Transfer Pricing Insider
Volume 3, Issue 1
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Effects of China's New Enterprise
Income Tax Law on Multinational Enterprises
Yingchun Zhao, Professor and Director of Taxation Department at Shanghai Lixing University of Commerce, Shanghai. Michael Dong, Director of Taxation for Sega Holdings U.S.A, Inc., San Francisco
The new enterprise income tax law does away with different tax treatment of domestic and international multinational enterprises, but uncertainties in the new rules on transfer pricing, contemporaneous documentation, thin capitalization, CFCs, and anti-avoidance have temporarily slowed capital investment in China.
The new Chinese Enterprise Income Tax Law (EIT Law), enacted on March 16, 2007, has ended different tax treatment for domestic and international multinational enterprises (MNEs), providing an equal tax environment and a level playing field for domestic companies competing with MNEs. On December 6, 2007, the China State Council passed the Implementation Regulations of the Enterprise Income Tax Law ("Regulations"). Both the EIT Law and the Regulations became effective on January 1, 2008.
Since beginning to attract foreign capital investment in the 1970s, China has accumulated foreign capital in excess of $750 billion. China's foreign capital investment is the highest of all developing countries, and has played an essential role in China's rapid economic growth and will continue to be crucial for its future prosperity. The EIT Law and the Regulations were strongly debated in and among various legislative bodies (e.g., People's Congress) and administrative branches (e.g., Ministry of Finance and the State Administration of Taxation) to avoid jeopardizing foreign capital investment.
Prior to the enactment of the EIT Law, China maintained two separate tax systems for domestic enterprises and MNEs1, which put domestic enterprises at a competitive disadvantage. In 2005, the Ministry of Finance and the State Administration of Taxation (SAT) conducted a nationwide survey and found that domestic enterprises had a 24.53% effective tax rate, while MNEs had only a 14.89% effective tax rate, which created an overall preferential benefit for MNEs of nearly 10%. The EIT Law basically ended this preferential tax treatment by reconciling the two separate systems into one uniform system.
This article reviews and analyzes the provisions within the EIT Law and Regulations that may negatively affect MNE investment in China, as well as provisions that may have neutral or positive effects. It also discusses the immediate reaction of MNEs after the enactment of the EIT Law, draws conclusions from statistics published by the Chinese Ministry of Commerce, and determines that the negative effects on MNE investment, if any, will be short lived.
Provisions Negatively Affecting MNEs
The EIT Law has unified the prior two separate tax systems and modified some provisions that might have an impact on foreign capital investment. The specific rules are discussed below.
1 Wang Degao and Li Jianbo, “Tax Preferential Theory for Foreign Direct Investment and Economic Impact Analysis,” J. Wuhan U. of Technology (December 2006).
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