Comment on the current Tax System of the PRC

By Richard Hoffmann, ECOVIS Beijing China

How would you summarize the current development of the Tax System in the PRC?

China has built its tax system from the ground in the 1980’s.  Since then there have been major changes and developments in the tax system.  The development of an international tax system is part of such changes.  With the unification of the two income tax law systems for both foreign investments and domestic companies, the Chinese government has put more effort into this area.

New rules have been introduced to deal with corporate reorganizations, transfer pricing,  thin-capitalization, controlled-foreign corporations, and treaty shopping. Major tax incentives available to foreign investors were redesigned. The Chinese tax authority has strengthened its enforcement efforts.  In view of the current trend, international companies should pay more attention to their compliance status of their China investments.

What are your overall thoughts and opinions on the recent news regarding China’s plans to significantly improve and update its national tax system?

Under China’s current tax system, its revenue comes mostly from the indirect tax sector (VAT, Business Tax), nearly 70%, much larger than the income tax sector (Corporate Income Tax, Individual Income Tax).  China’s overall reform in the finance and tax system is trying to slowly add more weight to income tax, rather than indirect tax, as more weight in the income tax sector will ease inequity in incomes.

To achieve this goal, the Chinese government has pushed a nationwide reform in unifying its indirect tax system by converting the Business Tax system into the VAT system.  Business Tax is something that only exists in China, where the tax becomes a sunk cost for companies and individuals, while for the VAT system, companies or individuals only pay tax on the part of the value they create.  This is good news for companies, especially in the pilot service industries.  The tax revenue has been reduced by billions of RMB due to this reform, which benefits companies.

On the other hand, as Chinese government taps more into tax revenue from non-tax resident enterprises, a series of tax regulations and circulars has been drafted and published in regulating cross-border transactions, for both equity and commercial contracts.  Overseas companies, especially those having commercial deals with Chinese parties should pay attention to the compliance requirements.  Otherwise, they will have difficulty receiving payments from their Chinese customer. For large equity deals, good planning is crucial.

What are the most appealing factors that China’s international tax system currently provides and what are the biggest drawbacks?

China currently has tax treaties or double tax arrangements with over 101 countries and regions.  China has become an important player in the international tax regime.  The Chinese government has worked closely with the OECD and other institutions, to absorb internationally accepted tax principles and rules into its national tax legislation.  The tax regulation on merger and acquisition is an example for this.  With this trend, international companies avoid difficulties in communication with the Chinese tax authorities, as they are using more common languages.

However, international companies should take into consideration that they should use the same or similar vigilance or due care when looking at their Chinese companies’ compliance status.  It is hard to say whether the costs for compliance are really reduced or not.  For example, the tax authority at the local level may not be able to understand or accept such very advanced tax principle or ideas.  Sometimes the communication at the local level could be very time consuming and costly.

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