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  • China’s Policies for the Attraction of Foreign Investment which have Reached a Turning-Point with the Passing of the “Enterprise Income Tax Law”

China’s Policies for the Attraction of Foreign Investment which have Reached a Turning-Point with the Passing of the “Enterprise Income Tax Law”

|China

China’s National People’s Congress (the Fifth Session of the Tenth NPC) came to a close on 16 March. The Hu Jintao–Wen Jiabao administration bade farewell to the “paramountcy of economic growth,” and reaffirmed its determination to advance resolutely on the path toward the realization of “societal harmony,” and it will surely be remembered as a congress at which overwhelming backing was won.

Among the items on the agenda, the ones receiving the most attention were the two major pieces of legislation of the “Enterprise Income Tax Law” and the “Property Law” which had been problems outstanding for several years.

The “Property Law” is a law that will put into effect the “inviolability of private property” recognized in a constitutional amendment at the NPC in 2004. In the process of formulating this law, it was subject to vehement objection from the old-liners within the Chinese Communist Party, yet in the event was passed with a huge majority. For foreign-investor enterprises the passing of this law has been welcomed as something that will lead to improvement in the fundamental investment environment of China.

For foreign-investor enterprises what has greater significance is the fact that the “Enterprise Income Tax Law” was passed. Formerly, the enterprise income tax (corporation tax) in China was twin-tracked—separate for domestic enterprises and foreign-invested companies. The basic tax-rate for both was 33% (of which 30% was national tax, and the remaining 3% was local tax), but for a great many foreign-invested companies preferential tax-rates (10%–24%) have been applied according to the locality or type of industry. Moreover, there has been a major contribution to the attraction of foreign investment and economic development in China with the adoption of such preferential treatment as “Èr mian san jian bàn”[*] (for two years after the first profit is made tax is exempted and for the next three years the tax is reduced by half).

In addition to the criticism of the “unequal taxation system” by domestic firms, however, ill effects became conspicuous such as Chinese firms temporarily moving capital abroad and then reinvesting it, and stirrings had been sensed over the past few years toward unifying the domestic and foreign taxation systems. The key points of the newly created law are: (1) unifying the basic tax rate at 25% for both domestic and foreign enterprises; (2) applying preferential tax rates, without discriminating against domestic enterprises, for “specific sectors such as the environment-related, total- resource-use and infrastructure sectors,” “high-tech enterprises,” “small concerns,” and “enterprises in minority autonomous areas,” etc., and; (3) foreign-invested companies already enjoying preferential treatment will move over to the new taxation rate under the governing principal of a five-year transition period which will come into being from 1 January 2008. The future will see the appearance of policy to strengthen selection regarding the introduction of foreign capital.

Simply from reading the legislation, however, there are many points which are unclear, such as the definition of “high-tech enterprise,” and the specific handling of tax rates during the transitional period. The other day at the “China Foreign-Investment Policy Seminar” staged in Tokyo by the Japan–China Investment Promotion Organization, according to the pronouncements made by the responsible officials from the Chinese authorities there would be a clarification of specific items with the publication of “detailed procedural regulations” by the end of 2007.

Until these “detailed procedural regulations” are settled, it is not possible to be certain whether there will be an increase in taxes for a given company, nor at what point in time that situation will arrive, yet for a considerable number of enterprises an increase in tax will be unavoidable. Furthermore, as there will be a reduction in taxation for many domestic competitor firms, depending on the sector, the competition in the Chinese market will become ever the fiercer.

If one considers things cool-headedly, however, there is also the point that we on the foreign capital side have in the past demanded from China equal treatment to domestic firms. The coming unification of the taxation system is probably an unavoidable transit point on the path of China’s maturing as a nation with a market economy.

In the future when we plan investment in China, it would be necessary to conduct a higher degree of careful investigation into the advantages and competitive strengths of any such project in the Chinese market. Furthermore, I look forward to consideration being given by the Chinese authorities so that there won’t be a situation of the long-awaited new taxation system lacking transparency and predictability in its practical application, and ending up sustaining inequalities.

[*] literally “Two exempt, three reduce half”

[Translated by ERINA]