Tax Alert: Chinese Tax Legislation To Unify Domestic and Foreign Corporate Tax Rates
After many years of discussion, the National People’s Congress finally approved the unification of China’s corporate income tax system earlier this year. The new tax law (which will take effect January 1, 2008) calls for increasing the marginal income tax rate for foreign corporations from 15% or 24% (depending on the type of company) to 25%. Simultaneously, the new law lowers the marginal tax rate applicable to Chinese companies from 33% to the same 25% rate applicable to foreign entities. Foreign companies will see their tax rate increase gradually over a five year transition period. Accordingly, foreign companies that have enjoyed special tax rates and other favorable tax provisions can continue to take advantage of preferential tax treatment during the transition period. However, foreign entities newly entering China will be subject to the new tax law from the outset.
Like U.S. tax laws, the new Chinese corporate income tax law has meaningful exceptions and special interest provisions aimed to stimulate development of certain industries. For example, the current preferential tax rate of 15% for certain hi-tech industries which was previously limited to designated areas within China will also now be offered nationwide. Similarly, the new law provides special provisions for companies with “small profits” which will be taxed at a 20% marginal tax rate. Of special note, the new tax law changes the criteria by which Chinese tax authorities will determine the residency of a corporation. In addition to considering the taxpayer’s place of incorporation, tax authorities will also now consider the location of management control as a factor. This may negatively impact some corporations that had previously engaged in corporate restructuring to take advantage of the more favorable tax regime for foreign corporations.
Of course, as further details and guidance are released by Chinese tax authorities in the coming months, it is certain to present new opportunities and challenges for foreign companies already in, or contemplating entering, China.