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Foreign firms lose a benefit in China

A decades-old tax break for non-Chinese businesses is to end after five years.

March 17, 2007|Don Lee | Times Staff Writer

SHANGHAI — Chinese lawmakers approved a tax overhaul Friday that would eventually end nearly three decades of preferential treatment for foreign companies.

The measure is likely to pinch a variety of U.S. and other foreign corporations, particularly larger manufacturers, whose sales and profits have been growing robustly in China. But analysts don't expect a significant slowdown in foreign corporate investment in China, given the country's large market, extensive supply chain and rapid growth.

Some American businesses welcomed the long-awaited change as a step toward creating a more simplified, transparent and uniform tax system in a nation where local governments often levy different rates depending on relationships with individual companies.

"The more important thing in the long term is that everybody is treated in a fair manner," said Alex Xu, a Los Angeles developer who has opened a chain of two dozen business hotels in China.

Chinese enterprises had long pushed for a unified tax policy, complaining that overseas firms enjoyed an unfair advantage over them. Foreign companies have been paying an income tax rate of 15%, while domestic firms were taxed as much as 33%. A single corporate tax rate of 25% is to take effect next year.

More broadly, the change in tax policy highlights a maturing Chinese economy, now the world's fourth-largest, that is becoming much more selective about foreign investments and focused on nurturing domestic companies and industries.

"Finally, foreign and domestic companies are standing on the same starting line and can compete with each other openly and fairly," said Shang Yugui, spokesman for Great Wall Motor Co., a large privately owned maker of pickup trucks and sport utility vehicles in Hebei province. He said the company expected to save at least $5 million in taxes next year.

The effect of the new law, though, will be complex. Some domestic firms may end up paying more in taxes, as many have set up holding companies overseas to take advantage of the two-tiered tax structure.

The hit to foreign companies also won't be as hard as some feared, thanks to a five-year phase-in period and continued tax privileges for high-tech and other high-priority industries.

General Motors Corp., Dell Inc. and many other big U.S. companies operating in China were reluctant to comment about how their business would be affected, in part because details of the law were unclear.

China's tax bureau has estimated that the measure will cut domestic corporate taxes by $17 billion while boosting foreign tax revenues by $5 billion.

Foreign companies long viewed their low tax rate as a benefit that helped them compete in a market they felt was tilted toward domestic players because of bureaucracy and other regulations.

But Chinese scholars argued that over the last five years, as China opened up its markets under commitments to the World Trade Organization, the balance shifted in favor of foreign companies.

Analysts say foreign enterprises contributed an estimated 33% to China's economy but paid only about 20% of the total in taxes.

Since opening up the economy to the outside world nearly 30 years ago, Chinese officials have offered tax, land and other incentives to attract foreign investment, which has fueled the nation's spectacular growth.

But in recent years Beijing has grown increasingly worried about an unbalanced economy that is relying on exports of lower-value goods, harming the environment and soaking up precious resources. The central government has been trying to rein in reckless lending and local governments that have been offering land and other incentives to draw investments.

The new tax law is seen as part of the overall push to achieve a more balanced and sustainable growth. It eliminates the 50% tax reduction for export-oriented foreign enterprises and specifies tax savings for companies that invest in conserving water and energy, for example.

"We realize that more foreign investment is not always better," said Liu Shangxi, deputy director general of the Institute of Fiscal Science at China's Ministry of Finance.

"Our economy is transforming.... We want to lift the quality of foreign investment."

American companies clearly see the tide shifting. In Chengdu in western China, which has become a hot destination for foreign investment, government officials now won't pay much attention unless investors are pledging $20 million or more, says Bill Gormley, a consultant in the city.

The higher tax rate won't make things easier for foreign investors, he said, "but we'll just ride the sugar train as long as we can."

The tax measure is likely to set off a burst of foreign enterprises registering in China before it takes effect, to qualify for the grace period that will allow them to enjoy their first two years of business without paying corporate income tax and their next three at half the current national rate.

Starting in 2008, "it's just not going to be as beneficial as it was in setting up new enterprises," said Dan Roules, an attorney at Squire, Sanders & Dempsey's office in Shanghai.

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don.lee@latimes.com

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