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China Plans to End Tax Break for Foreign Companies

The tax honeymoon for foreign companies investing in China is ending.

For two decades, China has rewarded new investors with hefty tax breaks, helping to lure the nearly $700 billion in investment that has helped make this the world's fourth largest-economy, but fueling growing complaints by Chinese companies about unfair treatment.

Now, China's legislature is expected to end this special status after it opens its annual session Monday. A law that state media say is expected to be enacted would equalize tax rates, raising foreign companies' tax bills and cutting those for many Chinese entities.

"This special treatment could not continue forever," said Winston Zhao, a lawyer in Shanghai for the U.S. law firm Jones Day who is advising companies on the change. "Foreign investors have to be prepared mentally, though nobody wants this to happen."

The change is part of sweeping efforts to modernize China's laws to keep pace with explosive economic change and meet World Trade Organization commitments to treat companies equally.

It is too early to know what the financial impact will be on foreign companies, say business groups and consultants. But they say major changes in business plans are unlikely, because companies are still attracted by China's low labor costs and 1.3 billion potential consumers.

In for the Long Term

"Companies are largely profitable, in it for the long term here and willing to put up with a change in the tax system that is more clear and more fair," said Robert Poole, vice president of the U.S.-China Business Council, which represents 250 American companies.

Until now, new foreign investors were exempt from income tax for two years and got a 50 percent cut for another three. After that, other provisions such as breaks for investing in special economic zones could keep taxes as low as 10%.

By contrast, Chinese companies pay 33% of their profits in taxes.

The new law would set taxes for all companies at 25%, with lower rates for companies in technology development, according to a draft that was given to foreign companies. It says tax breaks already granted to foreign investors would continue for up to five years.

"A unified tax code will create a taxation environment that favors fair competition among all ventures registered in China," Finance Minister Jin Renqing told lawmakers in December, according to state media.

The proposed new tax code is part of efforts to impose uniform business conditions nationwide. But it isn't clear whether Beijing can enforce the changes in a system where tax collection is run by local authorities who are hungry for investment. They often offer huge incentives of their own, and tax collecting, especially for Chinese companies, is uneven.

Chinese companies ranging from manufacturers to life insurers loudly criticize tax breaks for their foreign competitors, especially after Beijing's WTO entry required it to let more of them into its domestic market.

Equal Tax Rates

"We want equal tax rates with foreign companies so that domestic enterprises in our fields can better compete with overseas counterparts," said a spokesman for the China Light Industry Federation who refused to give his name. The group represents companies in manufacturing, publishing and other industries.

China attracted some $60 billion in foreign investment last year, raising the total over the past two decades to $659 billion, according to the government.

While many foreign companies will see taxes rise, the new code could be a boon to some.

Those that have no operations of their own in China and rely on local partners for manufacturing will see their partners' taxes fall, said Mary K. Thomas, director of the international tax department for the Dallas consulting firm Weaver and Tidwell LLP.

"I'm alerting those folks that when their contracts are up for renewal, they ought to keep in mind the reduction in the cost of doing business," Thomas said. "They should get a piece of that decrease."

Zhao said some of his clients are speeding up planned investments to lock in tax breaks before any legal change takes effect, though none has launched a project just to beat the deadline.

"If it's already in the pipeline, they certainly would like to accelerate wherever possible," he said.

A key issue will be whether Beijing can enforce the new standard.

"I doubt that it will travel so fast, especially to the remote western region," said Zhao. "So one can expect that there still will be arrangements made by local authorities in order to attract or retain investors."

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