NPC Approves China's Unified Corporate Tax

by Mary Swire, Tax-News.com, Hong Kong

20 March 2007

A proposal to unify the rate of corporate tax paid by domestic and foreign-owned companies operating in China took a large step towards becoming a reality last Friday when lawmakers voted to approve the measure.

The proposed law would unify corporate tax at a rate of 25%. While this would mean a cut in tax for domestic firms, foreign-backed companies would likely see their tax bill increase.

The new measure was approved by the National People's Congress, China's highest legislative body, on the final day of its annual session, when 2,826 members voted in favour of the legislation, against 37 who opposed it. There were 22 abstentions.

Currently, while the rate of corporate tax is nominally the same for all firms, foreign companies can take advantage of various tax breaks and investment incentives to whittle their effective corporate tax rate in China down to as little as 10% in some cases. Domestic companies cannot avail of such measures and must pay corporate tax on their profits at a rate of 33%, a situation that local businesses say has become increasingly unfair, especially as new foreign investors enjoy a tax holiday for their first two years in China and half the normal tax rate for the next three under current law.

China's tax breaks helped to attract nearly $700 billion in investment over the last two decades, but foreign corporations have in the main backed the move to equalise tax rates in the hope that the change will lead to a more simplified and transparent tax system. There will also be a five-year phase-in period for foreign companies to ease the transition. However, the new law is still likely to grant tax breaks to companies operating in certain industries, such as the technology and energy conservation sectors, to encourage more investment in these areas, although these will be available to domestic firms as well as foreign-invested businesses.

While the government says it is prepared to swallow the reduction in tax revenues brought about by the unified corporate tax, the impact on revenues is expected to be relatively small compared with China's overall tax take, which surpassed US$3 trillion last year. The Chinese government has estimated that it would gain an additional $5.5 billion in revenues from foreign companies as a result of their paying higher taxes, but will forfeit about US$12.5 billion in revenues from domestic firms as a result of them paying less.

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