The tax honeymoon for foreign investors in China is ending.
For two decades, China has rewarded new investors with hefty tax breaks,
helping lure the nearly US$700 billion (euro530 billion) in investment that has
helped make the country the world's fourth largest-economy, but fueling growing
complaints by Chinese companies about unfair treatment.
Now, China's legislature is expected to end this special status after it
opens its annual session Monday. A law that state media say is expected to be
enacted would equalize tax rates, raising foreign companies' tax bills and
cutting those for many Chinese entities.
"This special treatment could not continue forever," said Winston Zhao, a
lawyer in Shanghai for the U.S. law firm Jones Day who is advising companies on
the change. "Foreign investors have to be prepared mentally, though nobody wants
this to happen."
The change is part of sweeping efforts to modernize China's laws to keep pace
with explosive economic change and meet World Trade Organization commitments to
treat companies equally.
It is too early to
know what the financial impact will be on foreign companies, say business groups
and consultants. But they say major changes in business plans are unlikely,
because companies are still attracted by China's low labor costs and 1.3 billion
potential consumers.
"Companies are largely profitable, in it for the long term here and willing
to put up with a change in the tax system that is more clear and more fair,"
said Robert Poole, vice president of the U.S.-China Business Council, which
represents 250 American companies.
Until now, new foreign investors have been exempt from income tax for two
years and got a 50 percent cut for another three. After that, other breaks such
as for investing in special economic zones could keep taxes as low as 10
percent.
By contrast, Chinese companies pay 33 percent of their profits in taxes.
The new law would set taxes for all companies at 25 percent, with lower rates
for companies in technology development, according to a draft that was given to
foreign companies. It says tax breaks already granted to foreign investors would
continue for up to five years.
"A unified tax code will create a taxation environment that favors fair
competition among all ventures registered in China," Finance Minister Jin
Renqing told lawmakers in December, according to state media.
It is not clear when exactly the new regulations would kick in. China's next
tax year starts on January 1, 2008.
The proposed new tax code is part of efforts to impose uniform business
conditions nationwide. But it isn't clear whether Beijing can enforce the
changes in a system where tax collection is run by local authorities who are
hungry for investment. They often offer huge incentives of their own, and tax
collecting, especially for Chinese companies, is uneven.
"I doubt that it will travel so fast, especially to the remote western
region," said Zhao. "So one can expect that there still will be arrangements
made by local authorities in order to attract or retain investors."
Chinese companies ranging from manufacturers to life insurers loudly
criticize tax breaks for their foreign competitors, especially after Beijing's
WTO entry required it to let more of them into its domestic market.
"We want equal tax rates with foreign companies so that domestic enterprises
in our fields can better compete with overseas counterparts," said a spokesman
for the China Light Industry Federation who refused to give his name. The group
represents companies in manufacturing, publishing and other industries.
China attracted some US$60 billion (euro45 billion) in foreign investment
last year, raising the total over the past two decades to US$659 billion,
according to the government.
While many foreign companies will see taxes rise, the new code could be a
boon to some.
Those that have no operations of their own in China and rely on local
partners for manufacturing will see their partners' taxes fall, said Mary K.
Thomas, director of the international tax department for the Dallas consulting
firm Weaver and Tidwell LLP.
"I'm alerting those folks that when their contracts are up for renewal, they
ought to keep in mind the reduction in the cost of doing business," Thomas said.
"They should get a piece of that decrease."
Zhao said some of his clients are speeding up planned investments to lock in
tax breaks before any legal change takes effect, though none has launched a
project just to beat the deadline.
"If it's already in the pipeline, they certainly would like to accelerate
wherever possible," he said.
