The following is the full text of the Explanation on the Draft Enterprise Income Tax Law of the People's Republic of China, delivered by Finance Minister Jin Renqing at the Fifth Session of the Tenth National People's Congress on Thursday:
Explanation on the Draft Enterprise Income Tax Law of The People's Republic of China
(Delivered at the Fifth Session of the Tenth National People's Congress on March 8, 2007)
Minister of Finance, People's Republic of China
Entrusted by the State Council, I now wish to give you an explanation on the Enterprise Income Tax Law of the People's Republic of China (Draft).
To improve the socialist market economy and to unify the income tax system for all kinds of enterprises as called for at the Third Plenary Session of the Sixteenth Central Committee of the Communist Party of China, the Ministry of Finance, the State Administration of Taxation and the State Council Legislative Affairs Office worked together and drafted the Enterprise Income Tax Law of the People's Republic of China (version for comments) by taking into account the new developments of China's economy and society. In 2004, written comments were sought from the Financial and Economic Affairs Committee of the National People's Congress (NPC), the Legislative Affairs Committee of the Standing Committee of the NPC, the Budget Affairs Committee of the Standing Committee of the NPC, the people's governments of all provinces, autonomous regions, municipalities directly under the Central Government and municipalities separately listed in the State plan, and relevant departments of the State Council. Roundtable discussions were also convened among relevant ministries, enterprises and experts respectively to seek their comments. In 2006, comments were solicited again from 32 departments and agencies of the Central Government. The parties concerned generally agreed that it was quite necessary to accelerate the reform of the income taxation system for domestic and foreign-funded enterprises (including Chinese-foreign equity joint ventures, Chinese-foreign contractual joint ventures, wholly foreign-funded enterprises and foreign enterprises, the same as below), and enact and enforce a unified enterprise income tax law as soon as possible to create a uniform tax environment for fair competition among all kinds of enterprises. The Enterprise Income Tax Law of the People's Republic of China (Draft) (hereinafter referred to as the Draft) was then prepared with further revision and improvement on the basis of the views from all parties concerned. After being discussed and adopted at an Executive Meeting of the State Council, the Draft was submitted to the Standing Committee of the NPC on September 28, 2006 for deliberation. The Draft was deliberated at the 25th Meeting of the Standing Committee of the 10th NPC. In January this year, the General Office of the Standing Committee of the NPC circulated copies of the Draft to NPC deputies and organized discussions of the Draft. Members of the Standing Committee and NPC deputies generally held that it is the right time to enact a unified enterprise income tax law and that the Draft is basically feasible. At the same time, they put forward some suggestions to revise the Draft. On the basis of views of members of the Standing Committee and relevant special committees of the NPC and those of NPC deputies, the State Council made more revisions to the Draft and submitted it to the NPC for deliberation. I am now making the following explanation on the Draft:
I. Necessity and timing for this legislation
Domestic and foreign-funded enterprises in China are now governed by different legislations on enterprise income tax. Foreign-funded enterprises are governed by the Income Tax Law of the People's Republic of China for Enterprises with Foreign Investment and Foreign Enterprises (hereinafter referred to as the Tax Law on Foreign-funded Enterprises) adopted at the 4th Session of the 7th NPC in 1991, whereas domestic enterprises are governed by the Provisional Regulations of the People's Republic of China on Enterprise Income Tax (hereinafter referred to as the Tax Law on Domestic Enterprises) promulgated by the State Council in 1993. In order to attract more foreign investment and develop China's economy, a series of tax policies were implemented for foreign-funded enterprises since the adoption of the reform and opening-up policy in China at the end of 1970s, which are different from those for domestic enterprises. Those different tax policies have proved necessary in practice and played an important role in promoting reform and opening-up to the outside world, attracting foreign investment and developing China's economy. By the end of 2006, 594,000 foreign-funded enterprises had been approved nationwide in total and US$691.9 billion of foreign funds used. In 2006, all these foreign-funded enterprises paid US$795 billion in all types of taxes, accounting for 21.12 percent of the total national tax revenue.
Great changes have taken place in China's economy and society, and the socialist market economy has initially taken shape. With China's accession to the WTO, the Chinese domestic market has been further open to foreign capital; domestic enterprises have gradually integrated themselves into the world economy and are facing ever-increasing competition. If different tax policies continued to be implemented for domestic and foreign-funded enterprises, the former would definitely be put at a competitive disadvantage and the establishment of a unified market with standardized and fair competition would be obstructed.
Moreover, problems are becoming increasingly manifest in the implementation of the current income tax systems for domestic and foreign-funded enterprises and these taxation systems can no longer meet new situations in China:
First of all, rather large differences between the current domestic and foreign-funded enterprise tax laws have imposed unfair tax burden on different enterprises. Under the current income tax laws, foreign-funded enterprises enjoy more favorable and preferential treatment than that for domestic enterprises with respect to policies in tax preference and deductions. An estimate based on a national survey of enterprise income tax sources shows that the average enterprise income tax burden on foreign-funded enterprises is 15 percent while that on domestic enterprises is 25 percent, 10 percentage points higher than that on foreign-funded enterprises. Domestic enterprises strongly call for unifying taxation treatment and fair competition.
Secondly, some loopholes in current preferential policies on enterprise income tax distort enterprise behaviors and lead to revenue loss. For instance, some domestic enterprises enjoyed tax preference for foreign-funded enterprises by transferring their funds abroad and then investing them back to China.
Thirdly, great changes have taken place in China's economy and society during the past decade and more since the current domestic enterprise tax law and foreign-funded enterprise tax law were enforced. It is therefore necessary to have them timely revised and improved in line with new situations. Many important taxation policies in regulatory documents issued by government agencies shall also be timely incorporated into law.
In order to solve above mentioned problems in current enterprise income tax systems, it is necessary to unify domestic and foreign-funded enterprise income tax as soon as possible. The reform of unifying the two income tax laws will not only promote improvement in China's economic structure and upgrading of its industries, but help foster a legal taxation environment for fair competition. It is an institutional innovation adaptable to the new stage of China's socialist market economy and a supporting measure embodying "Five Balances" which will promote the sustainable development of the national economy and society. It is one of the landmarks featuring the gradual maturity and standardization of China's economic system, and a consensual voice of all walks of life.
China's economy is at a stage of rapid development. The overall performance of enterprises has increased considerably in recent years and fiscal revenues maintained strong momentum of growth. Under such circumstances, the conditions are ripe to launch such a reform by drawing on foreign practices because both the Government and enterprises are financially stronger to withstand the impact of the enterprise income tax reform.
II. Guidelines for and principles of the enterprise income tax reform
The guidelines for the enterprise income tax reform are as follows: to establish a scientific and standardized enterprise income tax system uniformly applicable to various types of enterprises and create an environment for fair competition among all enterprises in accordance with the overall requirements of the Scientific Outlook on Development and for improving the socialist market economy by basing the tax reform on the principle of simplifying tax regimes, broadening tax base, lowering tax rates and strictly enforcing administration of tax collection, and by drawing on international experience in this regard.
According to above-mentioned guidelines, the enterprise income tax reform will follow the principles below:
(1) the principle of equalizing tax burden to solve the problem of different tax treatment and largely differentiated tax burden between domestic and foreign-funded enterprises;
(2) the principle of putting into effect the Scientific Outlook on Development to make overall planning for a coordinated economic, social and regional development, promote environmental protection and social progress in an all-round way, and achieve a sustainable development of the national economy;
(3) the principle of giving full play to taxation as a regulatory instrument to promote industrial upgrading and technical progress, and optimize the structure of the national economy as required by the industrial policy of the State;
(4) the principle of referring to international practice to draw on the latest experience of tax reform in the world, and further enhance and improve the enterprise income tax system, and make tax law scientific, complete and forward-looking;
(5) the principle of rationalizing distribution relations to effectively collect fiscal revenues by taking into account both the fiscal affordability of the Government and the burden on taxpayers; and
(6) the principle of facilitating and standardizing tax collection to make tax payment easier and reduce the cost for both taxpayers and tax administrators
III. Main provisions of the Draft
Based on above-mentioned guidelines and principles and with reference to international practice, the Draft highlights "four unifications", that is, unification of income tax law applicable to both domestic and foreign-funded enterprises; unification and appropriate reduction of enterprise income tax rates; unification and standardization of deduction; and unification of preferential income tax policies to introduce a new preferential tax system of granting the industry-based incentives as the mainstay while the region-based ones as the supplement. What should be particularly explained here is that, after the NPC adopts the Enterprise Income Tax Law of the People's Republic of China (hereinafter referred to as the new Tax Law), the State Council will formulate implementing regulations according to the new Tax Law, which will further detail relevant provisions and become effective at the same time with the new Tax Law.
(1) Tax rate
The income tax is currently levied on domestic and foreign-funded enterprises at the same rate of 33 percent. In addition, foreign-funded enterprises in some special regions are levied tax at a preferential rate of 24 percent or 15 percent, and domestic low-profit enterprises are levied tax at two brackets of special rates of 27 percent and 18 percent respectively. Too many brackets of tax rates contribute to a relatively large disparity between nominal income tax rate and effective income tax burden of various types of enterprises. Therefore, it is necessary to unify the income tax rate between domestic and foreign-funded enterprises.
The Draft sets a new tax rate of 25 percent (Paragraph 1 of Article 4). It is mainly intended to ease the tax burden on domestic enterprises, and keep a rise as little as possible in tax burden on foreign-funded enterprises. The loss of revenues should be within an acceptable margin and the level of enterprise income tax rates in the world, especially the neighboring countries (regions), has to be taken into account. The average enterprise income tax rate is 28.6 percent in 159 countries (regions) around the world in which an enterprise income tax is applied, while that in China's 18 neighboring countries (regions) is 26.7 percent. The rate of 25 percent set in the Draft is relatively low in the world and will be conducive to enhancing enterprise competitiveness and attracting foreign investment.
2) Tax preference
(i) Main provisions
In order to unify the income tax burden on domestic and foreign-funded enterprises, the Draft integrates existing preferential income tax policies in the following five manners, taking into account the new situations of tax reform in various countries. Firstly, the Draft applies a preferential rate of 20 percent to eligible small low-profit enterprises and a preferential rate of 15 percent to hi-tech enterprises receiving priority support from the State (Article 28 of the Draft), and grants more tax preferential treatment to venture investment enterprises (Article 31 of the Draft) and to enterprises investing in environmental protection, energy and water conservation, work safety, and so on (Article 34 of the Draft). Secondly, the Draft retains the preferential tax policy on investment in agriculture, forestry, animal husbandry, fisheries and infrastructure construction (Article 27 of the Draft). Thirdly, the Draft replaces the policy of direct tax reduction or exemption with a substitute preferential policy for labor service enterprises, welfare enterprises and enterprises making comprehensive use of resources (Articles 30 and 33 of the Draft). Fourthly, transitional preferential tax treatment shall apply to newly-established hi-tech enterprises receiving priority support from the State and located in special zones prescribed by law to develop foreign economic cooperation and technological exchanges (i.e. special economic zones) or in the zone where the special policies for above-mentioned special zones are implemented with the approval of the State Council (i.e. the Pudong New Area in Shanghai). The income tax preferential policies for other State-defined enterprises the development of which are encouraged (i.e. enterprises the development of which are encouraged in the Western Development Region) will continue to be implemented (Article 57 of the Draft). Fifthly, some preferential policies are canceled. For example, the regular tax reduction and exemption for production-orientated foreign-funded enterprises as well as the 50 percent tax reduction for export-oriented foreign-funded enterprises are abolished. In addition, based on the opinions of some NPC deputies, it is provided in the Draft that enterprises may enjoy tax reduction and exemption treatment for their "income from environmental protection projects" and "income from eligible technology transfer" (Article 27 of the Draft), demonstrating the country's policy to encourage environmental protection and technological progress. Through the aforesaid integration, tax preferences provided for in the Draft mainly cover promotion of technological innovation and progress, encouragement of infrastructure construction, agricultural development, environmental protection and energy conservation, support to work safety, promotion of public welfare, support to disadvantaged groups, and special tax reduction and exemption for relief of natural disasters (Chapter IV of the Draft).
Hi-tech enterprises and small low-profit enterprises play a special role in the national economy. International practice indicates that it is necessary to apply favorable tax rates to hi-tech enterprises and small low-profit enterprises receiving priority support from the State. Given that the definition of a hi-tech enterprise or a small low-profit enterprise is an issue of policy implementation and the standards for such definition should be updated with the new developments and changes incorporated, it will be appropriate to set such criteria in the implementing regulations. Research and assessment on such criteria are being conducted by the relevant departments of the State Council.
(ii) Transitional measures for enterprises enjoying the existing statutory tax preferential treatment
Introduction of the new Tax Law will increase the income tax burden on some old enterprises. To ease this impact, the Draft develops some transitional preferential measures for old enterprises established before the promulgation of the new Tax Law which enjoy low tax rates or regular tax reduction and exemption treatment under current tax laws and administrative regulations. According to these transitional measures, old enterprises entitled to enjoy an income tax rate of 15 percent or 24 percent under the current tax laws may, pursuant to the regulations of the State Council, continue to enjoy a gradually increasing transitional income tax rate within five years after the new Tax Law becomes effective. Old enterprises entitled to enjoy regular tax reduction and exemption treatment under the current income tax laws may continue to enjoy remaining incentives in accordance with the requirements and period specified by the current income tax laws. However, for enterprises that have not made any profits and thus not enjoyed such preferential treatment, the period for enjoying preferential treatment shall be calculated from the year in which the new Tax Law becomes effective.
Given the policy considerations and complex background of these transitional measures, it is provided in the Draft that the State Council shall develop measures for implementing such transitional incentives (Article 57 of the Draft).
(iii) Taxpayers and their obligation to pay tax
When levying tax on organizations or entities other than individuals, most countries use "legal person" to define a taxpayer, and the reform to the enterprise income tax system should be accordingly orientated towards the introduction of a legal person tax system. Therefore, the Draft no longer uses the "independent economic accounting" criteria in the current Tax Law on Domestic Enterprises to define a taxpayer. Meanwhile, it defines a taxpayer as an enterprise or other organization that earns income. Such provision is basically in conformity with the relevant provisions of the current tax laws. To avoid double taxation, the Draft does not apply to individual proprietorship enterprises and partnership enterprises.
To be compatible with international practice, the terms of "resident enterprise" and "non-resident enterprise" are used in the Draft. A resident enterprise shall perform comprehensive obligation of tax payment and pay tax on all of its income from sources inside and outside the territory of China. A non-resident enterprise
shall perform limited obligation of tax payment and generally pay tax on its income from sources inside the territory of China. In the international community, several criteria may be used to define a resident enterprise, such as the "place of registration", "place of effective management" and "place of head office"; and most countries adopt a combination of two or more above-mentioned criteria. In light of the actual conditions in China, resident enterprises and non-resident enterprises are defined in the Draft by combining the criteria of "place of registration" and "place of effective management" (Article 2 of the Draft).
Taxable income is the base to calculate the amount of the income tax payable by an enterprise. According to the Draft, the taxable income of an enterprise is the amount remaining from its gross income in a tax year after the excluded income, exempted income, deductions, and carry-forward loss in previous years are deducted (Article 5 of the Draft).
In the Draft, "gross income" is defined as "an enterprise's monetary and non-monetary income from various sources" (Article 6 of the Draft). "Excluded income" is defined as income from fiscal funds such as fiscal appropriations, administrative charges subject to fiscal administration and government funds (Article 7 of the Draft). "Exempted income" is defined as income from interests on treasury bonds and from equity investment such as dividends and bonus between eligible resident enterprises (Article 26 of the Draft). These definitions clarify the scope of the taxable income of an enterprise.
(b) Deductions and taxation of assets
Domestic enterprises and foreign-funded enterprises are now subject to different deduction of costs and other expenditures as far as income tax is concerned. For example, a limited deductible salary and wage system applies to the income tax of domestic enterprises while an actual salary and wage deduction system to the income tax of foreign-funded enterprises. The Draft unifies the policy for deducting various actual expenditures of enterprises, prescribes the standards for deducting expenditures for public welfare donations (Article 9 of the Draft) and defines the scope of nondeductible expenditures (Article 10 of the Draft). It also makes unified provisions for the deduction of expenditures related to an enterprise's fixed assets, intangibles, long-term prepaid expenses, and investment assets and inventory (Articles 11 to 16 of the Draft).
(v) Administration of tax collection
The collection of enterprise income tax shall be administered in accordance with the provisions of the Law on the Administration of Tax Collection. However, there are some special requirements for administration of enterprise income tax, such as the place of payment and consolidated tax payment for branches of an enterprise. Supplementary provisions are made in the Draft to standardize the administration of enterprise income tax, make tax payment easier and reduce the cost for both taxpayers and tax administrators.
(a) Methods of tax payment. The current practice is that domestic enterprises pay tax locally as independent economic accounting entities while the head offices of foreign-funded enterprises shall make consolidated tax payment for them. To unify the methods of tax payment and make tax payment easier, the Draft provides that a resident enterprise establishing operational entities without legal person status shall calculate and pay enterprise income tax on a consolidated basis (Article 50 of the Draft).
(b) Special tax adjustment. Tax avoidance by some enterprises through various means is serious, and the struggle against tax avoidance is intense. Thus, on the basis of international practice, the Draft provides rules for preventing tax avoidance through transfer pricing among associated enterprises. It also provides general anti-avoidance rules and articles against thin capitalization and avoidance through tax havens. Moreover, it sets forth provisions for assessment procedures and collection of interest from settling tax arrears as provided for by the State Council. This will help guard against and prevent tax avoidance and safeguard the interests of the state (Chapter VI of the Draft).
IV. Impact on enterprise tax burden and fiscal revenues
With the implementation of the new Tax Law, the tax burden on different enterprises will change to a certain extent. Tax burden on a domestic enterprise will decrease while that on a foreign enterprise will increase slightly. However, the production and operation of old enterprises will not be seriously affected because they will continue to enjoy transitional preferential measures for a certain period. International experience has shown that political stability, sound economic development, big market, rich human resources, constantly improving legal environment and government services are main factors for absorbing foreign investment, and the tax preference is only one factor. Therefore, the new Tax Law will not exert a great impact on foreign investment.
With the entry into force of the new Tax Law, the statutory nominal income tax rate for both domestic enterprises and foreign-funded enterprises will see an eight percentage point decrease from 33 percent to 25 percent. However, for those foreign-funded enterprises that have been enjoying the preferential tax rate of 24 percent or 15 percent, their statutory nominal tax rate will rise by one or ten percentage points respectively. Since some foreign-funded enterprises may continue to enjoy preferential tax rates for hi-tech enterprises and small low-profit enterprises, and some others may enjoy transitional preferential tax policies, the current financial cost for foreign-funded enterprises will not be greatly affected after the new Tax Law becomes effective. Due to such factors as decreased statutory income tax rate and increased deductions, if the new Tax Law is implemented in 2008, domestic enterprise income tax will drop by 134 billion yuan while foreign-funded enterprise income tax will increase by 41 billion yuan and, therefore, fiscal revenues will drop by 93 billion yuan. Given that transitional measures will apply to old enterprises that have been enjoying the statutory preferential tax treatment, the decrease in fiscal revenues will be bigger, but such decrease is still acceptable to Government finance.
After the new Tax Law becomes effective, head offices will pay tax for their branches on a consolidated basis. This is likely to bring about tax source shift in some regions and affect the revenues of the regions from which tax sources are shifted. In the income tax sharing reform in 2002, we adopted measures such as tax prepayment and factor-based distribution of income tax revenues for trans-regional enterprises that pay tax on a consolidated basis, so that the issue of tax source shift is addressed to some extent. In addition, under the current practice of general transfer payment, the finance resources of the regions from which tax sources are shifted will be compensated to some extent. Following increasingly intensified efforts by the Central Government to balance financial resources among different regions, the role of this compensation mechanism will become more and more manifest. After the new Tax Law becomes effective, we will conduct a follow-up study of the issue of tax source shift and take quick steps to address new problems in this regard.
The Enterprise Income Tax Law of the People's Republic of China (Draft) and the explanation on the new law are hereby presented to you for deliberation.
(Xinhua News Agency March 8, 2007)