New rules provide fresh challenges
The implementation of a new corporate income tax (CIT) system in mainland China in January could provide a spur for high-end enterprises vying to establish strategic positions in the domestic market.
The new tax system uses a predominantly industry-oriented approach compared to the previous geography-based tax policy. Under the old regime, companies often enjoyed tax incentives based on where they were located rather than what they produced. And domestic-invested enterprises and foreign-invested enterprises were taxed at different rates.
Foreign-invested enterprises were often taxed at a lower rate than mainland companies and enjoyed tax holidays and tax incentives by locating their businesses where it was considered would generate employment and contribute to the local economy. Dongguan, for instance, was among the first to offer tax incentives to foreign-invested enterprises and Hong Kong businesses when the mainland began opening up to foreign investment in the late 1970s.
While corporate income tax brings about parity between foreign and domestic-invested companies, there is uncertainty as to which business sectors qualify for tax benefits under the government's proposal to encourage manufacturers and service industries to focus on added-value and higher end production.
The challenge for accountants was to help clients understand and comply with the new legislation. They also need to help clients comply with new financial reporting requirements and manage their businesses in the new tax environment efficiently.
PricewaterhouseCoopers National M&A tax leader, Tax and China Business Service Danny Po said the corporate income tax system was both significant and fundamental for companies and the accounting profession involved in activities in the mainland. 'Any time a major reform such as the CIT takes place it creates challenges and opportunities.'
The unified CIT consolidates two separate enterprise income tax regimes for domestic and foreign-invested enterprises into a single regime. Mr Po said it could pave the way for foreign-invested enterprises to look for retail and distribution opportunities within the mainland's fast-growing consumer market as the new tax system could provide attractive incentives.
While companies engaged in businesses such as low-end manufacturing could face increased tax payments, others could benefit under the new system. Low-end manufacturing companies will also need to look at expansion plans and future investments to evaluate their tax exposure.
'I don't believe the new CIT is sending the wrong message to mainland investors as it provides incentives for companies to engage in hi-tech or new-tech content of their products and production technology, and areas which are in line with industry sectors and projects encouraged and supported by the mainland government,' said Mr Po.
He said PricewaterhouseCoopers had been familiarising clients with the changes by staging seminars and knowledge sharing presentations. The firm has also been helping clients to conduct tax compliance health checks and evaluate the impact the new tax regime could have on current mainland operations and future investments. 'We have been working with clients and joined with Hong Kong and mainland tax authorities in ongoing dialogue to cover areas such as transfer pricing and double taxation.'
Transfer pricing occurs when one part of an organisation transfers or sells goods, services or know-how to a sister company. The price charged for these goods or services can be arbitrary. Mr Po said transfer pricing regulations were being developed as part of the overall tax reform policies.
He said there were many variables and tax incentives for companies involved in energy-efficient production, high-end research and development, and those offering environmentally friendly products and services. To minimise any adverse impact on existing operations, companies enjoying tax benefits will gradually have their tax rates increased to the standardised rate over the next five years.
Winnie Cheung Chi-woon, chief executive and registrar at the Hong Kong Institute of Certified Public Accountants, said the corporate income tax reform had brought the foreign-invested businesses in line with Chinese domestic enterprises from a tax incentive perspective. New tax interpretation rules are also more in line with the international tax practices. 'This is a reflection of the increased complexity of the business transactions in the mainland as well as the Chinese government's willingness to protect its revenue resource,' said Ms Cheung, noting that foreign-invested enterprises could face more stringent requirements concerning compliance issues.
She said the demand for mainland tax law knowledge, regulations and practices was increasing rapidly as the mainland's economic growth remained strong and attractive to foreign investors.
Ms Cheung said Hong Kong accounting professionals were well-trained to an international standard with good knowledge of best practices to help Hong Kong and international companies navigate the new tax regulations.
Many international certified public accountants firms in Hong Kong have established a close network with local firms in the mainland to provide first-hand and localised services to clients. Such networks and liaison is expected to expand rapidly.
Peter Kung, head of China Tax, Southern China region and Hong Kong at KPMG China, said there were still some uncertainties regarding the way companies operating in different industry sectors would be affected by the new tax system. 'There are some tax incentives for high-end companies and certain infrastructure projects, but the qualifying conditions have not yet been clearly defined,' he said. The challenge and opportunities for Hong Kong accountants is to help their clients fully understand the new regulations and identify areas where operating changes may be required.
Under the corporate income tax system some foreign-invested companies operating in the servicing, banking and insurance, retail and trading industries could find their tax rate reduced from 33 per cent to 25 per cent. Those involved in low-end manufacturing may face an increase from 15 per cent to 25 per cent. However, their effective tax burden may not necessarily increase substantially if they qualify for new tax incentives.
Daisy Kwun, a tax partner at Deloitte Touche Tohmatsu, said recent circulars and clarification documents issued by the mainland tax authority were helping accountants assist their clients with the transition from the old system to the new system. 'With the cancellation of the general manufacturing tax holidays, we need to help our clients re-evaluate their operating procedures, for instance, whether a company involved in a certain manufacturing sector could benefit from tax incentives by increasing R&D activities or focusing more on high-end production.'
Some industries will need to make provisions to pay more tax while other industries such as the service sector, high-end technologies and the finance sector could benefit from the new tax system.