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Jonathan Story

Legislation to unify two-tiered regime is unlikely to take effect until 2005

A bill to unify China's two-tiered income tax regime for domestic and foreign-invested companies is not expected to take effect until 2005 at the earliest, according to a senior official at the State Administration of Taxation (SAT).

Describing the bill's passage through the National People's Congress (NPC) next March as a theoretical possibility only, the official said it was more likely to be held up by official disagreements.

'There are differences of opinion on almost all of the critical issues,' said the official, who asked not to be identified. 'That's because the new tax scheme touches on a wide range of issues and affects the interests of a great variety of businesses. It's a huge project.'

Points of contention include what the unified tax rate should be, when it should take effect and whether transition periods would be granted.

'Some officials within the SAT think it's China's right but not obligation to amend its tax code [under its commitments to join the World Trade Organisation],' Ernst & Young China executive partner of international accountancy Alfred Shum Yuk-man  said.

Most foreign firms in China pay a corporate income tax of 24 per cent or less because of central and local government policies aimed at attracting foreign investment. This compares with the 33 per cent standard corporate income tax rate imposed on domestic companies.

China was widely expected to unify the two-tiered system to comply with the global trade body's  requirement of a level playing field for domestic and foreign companies after its WTO accession in December 2001. Instead, tax incentives would be put in place to boost investment in certain sectors and in the western hinterland area.

In June last year, then finance minister Xiang Huaicheng  was quoted as saying that 'income taxes for foreign-funded and domestic firms will be unified next year'.

In addition to domestic firms, the tax reform would also benefit foreign companies in service sectors, such as accounting, which had been subject to the 33 per cent rate, Mr Shum said.

Some foreign investors hope the reform will  improve China's taxation transparency by rooting out hidden subsidies for domestic companies.

The SAT had drafted the new tax bill, calling for the standard corporate income tax rate to be unified at about 25 per cent, Mr Shum said.

'Right now, it [the new tax bill] is being continuously refined,' the mainland tax official said. 'Whenever the State Council feels that a consensus has been formed [among government ministries], it will submit it to the NPC.'

As corporate income tax is levied annually, the NPC's rejection in March next year would mean the new bill would not affect companies' tax burdens until 2006 or later.

'There are obviously political issues involved in terms of different views as to what the ultimate tax rate should be,' said Stephen Nelson,  a Hong Kong-based partner of law firm Baker & McKenzie.

The NPC, for one, might prefer a higher unified tax rate, Mr Shum said.

Experts widely expect the new tax bill to contain a five-year grandfathering clause, allowing firms to lock in their existing tax benefits in the transition period.

Acknowledging the clause was likely to be part of the bill, the mainland official said the NPC would have the final say over its inclusion and the length of the transition period.

'People are very concerned about it,' he said. 'So it will be very difficult to dodge the issue.'

Although the mainland official denied it, analysts expected the Sars outbreak in China would have further disrupted the new bill's legislative process.

While mainland officials haggle over the  details, corporate lawyers and tax accountants are advising international clients to take advantage of the delay to push through new China investments and lock in their tax incentives with the  expected grandfathering clause.

'It  gives many companies a window to speed up their investments,' Mr Shum said.



Disagreements expected to  delay China's tax reforms