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Kate Watson

Change is in the wind for foreign invested companies in China  that enjoy tax breaks offered by the present taxation system.

China's new Corporate Income Tax Law  (the CIT law) was tabled before this year's National People's Congress and became law on March 16.  Its 60 articles will come into effect on January 1,  by which time the implementation regulations that will provide the finer details should have been issued.

The new law marks the introduction of a unified tax system for both domestic and foreign enterprises and follows many years of discussion and drafting.

'This unification of the domestic and foreign enterprise tax laws is a good thing,' said Anthony Tam Chun-hung, deputy managing partner for tax in southern China for Deloitte Touche Tohmatsu.

'It makes sense in the wake of China's opening up to foreign investment under the terms of joining the World Trade Organisation that domestic and foreign enterprises have the same tax rates and operate on a level playing field,' Mr Tam said.

In drafting the law, Chinese authorities followed three key themes: simplification of the existing tax system; lowering of the corporate tax rates; and the tightening of enforcement through the introduction of general anti-avoidance measures.

Under the new law,  the general corporate income tax rate will be reduced from 33 per cent to 25 per cent. Current tax preferences in the form of reduced rates and tax holidays will end, but there will be a grandfather period of five years, and in some cases 10 years, for firms established before March 16.

The new law proffers a framework under which roughly 90billion yuan  in corporate income tax will be collected annually. This amount accounts for less than 3 per cent of China's total tax revenues. Further details on definition of terms, scope of charge, and application to specific situations will be covered by implementation regulations to be issued by the State Council before  the end of the year.

PricewaterhouseCoopers (PwC) says the current tax regime has in it myriad  circulars and directives issued by various mainland authorities over the past two decades, so it will be a challenge for the authorities to review, align and clarify the ongoing applicability of many existing circulars.  Until these are clarified, corporate income taxpayers in China will face uncertainty on tax positions over many important issues.

However, there are immediate actions that foreign investors may consider taking in the light of the impact of the new law on their Chinese investments, while also maximising its benefits. Among the key implications of the new law that warrant action by foreign investors are the decision to reinstate a 20 per cent withholding tax on dividends payable by a Chinese subsidiary to its foreign investors, and the abolition of the reinvestment tax refund. Neither of these changes come into effect until January 1 next year.

The key is to maximise the opportunity to use those tax incentives that would cease under the new law, according to Danny Po, China tax partner at PwC in Hong Kong.  'Before year end, apply for a reinvestment tax refund and repatriate as much as possible of the dividends from available retained earnings, including interim dividends, because no withholding tax will be imposed before this year end,' Mr Po said.

The reinstatement of withholding tax on dividends also makes it important to establish an investment-holding vehicle in a country having a good tax treaty with China.

Peter Kung, senior partner, KPMG Shenzhen,  draws attention to Hong Kong, which has a double tax arrangement with the mainland with a 5 per cent dividend withholding tax rate. 'Many of the tax havens where some holding companies for foreign enterprises in China are headquartered do not have double tax treaties with China, so if you pay a dividend to these countries it will likely be subject to a higher dividend withholding tax rate than Hong Kong,' Mr Kung said.

'One point for investors to consider is that if they are using a tax haven to hold a Chinese investment then perhaps they should consider a review of their corporate structure.'

Moves by the Chinese government to tighten enforcement are definitely something foreign investors should be aware of. Under the new law, general anti-avoidance and controlled foreign corporation rules, and interest and penalties  on anti-avoidance and transfer pricing adjustments will be introduced.

So firms should review not only current transfer pricing policies and their compliance status but also supply chain and other tax planning to ensure compliance with the new law and the general anti-avoidance provision, according to Stephen Lee, tax partner with Ernst & Young in Shanghai.

'What any foreign investor in China should do now is to study and understand the information available, consult professional advisers and the Chinese tax authorities for clarification in case of doubt, and stay tuned for further developments,' Mr Lee said.

In the longer term,  the advice to corporate income taxpayers in China is to hold an immediate review of their  mode of operations and legal structure. This might include moving regional headquarter functions from China to Hong Kong to avoid worldwide taxation in China. Or it might encompass putting more hi-tech or environmentally friendly manufacturing in China to enjoy various tax benefits including relief on some capital equipment.



Unified system introduces new challenges