Impact of China's New Corporate Income Tax Law on Foreign Investments

China's New Corporate Income Tax Law ("CIT"), which was promulgated on 16 March 2007 by the People's National Congress, unifies the corporate income tax rate at 25% for both domestic enterprises and foreign invested enterprises ("FIE") with effect from 1 January 2008. FIEs established in the Special Economic Zones and Pu Dong New Area used to pay income tax at 15%. The tax rate will be gradually uplifted to 25% in a transitional period of 5 years from 2008. In addition, enterprises, which are classified as "small and thin-profit", are entitled to a reduced corporate tax rate of 20%. "Small and thin-profit" enterprises are defined in the Detailed Implementation Rules that, among other things, their annual profits before tax must not exceed RMB300,000. Enterprises engaged in State-encouraged high and new technology sectors enjoy a generous preferential tax rate of 15%. Enterprises engaged in agriculture, forestry and animal husbandry are exempt from tax. The above tax reductions and tax exemption are applicable to both domestic enterprises and foreign invested enterprises.

In contrast to the previous exemption from withholding tax on dividends repatriated by FIEs to their foreign investors, CIT imposes a withholding tax of 10% on dividend, interest, royalty and rental.

CIT has removed many preferential tax treatments conferred on FIEs, such as 2 years tax exemption and 3 years 50% tax reduction. Old FIEs, registration completed before 16 March 2007, are granted a grandfather rule of enjoying the above tax incentives until they expire. Old FIEs which have not started their tax holidays due to, for instance, loss making, are deemed to commence their first year tax exemption in 2008 regardless of their making profit or loss, until the incentives expire in 2012.

New incentives are, however, available to enterprises engaged in State-encouraged public infrastructure projects, environmental protection, water and resources conservation. They are exempt from tax for 3 years from the first income year and taxed at half rate for the subsequent 3 years.

On the other hand, CIT has introduced anti-tax avoidance measures, which include "thin-capitalisation" rule and "control foreign corporation" rule. The thin capitalisation rule sets a limit on interest paid to related parties by fixing a debt to equity ratio, whereas the control foreign corporation rule brings the profits of a foreign corporation to be taxed in China if they are under the control of a Chinese tax resident, as different from the previous remittance basis. The CIT has also tightened controls on transfer pricing arrangement.

The unification of corporate income tax rate has brought the domestic enterprises and the FIEs to a level playing field. The new incentives aim to encourage more investments in high and new technology sectors as well as environmental protection.

For further information, please contact Mr. Albert Cheung at +852 2894 6830 or albert@ccifcpa.com.hk.

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