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China’s Tax System. When “Equal” Is A Very Bad Thing.

Posted in China Business, Legal News

In the good old days, China gave foreign companies all sorts of tax breaks. In fact, China’s taxation system so favored foreign companies, many Chinese companies would form a company overseas and then enter China that way. This tactic came to be known as round-tripping and it became quite common.

Those days are truly over.

China recently put one more, pretty much final nail in the separate but unequal column earlier this month when it “unified” a few more rather obscure taxes. A friend of mine recently sent me an email from a China-focused accounting firm that nicely describes the most recent China tax changes further harmonizing the tax structures as between foreign and domestic enterprises. The email was from Kaizen Certified Public Accountants Limited/Yen and Associates Limited, and it stated the changes so clearly, I am going to just quote it directly:

Commencing from 1 December 2010, foreign enterprises, foreign funded enterprises and foreign individuals will begin to pay Urban Maintenance and Construction Tax and Educational Surcharge.

Urban Maintenance and Construction Tax (城市维护建设税) and Educational Surcharge (教育费附加) are two types of surcharges, levied on taxpayers who pay Value Added Tax (“VAT”), Consumption Tax (CT) and Business Tax (BT). Specifically, each surcharge is calculated as a percentage of the actual amount of the VAT, CT and BT paid by the taxpayers. The rate for Educational Surcharge is 3%. Depending on the location, the rates for City Maintenance and Construction Tax differ:

  • In city areas, the rate is 7%,
  • In county and township areas, the rate is 5%,
  • In other areas, the rate is 1%.

Since their introduction in 1985 and 1986 respectively, the two surcharges have been imposed on domestic enterprises and Chinese individuals only. Foreign enterprises, foreign invested enterprises and foreign individuals have been specifically exempted from these two surcharges.

The extension of Urban Maintenance and Construction Tax and Educational Surcharge to foreign enterprises and foreign funded enterprises, following the unification of Vehicle and Vessel Usage Tax in 2007, Enterprise Income Tax in 2008, Farmland Occupation Tax and Urban Real Estate Tax in 2009, is the last of such moves to unify the different tax systems applicable to domestic and foreign funded enterprises. This very last move signifies that the unification of the two tax systems has been completed and the beginning of a new era of “unified tax system and fair taxation” and now that there is one and only one tax system applicable to all enterprises doing business in China or with Chinese enterprises.

At the end of 2009, I did a post, entitled, “China’s Top 5 Business Law Trends For 2010.” In that post, I predicted 2010 would see China stepping up its tax collection efforts:

China will increase its tax collection efforts. This has been going on at a rapidly accelerating pace over the last six months or so. If your China operations are not making a healthy profit, do not be surprised if the government imputes healthy profits to it. In particular, the government will look very closely at your transfer pricing and in many cases it will not like what it sees. 

There is no doubt the same will hold true for 2011 and beyond.  

My friend had this to say about the above changes:  

My 2-cents on the tax increase are that I don’t really mind but wish there had been more advance notice. The amount is small and for a company with decent margins it shouldn’t be too harmful. But how do I know what other changes are just around the bend? In any case, the move to bring taxes for foreign and domestic enterprises in line is no surprise (especially to CLB readers!) and this is exactly the kind of thing we’ve learned to roll with. Maybe we can ask knowledgeable CLB readers to guess what other changes might be on the way…

So what tax changes do you see for China? For foreign businesses operating in China?  

  • http://www.qualityinspection.org Renaud

    I was told by a tax specialist that foreign companies get controlled (for tax-collecting purposes) more often than domestic ones, and that Chinese authorities don’t even try to conceal this policy.
    So the real discrimination is not (or no longer) the amount of tax to pay, but rather in the enforcement, isn’t it?

  • Mark Z.

    I saw these new taxes the same way. It really is the end of special benefits for foreign companies. Now though, the real problem is that these laws are strictly enforced against foreign companies but only laxly enforced against their Chinese competitors.

  • http://profit-today.in Nitin K. Parekh

    Businesses, irrespective of the country, are vexed with levy of a variety of taxes by governments under different names, disparity and discrimination in tax rates and ofcourse, the burgeoning compliance burden. Being the top exporter, sooner or later, China had to set right (to whatever extent) its tax laws to keep its lead. That CLB had predicted this in 2009 is really commendable.
    Even India is seriously contemplating unifying the Indirect Taxes to usher in a national common market. But the endless discussions between Centre and State governments over the last five years have not reassured the businesses that a solution is insight. Pakistan too is undergoing turmoil with its taxation system.
    In view of the growing discontent among the businesses, most of the countries of the world will be constrained to have a serious relook at their taxation systems and reshape them in the next five years or so.

  • Wen Zhao

    I’d say go to a China tax blog. This news is several weeks old and was on the SAT website. It’s been common knowledge this was happening since March. There’s no excuse really for MNCs not to have Chinese speaking staff to look out for this info and I know it has already been published in English by many firms.

  • Steven

    Just q quick comment on your statement : ” In that post, I predicted 2010 would see China stepping up its tax collection efforts ”
    I talked to a few Operating managers / Business owners in Suzhou industrial park, they faced more tax challenges from tax bureau since early this year. Transfer pricing is definitely a red flagged area for foreign companies. APA is now highly recommended.

  • Chris

    @ Renauld: “I was told by a tax specialist that foreign companies get controlled (for tax-collecting purposes) more often than domestic ones, and that Chinese authorities don’t even try to conceal this policy.”
    That was the case up until 24 months ago, then the SAT made massive compliance efforts with SOEs to extract both back taxes and ensure full compliance moving forward. Over the past 18 months huge efforts have been made into ensuring tax payment by local SMEs. There have been arrests, fines and large numbers of audits of Chinese enterprises, including SOEs, to ensure they pay tax in full.
    The rules of the game have changed for domestic enterprises. The Govt has an aggressive investment agenda and particularly at the local level, local tax offices need to identify the means to fund it. With the exception of a few regions, foreign enterprises are too few, to offer that much in the way of tax.
    If you follow the SAT website, you will see the vast majority of rulings, proclamations and policy changes are targeted at domestic enterprises. As foreign investors, we generally don’t follow this too closely, but it’s changing the way business in China operates.
    Local suppliers, partners & channels are all complaining (very loudly) that their tax bill has doubled or tripled since 2008.

  • Another CPA

    Next change is that foreigner working in China will be subject to Chinese social contributions, which means increased costs for foreign employers.
    In the past, mostly only Chinese nationals were subject to Chinese compulsory social security system (with the exception of Hongkong and Taiwan compatriots as wells as those from countries who have signed partial or full social security agreements with China – such as Germany for example).
    This has been announced recently and will apply from 1 July 2011…

  • http://www.zeanlaw.com Jian

    I think the unequal impact of the “equal tax rate” between FIEs and domestic entities is not because that the law is strictly enforced against one over another. Chinese companies are more adapted to the culture and take aggressive position in tax filing and report. FIEs are more prudent in tax matters and report everything according to book. U.S. companies are bound by FCPA and cannot do what Chinese companies usually do by giving gifts, meals, entertainment etc. to tax authorities.

  • Chris

    @ Another CPA. “Next change is that foreigner working in China will be subject to Chinese social contributions, which means increased costs for foreign employers.”
    This is likely only to apply for a small number of cities (Beijing & Shanghai) from July 1, 2011.
    Nonetheless, it is an alarming development, with the Chinese authorities seeking to make it even more expensive to employ expat staff.
    Given that expat staff can expect to receive ZERO benefit from the so-called social insurances, nor any refund on their way out of China, it will function as a tax.
    Local Govts using this to cover part of the massive hole in the welfare system. China already has the most expensive social insurance system in the world (from an enterprise perspective) with 44% of salary contributions from the enterprise (up to 3x local average salary) and 20% from the employee.
    The relevant question is where on earth is the rest of the massive tax yield collected by the SAT going, if not to fund basic benefits to the population…

  • Benjamin

    Chris, do you know of any specific notices that can be referred to regarding increased contributions for foreign staff? I ask because you seem to have very specific information regarding the date the new measures will become effective. Thanks!