Is China's tax heavy for enterprises?

Tax expense is a significant cost of doing business. Many enterprises actively seek to minimize their tax bills when structuring their business transactions. They also generally prefer low-tax countries in their global expansion.

From time to time, we hear comments that taxes for enterprises are high in China. Yet China has been a favorite destination for foreign direct investment. So how do enterprises make profits in China when the tax burden is heavy?

The key benchmark for the corporate tax burden is enterprise income tax. The standard enterprise income tax rate in China is 25 percent. China also offers a range of tax holidays and reduced tax rates to enterprises in targeted industries and activities. For example, for companies that qualify as "high and new technology enterprises" and "key software enterprises", the statutory tax rate is reduced to 15 percent and 10 percent respectively, in addition to a five-year tax holiday.

China also allows for super-deduction on research and development expenditure which helps reduce the effective tax rate further.

But how competitive is China's enterprise income tax regime when compared with other tax jurisdictions?

In 2020, the Organisation for Economic Co-operation and Development conducted a study comparing the corporate tax burdens in different countries. The results were published in a report titled "Corporate Tax Statistics" (third edition), which showed that China's effective average tax rate was 23 percent, only slightly above the global average rate of 20.4 percent.

Among the 77 jurisdictions surveyed, which included six tax havens, China figured in the middle, in the 33rd place. Many economies in the Asia-Pacific region such as Japan (29.4 percent), Australia (28.1 percent), New Zealand (27.1 percent) and the Republic of Korea (25.9 percent) have higher effective average tax rates than China. This suggests China's corporate income tax regime is fairly competitive, especially in the Asia-Pacific.

However, reviewing the effective average tax rate alone does not provide a comprehensive picture. With countries competing fiercely for investment in advanced technology, enterprises with significant R&D expenditure will assess the tax preferences offered when deciding where to set up their R&D units.

Therefore, comparing the effective average tax rate for R&D investments across jurisdictions gives a deeper insight into the incentives provided by the tax system for the location of profitable R&D investments.

According to Corporate Tax Statistics, the R&D-effective average tax rate for China is 11.7 percent, about half of the effective average tax rate (23 percent), which is almost the same as in the United Kingdom and France, and significantly lower than in the ROK (24.04 percent), Australia (22.69 percent), the United States (20.12 percent), Japan (19.29 percent) and New Zealand (17.33 percent).

The real-life impact of China's tax preferences available to qualified enterprises is reflected in public information such as the annual reports of listed groups. Take technology giant Baidu as an example. In the 2020 fiscal year, Baidu's tax was slashed by 4.4 billion yuan ($690.72 million) thanks to R&D super-deductions worth 1.5 billion yuan, and preferential tax rates and tax holidays worth 2.9 billion yuan. As such, Baidu's effective tax rate in 2020 was 17.6 percent. Without the above-mentioned tax reliefs, the effective tax rate would have been close to 30 percent.

For qualified small-and-low-profit enterprises (enterprises that are not engaged in restricted or prohibited industries with taxable profit not exceeding 3 million yuan, not more than 300 employees, and with total assets not exceeding 50 million yuan), the first 1 million yuan of annual taxable profit is currently taxed only at 2.5 percent. The portion of taxable profit above 1 million yuan but below 3 million yuan is taxed at 10 percent. For example, if a qualified enterprise's annual taxable profit were 2 million yuan, its effective tax rate would be just 6.25 percent, which is even lower than the preferential corporate tax rate of 8.25 percent in the Hong Kong Special Administrative Region.

In summary, the Chinese mainland's tax regime is competitive internationally, especially among its major competitors in the Asia-Pacific region. Young enterprises can enjoy high preferential tax rates when they start making profits. Therefore, it is not surprising that so many enterprises, both foreign and domestic, have blossomed on the mainland.

The author is a member of the 13th National Committee of the Chinese People's Political Consultative Conference, and former president of the Taxation Institute of Hong Kong.