China Taxes: Equal is a Bad Thing.

In the good old days, China gave foreign companies all sorts of tax breaks. China’s taxation system so favored foreign companies, many Chinese companies would form a company overseas and then re-enter China as a foreign company. This tactic came to be known as “round-tripping” and it became quite common.

Those days are over.

China recently put one more, pretty much final nail in the separate but unequal column earlier this month when it “unified” a few more obscure taxes. A China-focused accounting firm sent me an email that nicely describes the most recent China tax changes that further harmonize the tax structures as between foreign and domestic enterprises. The email was from Kaizen Certified Public Accountants Limited/Yen and Associates Limited, and it stated the changes so clearly, I am going to just quote it directly:

Commencing from 1 December 2010, foreign enterprises, foreign funded enterprises and foreign individuals will begin to pay Urban Maintenance and Construction Tax and Educational Surcharge.

Urban Maintenance and Construction Tax (城市维护建设税) and Educational Surcharge (教育费附加) are two types of surcharges, levied on taxpayers who pay Value Added Tax (“VAT”), Consumption Tax (CT) and Business Tax (BT). Specifically, each surcharge is calculated as a percentage of the actual amount of the VAT, CT and BT paid by the taxpayers. The rate for Educational Surcharge is 3%. Depending on the location, the rates for City Maintenance and Construction Tax differ:

  • In city areas, the rate is 7%,
  • In county and township areas, the rate is 5%,
  • In other areas, the rate is 1%.

Since their introduction in 1985 and 1986 respectively, the two surcharges have been imposed on domestic enterprises and Chinese individuals only. Foreign enterprises, foreign invested enterprises and foreign individuals have been specifically exempted from these two surcharges.

The extension of Urban Maintenance and Construction Tax and Educational Surcharge to foreign enterprises and foreign funded enterprises, following the unification of Vehicle and Vessel Usage Tax in 2007, Enterprise Income Tax in 2008, Farmland Occupation Tax and Urban Real Estate Tax in 2009, is the last of such moves to unify the different tax systems applicable to domestic and foreign funded enterprises. This very last move signifies that the unification of the two tax systems has been completed and the beginning of a new era of “unified tax system and fair taxation” and now that there is one and only one tax system applicable to all enterprises doing business in China or with Chinese enterprises.

At the end of 2009, I wrote an article China’s Top 5 Business Law Trends For 2010 predicting 2010 would see China stepping up its tax collection efforts:

China will increase its tax collection efforts. This has been going on at a rapidly accelerating pace over the last six months or so. If your China operations are not making a healthy profit, do not be surprised if the government imputes healthy profits to it. In particular, the government will look very closely at your transfer pricing and in many cases it will not like what it sees.

There is no doubt the same will hold true for 2011 and beyond.

A China-based CPA friend of mine had this to say about the above changes:

My 2-cents on the tax increase are that I don’t really mind but wish there had been more advance notice. The amount is small and for a company with decent margins it shouldn’t be too harmful. But how do I know what other changes are just around the bend? In any case, the move to bring taxes for foreign and domestic enterprises in line is no surprise (especially to CLB readers!) and this is exactly the kind of thing we’ve learned to roll with. Maybe we can ask knowledgeable CLB readers to guess what other changes might be on the way…

So what tax changes do you see for China? For foreign businesses operating in China?