By Josh Bramlett
As China and Asia are slowly becoming the manufacturing center of the world, its tax decisions are now drawing a lot more attention. China has passed new tax laws regarding foreign investment entities. The following is a summary taken from translations of the new laws, which are expected to go into effect in 2008.
There will be a unified tax enterprise income tax of 25 percent to bring Foreign Investment Entities in line with domestic businesses and a top withholding rate of 20 percent. Most commentators on this topic seem to favor this move by the government. The government has suffered bad publicity as a result of foreign businesses being subject to a lower tax rate than domestic businesses. Previously, domestic enterprises were subject to taxes of approximately 33 percent, while foreign-owned enterprises were paying an average of 15 percent after incentives. Existing foreign companies will have a five-year transition period with a gradual increase in tax rates throughout the period.
It is uncertain how increased tax rates will effect foreign investment in China. As a result of the increase, Vietnam and Taiwan will have lower tax rates on new investments and similar employee pay scales. Attracting foreign investment has been a major factor in economic planning for all of China during the previous five years. However, growth has been mainly concentrated in the coastal areas of China. There is still a major emphasis on developing the western part of China, and a desire to upgrade manufacturing capabilities. It is anticipated that special exceptions to the new tax laws may be implemented in order to meet such goals.
China still has a preferential tax regime for high-technology enterprises, which are taxed at 15 percent. There is also a 20 percent tax rate for small-scale enterprises. Additionally, China is trying to convert its manufacturing sector to produce higher margin types of goods and to domestically produce more high-end goods. This would result in meeting a major economic goal of the country to eliminate the need to import large and expensive manufactured items.
China is also eliminating the traditional broad tax holidays for more focused industry-specific tax holidays. The tax holidays enjoyed by current investors in China will continue in the short term. However if a current investor has not started its tax holiday period because it has not been profitable, the company would still be forced to commence the holiday term in 2008.
There was a small host of anti-abuse provisions in the new Enterprise Income Tax Act, including new transfer pricing rules with more guidance. The tax authority will also have the ability to adjust the income of enterprises engaged in activities considered to be tax shelters. Further, Chinese enterprises can no longer deduct losses of an overseas branch. This provision appears to be an extreme version of the duel consolidated loss rules that most countries currently have in their tax laws. Statutes are also expected to implement a debt-to-equity ratio for determining the deductibility of interest.
Not all changes are unfriendly to taxpayers. "Super" deductions (deductions equal to 150 percent or more of the amount spent) are still in effect for research and development expenditures, as well as for salaries paid to disabled workers. In addition, there appear to be several tax credits available for venture capital, special equipment purchased for environmental protection, energy and water conservation and worker safety expenditures.
Overall, it is anticipated that China will see only a slight slow down in growth over the next few years due to these tax increases. It appears that the manufacturing sector has accumulated enough critical mass to allow this sector to continue growing without the current foreign investment tax incentive regime due to the anticipated increase in domestic consumption. China is a huge potential marketplace and most multinational enterprises aim to capitalize on the projected economic growth in this region. Thus, it appears that the outlook is still good for business development in China.
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Decosimo has significant experience with international business affairs and has committed a team of professionals to work in this area exclusively. From transfer pricing to captive insurance design, Decosimo provides a full range of advisory services for both international companies conducting business in the United States and domestic companies conducting business abroad.
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