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Tax: China aims to level playing field for business

China General Interest

Ernst & Young's Tax team explains how with recent amendments to China's tax laws, the Chinese government is creating a level playing field for all businesses. 

You only have a few months to plan for radical tax changes in China, so there is no time to wait. The new rules came into force on 1 January 2008 and aim to level the playing field for foreign and domestic companies in China, through changes to tax rates, incentives and holidays.

The current law is heavily biased in favour of foreign invested enterprises (FIEs), with tax incentives on offer for certain types of industry that are willing to operate in specific areas of China. For instance, an FIE operating in a defined "special economic zone" will be paying a tax rate of 15%, as opposed to the standard 33% paid by domestic Chinese companies. A production/manufacturing FIE operating in a "coastal economic zone" will be on a 24% rate.

What's more, many FIE's have been eligible for a tax holiday: in the first two years of operation they pay no tax, followed by three years at a reduced rate. Add the tax incentives to the reduced costs and it’s easy to understand why so many businesses have shifted their production to China in the past decade.

The main reason is China is now part of the World Trade Organisation (WTO) and this new legislation will bring it in line with the WTO's fundamental principle of 'national treatment and transparency' - a level playing field for all businesses.

The Chinese government has opted to introduce a unified tax rate of 25%, which applies to all FIEs and domestic companies in China (with a 20% rate for companies that qualify as having small profits). The government is also repealing many of the existing tax incentives and holidays. It's important to note, though, the law will be grandfathered, so companies who entered into the old "two-year holiday, three-year tax reduction" system will be allowed to see their tax breaks out.

China retains the option to introduce new incentives for certain types of business, as it wants to encourage businesses to engage in high value activities. New tax incentives will apply to both FIE's and domestic businesses, in higher value industries such as, high-tech companies and those specialising in renewable energy and "green" projects. Many FIEs already in China are benefiting from tax incentives and will take advantage of the grandfather period. There will also be a transitional period when the tax rate will increase each year until it reaches the unified 25% rate. 

For those investing in China to access the domestic market, the new tax laws will mean they will be taxed at 25% rather than the current 33%.

The tax reform has also reintroduced withholding tax on dividends paid from Chinese subsidiaries to offshore companies. Previously, Chinese companies could pay dividends free of withholding tax. The domestic rate proposed was 20% but has now been reduced to 10%.

China is also toughening up on transfer pricing and its anti-avoidance rules as well as its sourcing and residency rules.

More information about China and you the pending changes to the tax regime you can contact:

Joanna Doolan                +64 9 300 7075

Florence Wong                +64 9 377 4790