Beijing increases tax on foreign firms to 18pc

Rise adds to costs also driven higher by new labour law

Foreign companies in mainland coastal regions will greet the new year with a three percentage point rise in income tax to 18 per cent - an unexpectedly high increase that will deal yet another blow to tens of thousands of manufacturers.

As a core part of a sweeping overhaul of the mainland's tax regime, the central government revealed over the weekend that the new tax rate would be raised progressively by two percentage points in 2009, 2010 and 2011 to 25 per cent in 2012, while mainland incorporated firms will have their tax lowered from 33 per cent to the same level in 2012.

Many tax experts said that the four-year transition was shorter than expected and a bigger tax bill would add to the woes of some 60,000 Hong Kong factory owners operating across the border that have already suffered shrinking profitability as a result of higher costs for labour, raw materials, electricity and land, as well as an appreciating yuan.

However, companies in hi-tech developments in five special economic zones - Hainan, Shantou, Shenzhen, Xiamen and Zhuhai - and Pudong New Area in Shanghai will be offered two-year tax holidays and half of the 25 per cent tax rate for the following three years.

'The new rate will begin at a harsher than expected level, and will jump to 25 per cent within four years instead of five years, which will increase costs and make the livelihoods of Hong Kong manufacturers even more difficult,' said KPMG tax partner Bolivia Cheung in Guangzhou yesterday.

'The new regime also shows China's strong push into hi-tech development and the manufacturing of higher value goods.'

Beijing's efforts to create a level playing field for domestic and foreign firms by introducing a universal 25 per cent tax rate by 2012 mark the end of the low-tax era of the past 20 years. By comparison, corporate tax in Hong Kong is 17 per cent.

Tomorrow will mark the start of a harsher year for manufacturers when a new labour contract law and the new tax rate come into effect.

Some economists fear the two new rules, which elevate tax and labour costs, will lead to a more hostile operating environment forcing financially vulnerable manufacturers to the brink of collapse in the lead-up to the Lunar New Year.

Tommy Leung, president of the 630-member Hong Kong Watch Manufacturers Association, said the bigger tax bill was yet another thorny issue for factory owners, particularly exporters.

'It is fair to have a level playing field,' Mr Leung said. 'But the tax issue is only one of the unfavourable factors that make operations more difficult.'

He said the biggest problem facing manufacturers was the policy forcing them to upgrade from labour-intensive, resources-driven, energy-consuming and highly polluting production processes to higher value products.

'The policy makes sense, but we hope the central government will extend the transition period,' Mr Leung said. He added that the watch industry needed clearer guidance on pollution controls with regard to the environment-unfriendly production process of electro-plating.

Eddie Lam Kwong-tak, chief executive of Onlen Fairyland (HK), a shoe exporter with 22 factories and 40,000 employees in Guangdong, Shanghai and Fujian, said the firm planned to offset the additional tax burden by expanding sales in the mainland.

Frustrated, Mr Lam said the inflated tax bill would add to a 40 per cent rise in labour costs next year as a result of the new labour contract law.

'We have tried to tap the domestic market for 10 years, but it only generates 20 per cent of our turnover at present,' he said. 'It is a massive market, but very competitive.'