Tax Preferences and Transitional Measures in China's New Tax Law

China's new Enterprise Income Tax Law is a major departure from the previous tax system. Unlike the old system, with its differentiation between domestic and foreign-owned enterprises and separate tax preference policies, the new tax law unifies taxes and tax rates for foreign and domestic enterprises. The new law scraps the original emphasis on regional incentives in favor of industry-oriented incentives supplemented by regional ones, and it establishes "special tax adjustments" to strengthen measures against tax evasion.

This article will first introduce the main tax incentive provisions of the new law before going on to describe certain transitional tax preference rules.

Tax Preference Highlights

Like the tax regime it replaces, the new law provides for tax credits, offsetting of earnings with losses, deductions of foreign taxes, and a reserve fund system.

The new tax law includes the following twelve key preference policies:

• Enterprises in the farming, forestry, animal husbandry or fishery industries enjoy a 50% reduction or exemption of income tax;
• Income from investment in designated key state-supported public infrastructure projects can enjoy a "3-year exemption and 3-year half payment" tax preference;
• Small and marginally profitable enterprises may enjoy a preferential tax rate (20%);
• A preferential tax rate (15%) applies to enterprises in high/new technology industries singled out for special support by the State;
• Tax reductions and exemptions are offered to enterprises in designated minority nationality autonomous areas;
• "Super" deductions (over 100%) are given for wages paid to disabled employees and other designated personnel;
• The "3-year exemption and 3-year half payment" tax preference is also provided for income derived from environmental protection or energy/water conservation projects;
• To avoid double taxation, dividends, bonuses and other equity investment proceeds distributed between qualified resident enterprises are tax-exempt;
• "Super" deductions are also granted to R&D expenditures for the development of new technology, new products and new production methods, and this extends to all enterprises;
• A venture capital enterprise may deduct up to 70% of its total investment from its taxable income;
• Special preferences may be offered in the event of natural disasters or other unforeseen events; and
• Where goods are produced in conformity with regulations on comprehensive utilization of resources, up to 90% of income may be deducted in calculating taxable income.

• To avoid excessive impacts and allow enterprises to make a smooth transition after implementation of the new law, given that governments at different levels use tax incentives to actively attract investment, and tax preference policies are important factors when foreign investors' make decisions on investment projects;
• To conform to the consistently held policy of progressive reform, and to realize the goal of "active reform, smooth conversion"; and
• To draw on the successful experience with transitional measures when the tax system was reformed in the early 1990s.

• Enterprises that were enjoying a 15% income tax rate before January 1, 2008 will be able to apply rates of 18% in 2008, 20% in 2009, 22% in 2010, and 24% in 2011, before being subject to the full 25% rate in 2012. Firms that had been using a 24% rate will apply the 25% rate in 2008.
• After January 1, 2008, enterprises that were enjoying limited-duration preferential tax treatments, such as the "2-year exemption and 3-year half payment", and the "5-year exemption and five-year half payment" privileges, may continue to enjoy them until they expire as originally provided, but where firms had not been able to enjoy such preferences because of a failure to make profits, the terms for applying the preferences are to be dated from January 1, 2008.
• Enjoyment of the above transitional preference policies is limited to those enterprises that were registered and established through the proper commercial administrative authorities prior to March 16, 2007. The items and scope of the transitional preferential policies are given in the "Table for the Implementation of Transitional Preferential Enterprise Income Tax Policies."

• New and high technology enterprises that have completed their registration on or after the first of January 2008 within a special economic zone or the Shanghai Pudong New Area and are designated as high and new technology enterprises requiring special support from the State (hereafter, "high/new technology enterprises") may apply transitional tax preferences on income derived from special economic zones and the Shanghai Pudong New Area, in the form of a 2-year exemption and 3-year half-rate payment based on the prescribed 25% tax rate.
• New/high technology enterprises "requiring special support form the State" refers to high and new technology enterprises that have core proprietary intellectual property, meet the criteria in Article 13 of the "Implementation Regulations for the Enterprise Income Tax Law", and are identified as such in accordance with the "Guidelines for Determining High and New Technology Enterprises."
• High/new technology enterprises newly established in special economic zones and the Shanghai Pudong New Area must calculate separately their income derived from within and outside of such special areas, and then make a reasonable allocation of period expenses. If they do not make such separate calculations, they will be unable to enjoy tax preferences.
• For newly established high/new technology enterprises inside special economic zones and the Shanghai Pudong New Area, enjoyment of transitional tax preferences will be terminated if review or random inspection during the period in which they enjoy those preferences finds that they are not qualified for them.