Insiders in domestic enterprises said that this unification has been long hoped for. It will finally provide a level playing field for Chinese enterprises to compete against foreign enterprises.

Domestic enterprises, which have been subject to over twice the income tax rate of foreign-funded enterprises, will now finally see an end to this heavy tax burden. The differential in domestic and foreign income tax rates is to be consigned to the history books now that it has served its historical purpose.

However, insiders in foreign-funded enterprises are not too sensitive about the pending unification. According to them, though foreign enterprises have enjoyed preferential tax rates under the umbrella of the dual system, domestic enterprises have been in receipt of compensating financial subsidies from local governments. Consequently, the composite tax burdens on domestic and foreign enterprises are already broadly equivalent in practice.

Internal Control Supervisor, Ma Huibing of ASIMCO (Asian Strategy Investment Company), said, “Theoretically, foreign-funded enterprises will lose their preferential tax treatment and face stronger competitive pressures once enterprise income tax is unified. But though they will have to operate on a level tax footing after unification, the positions have already been converged in practice”.

Ma Huibing holds that although the nominal tax rate for domestic enterprises is 33 percent, subsidies from local government have been sufficient to balance their tax burden. Thus the tax burdens for domestic and foreign enterprises are already equitable. Furthermore, domestic enterprises will gain some additional advantage through local business practices. Foreign enterprises do not accrue such benefits because of the internationally standardized nature of their operations.

Fan Zhongshan, a chief partner of Zhengde Dacheng Financial Consultants Co. Ltd., said that domestic enterprises are forced to seek financial subsidies from local governments by the unfair nature of the current enterprise income tax system. Domestic enterprises are pushed down this route by the artificial mechanism of the tax differential.

Foreign-funded enterprises presently benefit from full tax exemption for the first three years once in profit. This is then followed by a reduced liability for further two years. They also conform to the usual international practice of deducting allowable expenses before application of tax.

Domestic enterprises do not enjoy these tax breaks and in addition are subject to restrictions on the amount of their allowable expenses.

An insider in a Chengdu industrial company said that they had already made alternative arrangements for tax payment instead of receiving financial subsidy from the local government. As a result, the pending unification of enterprise income taxes will not have a big influence on their business.

China’s WTO (World Trade Organization) entry will have its greatest impact on the financial and agricultural sectors. Domestic financial enterprises in particular have long complained that the unfair tax burden has hindered them unfairly in their competition with foreign financial enterprises.

Zhou Qigang of the China Pacific Insurance (Group) Co. Ltd. said that foreign-funded insurance companies pay lower taxes and enjoy more benefits. They are then able to use these savings to offer discounts to their clients or to fund promotional advertising. China Pacific Insurance is not able to compete fairly via these marketing tools because it is more highly taxed.

A good example of a foreign-funded enterprise is China Ping An Insurance. It is located in Shenzen, a Special Economic Zone, and enjoys an enterprise income tax rate of just 15 percent.

China Ping An can shelter all its funds in this benign tax environment in Shenzhen and so maximize its returns to shareholders. Pacific Insurance however, as it does not have foreign backing is denied this opportunity and in fact has a composite tax burden of some 40 percent. Moreover, listed companies may make tax returns and again this is a facility unavailable to the unlisted Pacific Insurance.

A Necessary Change?

Gao Peiyong, a professor with the People’s University of China thinks that tax unification is a natural outcome of China’s WTO entry as well as of the development of China’s tax system. He said that China had committed itself to the “WTO National Treatment Principle” not to discriminate against foreign-funded enterprises. But in the field of enterprise income tax, it is actually the foreign enterprises that enjoy preferential treatment and the domestic enterprises that suffer discrimination. Since last December when China joined the WTO, enterprise income tax laws have remained unchanged. Though trade disputes have begun to emerge, no enterprise income tax dispute has so far been filed. WTO rules include no specific requirements that would directly require unification of the two tax regimes.

Formula rules under which deductions are calculated vary for domestic and foreign enterprises. The net effect is that foreign enterprises might be paying about 50 percent of what domestic enterprises pay.

As a result of past adverse trading conditions, domestic enterprises do lag somewhat behind in levels of equipment and staff training. It would be over-ambitious to expect them to be immediately ready to stand up to the full force of international level competition. It’s not the WTO rules but China’s tax system itself that has led to the need for review. In the field of income tax, the “WTO National Treatment Principle” should be applied first to domestic enterprises rather than to foreign enterprises.

Gao Peiyong went on to say that even if China had not joined the WTO, the development of the socialist market economy would also require unification of the two systems of taxation. The issue has been on the agenda since 1992. As current tax laws set disparate conditions for the two different types of enterprises, competition clearly cannot be on an even footing. It is discriminatory and is a rather obvious example of the anomalies that exist in the economic system.

Another characteristic of a market economy is free movement of trade. To join the growing swell of the global economic family, it is necessary to trade across international boundaries. This will inevitably involve convergence of China’s tax system with international practice. This will provide a challenge in reaching agreement on such issues as double taxation and tax exemptions. Difficulties will arise from the dual nature of the current system. Opening-up the economy will require our tax system to conform with international practice so revision is inevitable.

Already Done the Job?

Though the dual income tax laws were enacted in 1994, they can trace their roots back to the 1970s.

In 1981, the government first passed the Sino-foreign Joint Venture Enterprises Income Tax Law, then later the Sino-foreign Cooperative Enterprise Income Tax Law. By 1987 these two laws had been subsumed into a single Foreign Enterprise Income Tax Law.

In 1994, income tax requirements placed on state-owned enterprises, collective enterprises, private enterprises and the self-employed were unified to create the Domestic Enterprises Income Tax Law. The extant dual enterprise tax system has been in place since then.

There were sound historical reasons for the introduction of preferential enterprise income tax. It promoted inward investment during the early years of economic reform and the opening-up of the country. Now that the economy is becoming more and more global, it is no longer necessary to retain such differential tax treatment.

However, Gao Peiyong said that it was not yet certain that reform could be put in place as early as next year.

(china.org.cn by Alex Xu, July 16, 2002)