Two Major Laws Adopted that Affect US Companies investing in China
New Property Law and Unified Company Income Tax Law
At the end of its 2007 annual meeting, China's National People’s Congress approved two laws that are important for all foreign businesses operating in China. The NPC meets once a year. By the time a law is formally approved, it receives nearly unanimous support. That does not mean that it was non-controversial or was dictated by the Party Chairman. It means that a long period of consultation within the leadership and then among provincial and self-governing city forces shaped something that can achieve a virtually undivided vote of approval. Both new laws passed by overwhelming margins.
The new Property Rights Law follows a 2004 change to China's Constitution that declared “inviolable” lawful private property. The 2007 law creates four categories of property – state, collective, individual and other. Equal protection is granted to all four forms. The new civil code provisions aim to assure those who control property that it will not be confiscated without fair compensation and otherwise to establish rules about property regulation. How the lengthy text of the new law is interpreted and applied in practice will be crucial. The signal in March 2007 is that protection of private property rights is essential for China to continue its path of growth and market development.
The Enterprise Income Tax Law eliminates over time favoritism towards foreign firms. For about 25 years, China has extended special benefits to foreign-owned or foreign-invested businesses, which give them advantages over their Chinese domestic competitors. This was part of China's effort to lure foreign investors. Anyone who has traveled the special economic zones of China, where foreign investment combined with Chinese talent and labor have created vast new cities and industrial parks, understands that this policy succeeded. Extended tax holidays for foreigners, with an eventual profits tax of 15% (compared to the current 25% rate charged to Chinese-owned businesses) created a favorable investment climate, offsetting risks foreigners perceived in going to China.
Starting January 1, 2008, with some exceptions (e.g., high technology), Chinese entities, including foreign-owned and foreign-invested enterprises, will have a unified income tax rate of 25%. Various subsidies such as pre-tax reductions and tax rebates for re-invested profits will be eliminated or phased out for foreign investors and firms. A key question will be whether city and provincial officials can continue to extend tax holidays to entice additional foreign investment to their areas, or whether these temporary advantages will be ruled out by Beijing.
A foreign investor thinking of entering China should see these moves as favorable, not adverse. Rather than being directed against foreigners, the unified tax approach simply moves China more in line with the prevailing national treatment expected in a developed economy. The action represents a normalization rather than adverse treatment of foreign business. In this way, it eliminates a deep-seated animosity towards foreigners among Chinese businesspeople, who may see the special incentives as a glimmer of past degradations that European powers inflicted on China in former centuries, including treaty ports and the Opium War. China's Minister of Commerce Bo Xilai promptly sought to reassure the world that the equalization of tax rates was basically a reflection of China's maturity as a destination for foreign direct investment. “Foreigners investing in China are not only attracted by tax preferences, but also other factors like infrastructure, science and technology, labor quality, industrial support, financing and social stability, which weigh heavier with investors,” the Minister was quoted in China Daily of today. Interesting but not surprising that there was no mention by the Minister of low wage rates and favorable currency exchange rates.
An example of immediate impact when the law takes effect in 2008 is the elimination of “round-tripping.” This a technique used by Chinese domestic enterprises with foreign investment that take advantage of the foreign favoritism to transfer domestic capital overseas and then make investments that appear to be foreign back into China. This loophole will be closed.
A foreign firm with existing investments in China should review the law carefully to see when and how existing tax planning must be adjusted in light of the March 2007 changes. As in the United States, tax laws in place at one time are subject to change, and change does not amount to confiscation or action that would justify a claim against the Government. This is the case within China as well. Rather than be surprised that a plan based on the prior foreign-favored regime is not longer working as expected, a US business should adjust its business and financial forecast to a new attitude that will, over time, align its treatment with that of Chinese domestic firms.
For further information, please contact Joseph J. Dehner at firstname.lastname@example.org.
Frost Brown Todd’s China Consulting Group serves both US and Chinese companies. Through an Alliance with the Hubei Sunshine Firm in Wuhan, offices in Shanghai and Beijing through the firm’s affiliated FK MidAmerican Consultants LLC and strong established connections with Chinese law firms, Frost Brown Todd is committed to China's further integration into a globalized economy.
For those with serious interest in Chinese legal and business developments, you may bookmark (free of charge) to www.fbtchina.com, where a China Blog appears. The China Blog regularly reports on developments of interest to businesspeople involved with China.