New corporate tax offers level playing field

By Jiang Wei (China Daily)
Updated: 2007-03-09 07:26

China has fulfilled almost all its commitments to the World Trade Organization (WTO) since joining it more than five years ago. And it will meet one of its last pledges next year if the ongoing session of the National People's Congress (NPC) approves a draft.

The long awaited law on new corporate income tax is expected to take effect in 2008, changing China's existing rates for domestic firms (33 percent) and overseas-invested companies (15 percent) to a unified 25 percent. That will provide domestic and overseas-funded firms with a level playing field for the first time since the economic reforms began in the 1980s.

Overseas firms that have invested in sectors such as high-tech manufacturing and services will, however, continue to enjoy the favorable treatment. New corporate tax offers level playing field

Companies from abroad have been enjoying the favorable tax structure since they first tapped the Chinese market.

The government granted them the favor because they faced various investment restrictions in some industries and sharing of stakes, says investment researcher at the University of International Business and Economics Lu Jinyong. "But we cannot grant them preferential treatment forever. They have to be treated equally now, given that China has opened nearly all its markets to foreign players."

In fact, the proposed 25 percent tax is low compared to most other countries. Government data show the average corporate income tax rate in 159 counties and regions was 28.6 percent in 2005-06, with the average rate in the Chinese mainland's 18 neighboring countries and regions being 26.7 percent.

Ever since the subject of a unified corporate tax rate was raised, some experts and analysts have been voicing concern that the move could hurt the inflow of overseas direct investment into China. But Lu feels most overseas-funded firms would not change their investment strategy in China in the long run.

Why? Because, CITIC's China Securities analyst Hu Yanni says, a unified tax regime is one of the factors that attracts overseas direct investment. The key issues in China should be abundant human resources, social stability and an irreplaceable market.

The new system, however, will be phased out over five years, with the tax rate for investors from abroad being raised by 2 percentage points every year. "Overseas investors have five years to adapt to the changes," Hu says. In fact, a number of such businesses have already started internal adjustments to offset the impact of a unified tax rate.

The changes in the corporate income tax rates are expected to benefit some domestic industries. For example, a lower tax rate means higher profit for domestic banks.

CITIC China Securities banking analyst She Minhua says a bank will see a 1 to 1.5 percent profit gain if the income tax is cut by 1 percent. Therefore, if it's lowered from 33 to 25 percent, domestic banks could realize an added profit of 8 to 12 percent. For a bank like the Industrial and Commercial Bank of China (ICBC), which had a pre-provision profit of 78 billion yuan ($10.08 billion) in 2005, it means an added gain of 6 billion yuan ($775.19 million).

Domestic manufacturing companies involved in some traditional sectors would be among the major beneficiaries. Most of such firms now have to pay a 33 percent income tax because they neither enjoy the favorable tax rates like the overseas firms, nor any of the tax reductions given to domestic high-tech businesses.

Analysts say sectors such as food and beverages, iron and steel, coal, papermaking and non-ferrous metals, too, stand to gain from the tax cut.

An automobile business analyst, who doesn't want to be named, says: "Commercial vehicle enterprises such as China National Heavy Duty Truck Group Corp and bus giant Yutong Group may benefit a lot (from a unified tax policy) because most of their funds come from domestic investors ."

The move is expected to prompt some domestic manufacturers in some traditional industries to seek independent and national brands. Some firms now earn most of their profit from joint ventures, which enjoy the preferential tax rates, rather than from their wholly owned businesses.

Apart from the direct tax cut, domestic investors are also expected to benefit from other measures in the proposed tax reform package.

If the new law is passed, domestic companies, like their overseas counterparts, will be allowed to list all the wages they pay as costs, instead of pre-tax deductible items.

Most Chinese companies get a wages deduction of only 1,600 yuan ($206.73) per employee per month, meaning any amount they pay above that is not exempt from corporate tax. "The pre-tax deduction of all paid wages is important for banks because they have a large number of employees and a big wages bill," says She of CITIC China Securities.

Bank of China and the ICBC have "already got the State Administration of Taxation's approval" to raise their wage-deduction threshold.

The new tax system includes other measures that are expected to benefit domestic firms and overseas investors both.

First, the new law will be based more on sectors than regions; preferential tax rates will be granted to firms in high-tech sectors, particularly to biotech and aerospace companies. Preferential rates will also be enjoyed by sectors such as shipbuilding, equipment and machinery, banks, insurance, logistics and the traditional labor-intensive service industry.

Second, the new tax system will encourage corporate firms to take up more social responsibility by raising the deduction rate for donations.

Third, favorable tax rates will be extended to a wide range of sectors such as environmental protection, energy preservation and agricultural infrastructure.

Also, such preferential policies will be adopted across the country, instead of focusing on specific regions.

Four, small-sized enterprises, accounting for a large percentage of businesses, are expected to enjoy favorable tax rates or preferential measures.

(China Daily 03/09/2007 page8)