China's parliament, the National People's Congress, adopted the enterprise income tax law Friday morning with 2,826 votes for and 37 against, and 22 abstentions, a key signal of a phase-in end of superior treatments to foreign investors for two decades.
The 60-article law was ratified by the lawmakers as they concluded their 11.5-day annual full session at the Great Hall of the People in downtown Beijing. The law is due to take effect on Jan. 1,2008.
The voting result, announced by NPC Standing Committee Chairman Wu Bangguo, was warmly applauded by lawmakers. Four legislators did not cast their votes.
Experts say the law marks an adjustment of China's policies toward foreign investment in the current times.
The law, which sets unified income tax rate for domestic and foreign companies at 25 percent, came after years of criticism that the original dual income tax mechanism is unfair to domestic enterprises.
Currently, the actual average income tax burden on Chinese companies is 25 percent, while that on foreign enterprises is 15 percent. Many people think such a policy forces domestic businesses to face tougher competition since China's accession to the World Trade Organization (WTO) in 2001.
"It's a basic requirement of the WTO to create a fair environment for competition, and the new unified income tax will, in a real sense, grant foreign investment the same treatment as domestic businesses," said Miao Gengshu, chairman of the China National Foreign Trade Transportation (Group) Corp.
Apart from increased income tax, foreign companies will also be wiped from some other tax incentives, including pre-tax reduction and tax rebate for re-investment, in the future, insiders say.
China is gradually taking back preferential policies toward overseas-funded businesses, which have been levied the same tax as their domestic counterparts in the use of urban land from Jan. 1 this year.
Preferential taxation and land policies, which are described as "policies superior to national treatment", have always been important attractions to overseas investment since China began reform and opening-up in the late 1970s.
"It's necessary to offer certain incentives to foreign investors during the initial period of reform and opening-up, when China was stranded by the lack of capital, foreign exchange and an unsound market system," said Justin Yifu Lin, a renowned economist and a member of China's top political advisory body.
Generous tax incentives have fueled foreign capital influx. China has been one of the world's top destinations for foreign direct investment, taking in 53.5 billion dollars in 2003, 60.6 billion dollars in 2004, and 60.3 billion dollars in 2006 in terms of the amount actually used.
But problems have surfaced along with China's rapid economic development. Dual income tax rates have incurred growing complaints from domestic enterprises, some of which even disguise themselves as overseas-funded ones to dodge tax, according to the Ministry of Finance.
Zhang Yansheng, director of the International Economic Research Institute under the National Development and Reform Commission, pointed out that China's situation has changed a lot over the years.
"Capital and foreign exchange have ceased to bottleneck China's economic development, and they have declined from the primary means of attracting foreign investment," Zhang said.
Minister of Finance Jin Renqing has depicted the tax reform as "an institutional innovation adapted to the new development of China's socialist market economy and a subsidiary measure supporting the country's sustainable development strategy."
"It marks the maturity and standardization of China's economic system," Jin said.
Commerce Minister Bo Xilai told Xinhua that the implementation of the law would not affect certain industry-specific preferential tax policies, but help improve the use of foreign investment to a higher level.
China will continue to offer tax incentives to investment in projects concerning environmental protection, agricultural development, water conservation, production safety, high-tech development and public welfare undertakings, according to the law.
Bo said high-tech foreign-funded companies can still enjoy a 15- percent income tax rate, and small and medium-sized foreign companies with slim profits are only required to pay income tax at 20 percent.
Certain tax breaks will also be granted to enterprises in special economic zones and less-developed western areas of the country, he said.
Experts expect the law to spur local authorities, which often offer various tax incentives to lure investors usually for a reckless GDP growth, to head toward a scientific development mode.
Actually, some multinationals have adapted their business plans to the policy change. GE (General Electric) China has announced it will invest 50 million U.S. dollars in its Shanghai-based technology center for products serving environmental protection, including more efficient airplane engines and wind power generators, seawater desalination technology, and energy-saving bulbs.
Steve Bertamini, chairman and CEO of the GE North East Asia, packed the new series of products into the idea of "eco- imagination", saying the "green" business will become China's most booming industry in the future.
Liang Hong, chief China economist from Goldman Sachs Asia, said the massive influx of foreign investment in China will not be stumbled over an increased enterprise income tax rate.
"The law does not intend to put restrictions on foreign companies, nor will China change its plan of drawing more foreign capital via reform and opening-up and boosting competition between domestic and foreign companies," Liang said.
Experts agree that the tax change is actually a commitment to the WTO for equal treatment to enterprises, which can only strengthen China's responsible role and make it more attractive to foreign investment.
Joseph Lee, a tax and business advisory partner of Ernst & Young Beijing, is sure that a ten-percent tax increase will not crush out the zest of foreign investment.
"What weighs in their decision is China's huge market potential. The appeals are not only confined to preferential tax policies," said Lee, who has provided 20 years of consulting service on taxation for multinationals.
A research report from the World Bank analyzed that stable political situation, sound economic development, broad market, rich labor sources as well as increasingly upgraded business infrastructure and government service in China are the major factors attracting foreign investment.
Meanwhile, a five-year transitional period has been offered to offset the impact on foreign companies, according to the law.
"The income tax rate will be gradually increased to the 25 percent during this period, and old foreign enterprises can still enjoy tax breaks within a regulated time limit as before," Jin Renqing said.
Experts point out the 25-percent tax rate is still favorable compared with those in some countries and regions.
The average enterprise income tax rate is 28.6 percent in 159 countries and regions around the world in which an enterprise income tax is applied, while that in China's 18 neighboring countries and regions is 26.7 percent.
By the end of last year, China had approved the establishment of 594,000 overseas-funded enterprises, with actually used overseas capital of 691.9 billion U.S. dollars. Last year, overseas-funded companies paid 795 billion yuan (101.9 billion U.S. dollars) of taxes, about 21.12 percent of China's total tax revenue.