2008 tax rate changes in China.

• Author: Thomas, Mary K.

The Enterprise Income Tax Law (EITL) will become effective in China on January 1, 2008. It was approved at the 10th National People's Congress of China, which concluded on March 16, 2007. The function of the EITL is to streamline the new tax rates and allowable deductions for domestic and foreign-owned enterprises. This law could affect U.S. companies doing business in China in several ways.

New Tax Rates

China's new tax rate under the EITL is 25%, which is higher than the 15%-24% rate many foreign-owned enterprises positioned in allotted foreign investment zones currently receive, but it is lower than the 33% rate currently applied to domestic-owned enterprises.

The new rate, however, will not go into effect immediately. It will be phased in over a five-year transition period for foreign-owned enterprises, which will thereby reduce the impact of the tax increase.

Effect of tax rate change: Domestic-owned enterprises in China will enjoy a cut in taxes. This, in turn, affects U.S. companies that work with domestic-owned enterprises, such as through contract manufacturing arrangements. U.S. companies should be aware of any and all tax decreases when negotiating contracts and contract renewals.

The 1%-10% tax rate increase for foreign-owned enterprises will most likely not drastically alter the amount of foreign business in China--mainly because emerging domestic markets in mainland China and Asia are becoming too large to overlook. However, foreign-owned enterprises that plan to move to China exclusively to cash in on lower manufacturing costs may be affected by the increased tax rate.

Mitigation of tax rate increase: High-tech businesses that promote technological development are eligible for a preferential tax rate of 15% under the EITL. What "technological development" is subject to the 15% preferential tax rate, however, is not clearly defined. Forthcoming regulations might offer further details, but it is anticipated that the rate will be applied rather liberally.

Venture capital enterprises--those engaged in start-up investments--as well as foreign and domestic companies involved in environmental protection, production-safety projects, infrastructure construction, and water conservation also qualify for the preferential tax rate.

Tax Holiday Repealed

Current regulations allow eligible foreign-owned enterprises to attain approval for an initial two-year tax exemption and a further three-year, 50% tax rate reduction (2+3 tax holiday). For...