However, it decreased the current corporate income tax rate from 33% to 25%. The new law which is set to take effect on January 1, 2008, makes a precautionary attitude towards foreign investment while the law takes a much friendly approach towards domestic-invested companies and foreign invested companies.



It combines the two different tax regimes for domestic-invested companies ("DEs") and foreign invested companies ("FIEs") that have been on prominence for over a decade into a unified system and basically alters prevailing tax incentive guidelines. These changes include the end of general tax holidays for foreign invested manufacturing and export-oriented undertakings. These incentives specifically allowed a 2-year income tax exemption starting with the primary year of profitability followed by a 50% deduction of income taxes for an extra 3-year period.

The new CIT Law is the authority on prevailing FIE tax holidays. In the case of FIEs tax, holidays have not commenced yet as they have not enjoyed their first year of profitability. Their tax holidays shall be considered to begin from 2008 and continue for 5 years.

This could end up in a partial or total loss of the incentive relying on when profitability is actually realized. It seems that the new CIT Law has closed the tax refund possible for foreign investors that reinvested the dividends they got from their FIEs in China. This was not granted to domestic investors under the old tax law. The new CIT Law puts forward four tax reform proposals that China hopes to realize and they are a less puzzling tax system, a wider tax base, a decreased tax rate and a focused tax administration.

The new law consists of two exceptions to the updated flat rate for domestic and foreign invested companies. One for qualified small scale and light profit companies which will be put to a rate of 20% and another for supported high-tech companies which are to be levied a rate of 15%.

The new incentive policies aspire to improve technology innovation and transfer, core infrastructure construction, agriculture development, environmental preservation and natural resources management. The new CIT Law states the new incentive policies which provide little information as to the exact implication of the terms used or how they will be put into practice.

Besides the tax incentive changes, the new law instills the concepts of "Tax Resident Enterprise" (TRE) and "Special Tax Adjustment" (STA) and implements other anti-tax-evasion rules which are predicted to have a telling effect on foreign invested companies in China. The TRE stipulations widen the horizons of authority of China's State Administration of Taxation ("SAT") to permit it to tax the off-shore income of foreign enterprises. These enterprise's effective management functions for off-shore operations are located in China.

Numerous questions pop up relating to how the new CIT law will take effect. These questions are extremely relevant for foreign investors, whether they have set up a business in China or are contemplating in that direction. The State Council, China's top administrative body, which will proclaim the detailed implementation rules, is undecided on when the rules will be available.

Considering the impact of the changes in the new CIT Law foreign investors having live investments in China will need to investigate their consequences and update their tax profile to suit the new rules. For those who are planning to invest in the China market, a deep study of the new CIT Law relating to both incentives and taxation is required.