Newsletter
TAX BREAKS UNDER PRC EN-TERPRISE INCOME TAX LAW
On 16 March 2007, the PRC National People's Congress passed the Enterprise Income Tax Law (EITL), which will come into force on 1 January 2008. After the EITL takes effect, the preferen-tial income tax regime that is currently enjoyed by foreign-invested enterprises will be gradually phased out, thus removing the two-track tax system that has differentiated between for-eign-invested and local enterprises, under which some foreign-invested firms have been granted "super-national" treatment.
Before the enactment of EITL, the PRC has al-lowed, on the basis of a 30% enterprise income tax rate, foreign-invested enterprises in different geographical regions and business sectors to benefit from preferential tax rates of 24%, 15%, or 10%, along with a variety of tax holiday ar-rangements, depending on the type of enterprise, that apply from the first fiscal year after the en-terprise becomes profitable. These include one year of tax exemption plus two years of reduc-tion by half, two years' exemption plus three years' reduction by half, two years' exemption plus six years' reduction by half, and five years' exemption plus five years' reduction by half. Certain tax rebates are also granted in respect of reinvestments within China by foreign-invested enterprises. By contrast, many locally invested enterprises have been subject to the full 30% income tax rate, without similar preferential treatment.
The new EITL instead adopts a system of tax incentives from a different perspective. Rather than looking at the "nationality" of the investors involved, the EITL provides preferential treat-ments or incentives primarily based on the des-ignated industrial sectors, and secondarily on the locality of the investments made. The new sys-tem is outlined below:
The EITL abolishes the tax breaks that were available only to foreign-invested enterprises, and mainly grants tax incentives to business sectors whose development the state wishes to encourage. This is specifically expressed in in-centives for investment in certain sectors, to encourage technological innovation and progress, to support agriculture, forestry, animal hus-bandry, and fisheries, and to promote investment in basic infrastructure, as well as giving incen-tives for investment in service enterprises, social welfare enterprises, and enterprises achieving integrated utilization of resources, in order to promote environmental protection, energy sav-ings, and industrial safety. The specific types of preferential tax treatment include the following:
‧Tax exemptions and reductions: For example, small low-margin enterprises, and high-tech and new-technology enterprises that require key state support, are subject to enterprise income tax at reduced rates. Enterprises' in-come from specific projects in agriculture, forestry, animal husbandry, and fishery, in-come from investment in or operation of in-frastructure projects receiving key state sup-port, income from environmental protection and energy or water conservation projects that meet certain conditions, and income from technology transfer projects that meet certain conditions, are exempted from income tax or subject to reduced rates.
‧Offsetting of investments against taxable in-come: A venture capital enterprise that invests in business start-ups in a sector receiving key state support or encouragement can offset a certain proportion of the amount invested against its taxable income.
‧Offsetting of investments against tax liability: A certain proportion of sums that an enterprise invests in purchasing designated equipment for the purposes of environmental protection, energy or water conservation, or industrial safety can be offset against the enterprise's tax liability.
‧Uprated deductions from taxable income: R&D expenditures that an enterprise incurs for the development of new technologies, products, or processes, and wages paid to disabled employees or other persons whose employment is encouraged by the state, can be deducted at a higher rate when calculating taxable income.
‧Discounted calculation of income: An enter-prise's income from products that comply with the requirements of state industrial policy and that it produces with integrated utilization of resources can be counted at a reduced rate when calculating taxable income.
‧Reduced depreciation periods and accelerated depreciation: When there is a genuine need for accelerated depreciation of an enterprise's fixed assets for reasons such as technological progress, the period of depreciation may be reduced, or accelerated depreciation methods may be adopted.
‧Exemption or reduction of taxes payable to autonomous ethnic minority localities: The government of an autonomous ethnic minority locality may decide to reduce or waive the portion of enterprises' income tax liability that would normally go to the autonomous local-ity.
It had been rumored for many years that the in-come tax systems for locally and for-eign-invested enterprises in the PRC would be unified, so the enactment of the EITL should come as no surprise to many Taiwanese and foreign enterprises that have invested in China. The issues that are surely now of greater concern to such enterprises are the period and arrange-ments related to the transition from the old to the new tax system.
Article 57 of the EITL provides that pursuant to PRC State Council regulations, during the five-year period from 1 January 2008 to 31 De-cember 2012, foreign-invested enterprises that were established before the EITL was promul-gated, and that enjoyed preferential treatment under previous legislation or administrative or-ders, may gradually transit to the tax rates pro-vided for by the EITL. After the EITL takes effect on 1 January 2008, foreign-invested en-terprises that enjoy time-limited tax reductions or exemptions may continue to enjoy them until the originally envisaged period expires. However, if a foreign-invested enterprise has not become profitable by 2008, the tax holiday period will nonetheless begin to run from 2008.
Although the EITL sets out the types of prefer-ential tax treatment available and the principles for their applicability, many details remain un-clear. For instance, it contains no express criteria for identifying small low-margin enterprises, or high-tech or new-technology enterprises requir-ing key state support; nor does it define propor-tions for offsetting investments against taxable income or tax liability, or the methods for uprated deduction of expenditures or discounted declaration of income. The above issues all re-main to be clarified in secondary legislation or regulation still to be passed by the State Council. Because the EITL is due to enter into force in 2008, it can be expected that in the coming months the State Council will gradually release related administrative regulations.
For example, it is understood that the State Council is likely to promulgate the implementing regulations to the EITL in October 2007. Clearer and more specific information should then be-come available on many issues that currently remain very unclear in the EITL itself. We will keep our readers informed.