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Preferential Tax System Cracked Open
Foreign-funded enterprises that have for years enjoyed preferential tax incentives will eventually be treated the same as domestic firms.

Analysts suggest the policy change, announced recently by China's tax authorities, will eventually unify the country's dual tax systems.

State Administration of Taxation (SAT) officials recently confirmed foreign-funded firms in which foreign partners own less than 25 percent of the total equities will no longer enjoy preferential income tax policies.

Few analysts and experts - especially those who have argued China should adopt a uniform tax system that treats domestic and foreign firms equally - were surprised by the announcement.

Although no timetable has been set, analysts believe piecemeal reforms are already under way.

Analysts contend the new policy will inevitably sway some foreign investors, who might otherwise choose to hold fewer shares in a firm.

The policy will have a negligible impact on most foreign investors seeking entry to China's vast market, suggested Yang Zhiqing, a taxation professor with the Central University of Finance and Economics.

China's current dual-track tax system distinguishes between domestically owned companies and foreign-invested ones.

Foreign-funded enterprises qualify for tax rates as low as 17 percent. The tax rate for domestic enterprises is 33 percent.

Many foreign-funded enterprises also receive exemptions from local tax authorities, which reduces further - sometimes to 10 percent - their actual tax rates.

"Foreign-funded firms, in practice, enjoy more benefits than the WTO requires," Yang said.

This clearly is unfair to domestic firms, even though the so-called "super national treatment" for foreign-funded businesses does not violate WTO principles, Yang added.

But Jin Renqing has ruled out any immediate, dramatic changes to the dual-track tax policies.

Jin, China's finance minister and former SAT director, previously confirmed no timetable had been set.

"We will honour ... incentives granted to previously established foreign-funded companies, and give full consideration to their interests," he said.

China's economic interests, roughly interpreted as high economic growth and low unemployment, have never before been bound so close to the country's performance in attracting foreign investments.

China last year overtook the United States as the world's No 1 country in reaping foreign direct investments (FDI), which now account for 5 percent of China's gross domestic product (GDP).

China's FDI is expected to exceed US$60 billion this year, despite the outbreak of severe acute respiratory syndrome (SARS), a Ministry of Commerce official predicted early last month.

"Preferential tax breaks for foreign-funded companies will continue to play an important role in wooing foreign investors," said Zhang Tianming, a senior consultant with China International Tax Consultancy Co.

"A uniform system of tax policies is still far off," Zhang said.

"And a cushion period is extremely important for foreign-funded companies as they adjust their footings.

"The continuity of the government's policies should first be guaranteed," Zhang added.

Some analysts argue China has comparative advantages - low-cost labour and a massive domestic market.

Both advantages, they contend, appeal to foreign investors, who are unlikely to turn to other countries after China eliminates the preferential tax rates.

Some analysts argue China should abolish existing preferential tax incentives, which do not differentiate between industries.

More flexible policies, which favour the high-tech and other sectors, should be implemented in line with China's industrial policies, they contend.

China will have to amend its laws regarding enterprises' income taxes before it can unify the tax systems.

"The whole process will be time consuming," Yang said.

China overhauled its tax system in 1994, in response to early reforms in fiscal revenues, which had helped spur rapid economic growth in the 1980s.

The 1994 tax reforms were aimed at boosting the central government's tax revenues, while containing tax cuts and/or refunds by local governments across the nation.

Local governments across China used favorable tax policies to compete with each other in attracting foreign investments.

Under China's current tax laws, foreign-funded firms begin paying income tax two years after they begin earning profits.

China's tax revenues in the year's first five months surged 25.2 percent, year-on-year, to 863.9 billion yuan (US$104.5 billion), Jin said on June 15.

(Business Weekly July 2, 2003)

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