China economy

US reform bill puts pressure on China to tweak its tax code to avert fund flight, lure investment

PUBLISHED : Wednesday, 06 December, 2017, 7:27am
UPDATED : Wednesday, 06 December, 2017, 10:36pm

China’s tax authorities may have to reconsider whether they should accelerate their plans to simplify the country’s tax code and cut tariffs, as America’s biggest tax reform in three decades could set in motion a global race to slash taxes to attract capital.

US lawmakers are working this week to reconcile the tax-reform bills passed by the House of Representatives and the Senate, before sending the legislation to President Donald Trump to be signed into law.

The proposed bill would consolidate seven tiers of personal income taxes into three, slash the top corporate tax rate to 20 per cent from 35 per cent, and move the world’s largest economy toward a territorial tax system to encourage American companies to return their offshore profits and earnings home.

“The Trump administration’s tax cut plan will give US companies in China a shot in the arm to repatriate deferred profits back home,” said Andrew Choy, international tax leader for Greater China at EY.

The tax burden in China, inclusive of income tax, pension contributions, administrative fees and a variety of surcharges, could be as high as 40 per cent, according to the Unirule Institute of Economics’ 2016 report. The “killer tax” has already sent some of China’s largest companies packing for lower-tax jurisdictions.

Cao Dewang, founder of the Chinese windscreen maker Fuyao Glass Industry Group, last year opened the world’s biggest assembly for automotive glass in the American Midwest state of Ohio, far from his hometown of Fuqing in Fujian province. Zong Qinghou, founder of China’s largest beverages bottler Wahaha Group, has been prowling for an overseas acquisition since 2012, dispatching his daughter Kelly Zong to lead a possible takeover of the biggest US milk processor Dean Foods, according to his May interview with Bloomberg Television. Foxconn Technology, the world’s biggest contract producer of consumer gadgets, announced a plan in August to set up a US$10 billion assembly in the US state of Wisconsin to make display panels.

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The exodus by some of China’s largest corporate tax payers has attracted the attention of the Chinese government, which depends on tax income for up to 80 per cent of fiscal revenue. Income from taxes rose 11.9 per cent in the first 10 months to 12.7 trillion yuan, helping to bolster total fiscal revenue by 9.2 per cent to 15 trillion yuan (US$2.27 trillion), according to the finance ministry’s data.

“How the tax cut lifts American competitiveness, productivity and worker’s wage deserve our high attention,” vice finance minister Zhu Guangyao said during a Beijing forum over the weekend.

To be sure, Chinese Premier Li Keqiang had already put tax reform on his policy agenda, with a 1 trillion yuan plan to slash corporate taxes, reduce fees and reform the value-added tax system, according to his annual work report to parliament in March.

“China has already taken actions to offset the impact, as Beijing is working on plans to allow tax deferral on profits reinvested in China in an attempt to counter the repatriating impetus,” said EY’s Choy.

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Still, the effort had been piecemeal. China provides discretionary tax cuts for small and medium enterprises and offers a 15 per cent preferential tax incentive for high-tech companies, enough to spur the country to rank as the world’s third-largest recipient of foreign investments, according to United Nations data. Those slew of incentives have led to dozens of special economic zones and aspirants to Silicon Valley to sprout all along the nation’s coast.

But the US tax reforms leaves China as one of the few remaining countries among the world’s 20 largest economies to manage taxation based on residency, instead of territory.

A resident-based tax system taxes offshore profits. If the offshore tax rate is higher, no onshore tax liabilities will be incurred. If the offshore rate is lower, then the onshore business must pay the difference in the form of a residual tax. Under a territorial tax system, offshore profits in the form of dividends are tax free to encourage the repatriation of capital back to the home country.

The US tax reforms will put pressure on China to quicken the pace of reforming China’s personal income tax, and lower the value-added tax, which now comprise three tiers with the highest rate at 17 per cent, said Guotai Junan’s analyst Luo Zhihuan.

Additional reporting by Wendy Wu in Beijing, He Huifeng in Guangzhou.