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Foreign-Related Tax Policy and Development of the Tax System
di Cheng Faguang,
Deputy Director of the
State Administration of Taxation
in "Beijing Review", 42(1999), n. 4
I. Tax Reform
To meet the development needs of a socialist market
economy, China began to reform its industrial and commercial tax system and adopted a
revenue-sharing tax system in 1994. It was an all-round structural reform under the
guideline of "unifying tax laws, fairly sharing tax liabilities, simplifying the tax
system and rationally delegating power''.
The reform embraced six principal taxes, including turnover and enterprise income
taxes, and the majority of local taxes. Afterward, foreign-funded enterprises, foreign
enterprises and foreign nationals enjoy the same tax treatment as Chinese enterprises and
nationals, except for enterprise income tax and some local taxes.
Restructuring of the turnover tax is the most important part of the reform, as its
revenue accounts for three-quarters of total proceeds from industrial and commercial
taxes. The new turnover tax system, applying to both Chinese and foreign-funded
enterprises, facilitates the principle of fairly sharing tax liabilities and setting
competition on an equal footing, and meets the requirement of standardizing the value-
added tax (VAT).
The reform of enterprise income tax covered domestic enterprises. A separate income tax
was maintained for foreign-funded enterprises.
The reform of personal income tax aims to establish a unified system applicable to all
Chinese citizens and foreign nationals working in China. After the reform, a threshold of
800 yuan is allowed for deduction per month. For foreign nationals and Hong Kong, Macao
and Taiwan compatriots, the threshold is, inter alia, 3,200 yuan per month.
The reform also involves the refinement of natural resources tax, the imposition of
land appreciation tax, and the abolition of taxes on transactions in market fairs and of
draught animals, and on fuel, bonus and salary.
Through the 1994 reform, the original 32 industrial and commercial taxes were reduced
to 18, with 12 applicable to foreign-funded enterprises and foreign nationals. The tax
system is greatly simplified and becomes more rational. However, much work needs to be
done to improve the system.
1. Improving personal income tax. This now follows a scheduled system. In the future,
it will be replaced by one combining a scheduled and a comprehensive system. Taxable items
will be increased, and allowable deductions set more rationally.
2. Unifying enterprise income tax for Chinese and foreign-funded enterprises. To ensure
fairness in liability, promote competition on an equal footing and gradually grant
national treatment to foreign-funded enterprises, taxes on Chinese and foreign-funded
enterprises will be unified, although necessary preferential taxes maintained. Successful
overseas experiences will be referred to in an effort to regularize enterprise income tax,
making it simple and highly efficient.
3. Improving the local tax system. Efforts are called for to formulate estate and gift
taxes, and reform urban construction and maintenance tax and land occupancy tax.
4. Refining VAT. The administration of value-added tax will be strengthened.
II. Preferential Policies to
Encourage
Foreign Investment
Preferential tax policies to encourage foreign
investment are mainly embodied in the enterprise income tax.
1. Reduced tax rates in defined areas. For enterprises located in special economic
zones and production enterprises located in economic and technological development areas,
the income tax rate is reduced to 15 percent. For foreign-funded production enterprises
located in coastal open cities and areas, in riparian cities, open border cities and
provincial capitals in inland areas, as well as foreign-funded enterprises located in
tourist and holiday resorts, a reduced 24 percent income tax rate is applied.
2. Reduced tax rates for defined trades and projects. A 15 percent income tax rate is
applied to the following:
* Sino-foreign joint ventures engaged in harbor and wharf construction;
* Foreign banks and Sino-foreign jointly funded banks located in special economic zones
and in areas authorized by the State Council, with foreign investment or capital input
exceeding US$10 million and the term of operation surpassing 10 years;
* Projects located in open economic areas with foreign investment exceeding US$30
million and a long term set for investment recovery; and
* Energy, transportation and harbor and wharf construction projects.
3. Preferential policies for defined industries and projects in the given time.
* Foreign-funded production enterprises scheduled to operate for no less than 10 years
are exempt from income tax in the first two profit-making years and enjoy a 50 percent
reduction in the ensuing three years.
* Foreign banks and Sino-foreign jointly funded banks scheduled to operate for no less
than 10 years are exempt from income tax in the first profit-making year and enjoy a 50
percent reduction in the ensuing two years.
* Sino-foreign joint ventures engaged in harbor and wharf construction scheduled to
operate for no less than 15 years are exempt from income tax in the first five
profit-making years and enjoy a 50 percent reduction in the ensuing five years.
4. Preferential policies to foreign investors for establishing export-oriented or
technologically advanced enterprises. In the wake of the expiration of the legal term for
tax reduction and exemption, export-oriented enterprises set up by foreign investors, with
the output value of exported products reaching or surpassing 70 percent of the total
output value in a tax year, enjoy a 50 percent reduction of enterprise income tax. If the
tax rate is under 10 percent subsequent to the 50 percent reduction, a 10 percent rate
shall apply. Technologically advanced enterprises funded by foreign investors may enjoy a
50 percent reduction of enterprise income tax for another three years following the
termination of the legal term for tax reduction and exemption. If the tax rate is under 10
percent subsequent to the 50 percent reduction, a 10 percent rate shall apply.
5. Preferential policies for the transfer of advanced technology. Royalties from the
transfer of special technologies used in such areas as agriculture, forestry, animal
husbandry, scientific research, energy, transportation and other key technological fields
enjoy a 10 percent withholding income tax. Those offering advanced technologies and
favorable terms are exempt from the withholding income tax. Foreign investors deriving
income from profits of foreign-funded enterprises in China are exempt from income tax.
6. Preferential policies for foreign investors to expand investment in China.
Foreigners already investing in Chinese enterprises, who directly reinvest their share of
the profits to increase their registered capital, or use the profit as capital investment
to establish other enterprises scheduled to operate for no less than five years, are
allowed a 40 percent refund on tax paid on the reinvested amount. For foreign investors
who reinvest in China to establish or expand export-oriented or technologically advanced
enterprises scheduled to operate for no less than five years, the full refund is allowed.
In order to attract direct foreign investment, the Chinese Government decided, in 1998,
to reinstate exemption from tariffs and VAT on machinery and other equipment imported by
foreign-funded projects involved in areas encouraged by the State.
III. Necessity for the
Readjustment of
Foreign-Related Tax Policy
China's foreign-related tax system was established and
developed in the process of deepening the reform and opening program beginning in 1979.
Several laws were promulgated in 1980 and 1981 by the third and the fourth sessions of the
Fifth National People's Congress (NPC), including the Income Tax Law of the People's
Republic of China on Sino-Foreign Joint Ventures, the Income Tax Law of the People's
Republic of China on Foreign Enterprises and the Personal Income Tax Law of the People's
Republic of China. It was also clarified that foreign-funded enterprises were liable to
industrial and commercial consolidated tax, urban real estate tax, and vehicle and vessel
usage license and plate tax. Thus, a comprehensive foreign-related tax system was
formulated involving income, turnover and local taxes.
In April 1991, the Fourth Session of the Seventh NPC adopted the Income Tax Law of the
People's Republic of China on Foreign-Funded Enterprises and Foreign Enterprises,
establishing a unified income tax system by abolishing the previous Income Tax Law on
Sino-Foreign Joint Ventures and the Income Tax Law on Foreign Enterprises.
For foreign-funded and foreign enterprises, the tax system reform mainly covers the
restructuring of the turnover tax. In December 1993, the Fifth Session of the Eighth NPC
decided that, effective from January 1, 1994, foreign-funded and foreign enterprises
should be subject to the Provisional Regulations on Value Added Tax, the Provisional
Regulations on Excise Tax and the Provisional Regulations on Business Tax promulgated by
the State Council. Meanwhile, the Regulations on Industrial and Commercial Consolidated
Tax were abrogated. As a result, a unified turnover tax is levied to both domestic and
foreign-funded enterprises. This helped change the pattern featuring the application of
different turnover taxes to domestic and foreign-funded enterprises, representing a
significant step toward the unification of the taxation system.
Since its formulation, the foreign-related tax system has remained a separate structure
from the domestic tax system. This basically catered to the needs of China's reform and
economic development at the time and played an important role in mobilizing revenue,
attracting foreign capital, introducing advanced technology, expanding international
economic exchange and safeguarding the country's economic rights and interests. Following
the establishment of the target of building a socialist market economy, however, the
separate foreign-related tax system no longer meets the needs of economic restructuring
and development. So, the introduction of a unified tax system is essential.
The different tax treatment for foreign-funded enterprises mainly lies in income tax.
In 1991, when the two income tax laws for foreign-related enterprises were merged,
appropriate readjustment was made in preferential policies for income tax, with focus on
sectors encouraged by the State. These policies contributed greatly to attracting foreign
investment, especially investment in coastal areas. But the obvious policy discrepancies
between foreign-funded and domestic enterprises have brought about some problems,
including the following:
1. Regional discrepancies at multiple levels in existing preferential tax policies
hamper foreign investment in the development of border, remote and poor areas. At the same
time, it also triggers harmful competition between local governments by willfully
formulating preferential policies, leading to unnecessary losses for the State.
2. Current preferential policies to certain industries fail to stand in tandem with the
national industrial policy. These policies are mainly geared to production enterprises.
However, tax regulations cannot list all manufacturing industries when defining production
enterprises. They only generally categorize enterprises into several major industries.
Judging from the national industrial policy, some "production'' enterprises are not
included in the category encouraged by the State, while some others, traditionally defined
as "non-productive'', are in the list encouraged by the State under the present
industrial policy.
3. Complicated tax incentives bring about difficulties in implementation, thus lowering
the transparency of laws and regulations and providing some taxpayers with chances to take
advantage of policy loopholes.
According to the tax system reform plan, it is an important task in the coming years to
readjust and unify the two existing enterprise income laws.
IV. Export Tax Refunding
Following tax reform, foreign-funded enterprises
established after January 1, 1994, are, as domestic enterprises, liable to the same
unified regulations on VAT, excise tax and business tax. The problem of increased tax
liabilities by refunding is non-existent. These enterprises may, pursuant to the
provisional regulations on VAT, claim refund of relevant input tax for products directly
exported.
It is a common international practice to offer tax refund for exported products.
Generally speaking, the refund rate is dependent on the statutory tax rate.
The State Council decided that, as of July 1, 1995, the refund rate for exported goods
should be lowered according to the actual tax burden. The readjusted refund rates were as
follows: 3 percent for farm produce and coal, 10 percent for industrial goods using farm
produce as raw materials and other goods entitled to a VAT collection rate of 13 percent,
and 14 percent for goods entitled to a VAT collection rate of 17 percent. Soon afterward,
the State Council decided to revise the refund rate again. Effective from January 1, 1996,
the previous refund rates of 10 percent and 14 percent were respectively reduced to 6
percent and 9 percent, while the refund rate for farm produce and coal remained unchanged.
However, in the second half of 1997, in order to promote the export of products of certain
industries, the State Council consecutively approved the readjustment of the refund rates
for products produced by the textile, shipbuilding, coal mining and building materials
industries.
In accordance with the aforementioned refund rate, foreign trade enterprises are liable
to VAT payment prior to refunding. Manufacturing enterprises handling exports
independently or via proxies (including foreign-funded enterprises approved and
established after January 1, 1994) should adopt the method of "exemption, credit and
refund'' as an alternative to collection prior to refunding at the stipulated rate with
the refunds calculated at the FOB price.
From January 1, 1999, all foreign-funded enterprises will get the tax refund for their
exported products pursuant to the aforementioned regulations. As a result, there is basic
uniformity in the tax refund policy for both domestic and foreign-funded enterprises.
V. Reform of Tax Collection and
Administration System
After several years of experiments, a brand-new tax
collection and administration system has been established. On the basis of self-assessment
and improved taxpayer service, and backed up by a computer network, collection has been
centralized, with inspection conducted over key tax payers. The major contents of the new
model include:
1. Establishing a self-assessment system. Self-assessment is a basic requirement for a
modern tax administration system. The taxpayers' awareness of the importance of tax
payment will be enhanced through the adoption of scientific, simplified and convenient tax
reporting and payment procedures, and the means of tax reporting and payment will be
standardized. The original practice of sending tax collectors to taxpayers to ask for
payment will be replaced by the self-assessment method which requires taxpayers to assess
their own liabilities, file their returns and pay tax on their own.
2. Establishing a taxpayer service system that combines the efforts of both tax
authorities and social intermediate agencies. The major task is to enhance tax officials'
awareness of service, which includes the establishment of a tax law notification system to
publicize laws, administration statutes and regulations and other tax-related documents,
the founding of tax legislative databases at central and provincial levels, the
establishment of declaration halls in cities, county towns and other places where
transportation is convenient and taxpayers are relatively concentrated, and the
development of tax service agencies to provide service for taxpayers.
3. Establishing a computerized administrative and monitoring system. Computers are
being widely applied to consultation, registration, invoice selling, filling acceptance,
collection, accounting, statistics, inspection, target selection for inspection and all
other phases of tax administration.
4. Establishing a complete tax inspection system. Inspection will be the priority of
tax administration and the most powerful guarantee for the implementation of the new tax
system.
VI. Tax Relations Between the
HKSAR and China's Mainland
In accordance with the Basic Law, after reunification,
Hong Kong is a special administrative region of the People's Republic of China. According
to the principle of "one country, two systems'', capitalism will be retained in Hong
Kong. As a special administrative region exercising a high level of autonomy, Hong Kong
practices independent laws and tax system. It enjoys the power to formulate tax
legislation, design its own tax categories, items and rates, confer tax concessions on its
own and make its own decision on other tax affairs. After the reunification, tax laws and
regulations exercised in inland areas are not applicable to Hong Kong.
1. The relationship between Hong Kong and the mainland with regard to concluding and
implementing tax treaties. According to Article 153 of the Basic Law, "The
application to the Hong Kong Special Administrative Region of international agreements to
which the People's Republic of China is or becomes a party shall be decided by the Central
People's Government, in accordance with the circumstances and needs of the HKSAR, and
after seeking the views of the government of the HKSAR.'' In addition, consultation and
agreement with the other signatory party is indispensable for the final decision of
whether or not to apply the treaties to Hong Kong.
Reviews of the practical operation of the 57 tax treaties China has signed with other
countries have found that none of them is applicable to Hong Kong, because the taxes
covered in all these treaties are only applicable to the mainland.
Since the conclusion of tax treaties is based on the result of negotiation between the
two signatory parties on their own tax systems, requiring one signatory party with two
different tax systems to negotiate with another signatory party having a unitary tax
system is bound to encounter technical barriers when coming to specific articles, not to
mention the difficulties in implementation.
Besides, Article 151 of the Basic Law stipulates, "The Hong Kong Special
Administrative Region may, on its own, using the name ?ong Kong, China', maintain and
develop relations and conclude and implement agreements with foreign states and regions
and relevant international organizations in the appropriate fields, including the
economic, trade, financial and monetary, shipping, communications, tourism, cultural and
sports fields.'' In agreement with the essence, the HKSAR may conclude and implement tax
treaties and maintain or develop tax relations with other countries, areas and
international organizations using the name "Hong Kong, China''.
2. Issues related to investment and tax payments by Hong Kong compatriots on the
mainland. After reunification, policies applicable to foreign companies, enterprises,
economic organizations and foreign nationals are still applicable to investment by Hong
Kong compatriots and their income from the mainland. The Central People's Government will
continue to encourage Hong Kong compatriots to invest in the mainland. Those who fulfill
their tax obligations in accordance with related laws and regulations can continue to
enjoy the preferential tax policy granted to foreign investors.
Article 116 of the Basic Law stipulates, "The Hong Kong Special Administrative
Region shall be a separate customs territory.'' After reunification, trade (purchase and
sales of goods, excluding service) between Hong Kong and the mainland are still regarded
as transactions between the People's Republic of China and foreign companies, enterprises
or other economic organizations and individuals. That is to say imports from Hong Kong to
the mainland are still exempted from or enjoy a reduced rate of custom duties, as well as
value-added tax and consumption tax, in accordance with the tax law. The mainland's
exports to Hong Kong may be entitled to refunds (or exemption) in accordance with related
regulations.
3. Avoidance of double taxation. This is an issue that attracts widespread attention
from Hong Kong business circles. Given the existing tax practice in Hong Kong and the
mainland, the problem of double taxation can be resolved automatically in most cases
because Hong Kong practices tax jurisdiction of source principle (i.e. no levy of tax on
income obtained outside Hong Kong) and the mainland has the stipulation that tax paid
overseas may be credited. For possible double taxation, the State Administration of
Taxation and the HKSAR Government reached an arrangement on double taxation avoidance at
the beginning of 1998, which went into force last April in the HKSAR and in last July on
the mainland.
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