Until recently, foreign-owned business operating in China have been able to benefit from a series of tax incentives that were established under Chinese law. These tax incentives provided many foreign-owned entities with a tax rate of just 15% or less, which was much lower than the standard 33% applicable to domestic businesses. However, on March 16, 2007, the Chinese government enacted a new income tax law that will significantly reduce these tax incentives and change the way China will tax foreign-owned businesses in the future.
Some of the changes to be made by this new Chinese tax law reflect minor changes to the existing tax rules. For example, the new law includes a gradual five-year phase-out of tax holidays for qualifying production companies. That incentive previously allowed for a two-year tax exemption followed by a 50 percent tax reduction for these years. In addition, the new tax law indicates that certain foreign-owned businesses may still qualify for a reduced 15% tax rate if they constitute a new or high-technology enterprise.
Other changes by the new Chinese tax law represent significant departures from the existing tax rules. First, implementing guidance will provide for increases of withholding taxes on repatriation in the form of dividends, interest, royalties, rentals, and other fees. In addition, the new law, which becomes effective on January 1, 2008, provides for a 25% tax rate for both domestic and foreign-owned entities.
The new law was released in the form of a “policy statement” which is only 15 pages long. As a result, the exact details of these new Chinese tax laws are not yet known. However, the policy statement clearly states that the new law will include anti-avoidance rules and that there will be the management and control standard to determine residency for tax purposes. Thus, these upcoming tax law changes, coupled with this anti-avoidance regime, will increase the need for specialized tax and structural planning to minimize the adverse effect that these new tax rules will have on foreign-owned business that are operating in China.
The new tax law in China will significantly change the analysis that previously applied to foreign-owned business that were considering establishing operations in China. U.S. businesses that are already conducting or plan to conduct business in China should consider whether these changes would impact their current or planned structure.
