crisis, direct foreign investment of US$90 billion flowed into China.

Call for Fair Play

Since joining the WTO in 2001, according to the principle of fair competition, China must solve its problem of unfair tax burden. The Urban Maintenance and Construction Tax and Education Surcharge are purpose-specific taxes that go into special governmental funds. Since their enactment more than 20 years ago, they have been levied only on Chinese citizens and domestic enterprises. As of Dec. 1, 2010, these two taxes have been extended to foreign enterprises and foreign nationals, so as to unify the tax burden on both domestic and foreign-funded enterprises, as well as Chinese and foreign individuals. This is fair to all and will promote fair competition.

According to an official of the Beijing Municipal Local Tax Bureau, the Urban Maintenance and Construction Tax and Education Surcharge are levied on the basis of value-added tax, consumption tax and business tax (product tax, value-added tax and business tax before 1994) actually paid. The Urban Maintenance and Construction Tax is applied at three rates: 7 percent, 5 percent, and 1 percent, according to the location of the taxpayer (city, county or other areas). The Education Surcharge is applied at a unified rate of 3 percent. For instance, an enterprise in Beijing with an annual turnover of RMB 1 million should pay business tax of RMB 70,000, Urban Maintenance and Construction Tax of RMB 4,900, and Education Surcharge of RMB 2,100. The last two items represent only 0.3-0.7 percent of its total turnover, having little impact on the enterprise.

An official of the Ministry of Finance said that the Urban Maintenance and Construction Tax and Education Surcharge are used specifically for public facilities and education. Any units and individuals enjoying the use of public facilities and education services should pay such taxes. Therefore, foreign-funded enterprises and domestic enterprises have the same obligations.

With the unification of taxation on domestic and foreign-funded enterprises, the latter lose some preferential treatment, but this will spur them to reconsider and perhaps adjust their business mode, investment structure, selection of investment location, and financing tactics. Investors now will pay more attention to the natural resources, local environment and talent pool of the areas in which they invest. Thus, making strategic and profitable investments will become another driver of industrial upgrading. For domestic enterprises, this is conducive to building their competitive strength, and will help reduce the incidence of pseudo foreign-funded enterprises in which funds are transferred abroad and returned to China as "foreign investment" so as to enjoy a preferential tax regime. It will benefit the building of a fair market environment, and conforms to the basic principles of the market economy.

Reprinted by permission of China Today (www.chinatoday.com.cn).

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