China Update: New Enterprise Income Tax Law Promulgated

In this Issue:

Resident Status and CFC Rules

Reduced Standard Rate

Tightened Tax Incentives and Grandfathering Treatment

Heightened Anti-tax Avoidance Rules

Consolidated Tax Filing

Indirect Foreign Tax Credit

The long-awaited new Enterprise Income Tax Law of the People’s Republic of China (“New EIT Law”) was finally promulgated by the National People’s Congress (“NPC”) on March 16, 2007, and is scheduled to come into effect January 1, 2008. The New EIT Law will replace the two separate, existing laws on enterprise income tax (“EIT”) that are applicable to domestically funded enterprises

(“DEs”) and foreign invested enterprises (“FIEs”), respectively.

As background, it is commonly understood that FIEs enjoy a more preferential tax treatment than DEs in the People’s Republic of China (“PRC” or “China”). With China’s accession to the WTO in 2001, there have been increasing calls to level the playing field of DEs and FIEs. Passage of the unified New EIT Law is an attempt to heed such calls and results in both DEs and FIEs being subject to taxation under the same law. The new EIT legislation also abolishes certain generally available tax incentives for FIEs, for example, the typical 2+3 tax holiday for simply being a

production-oriented FIE. With the removal of special tax incentives for FIEs, such entities may face more competitive pressure from DEs.

Overall, the approach of the New EIT Law to FIEs, appears from a technical standpoint, to be similar to the approach for imposing EIT to FIEs under the current legislative regime. For example, the New EIT Law imposes restrictions, albeit to a lesser extent, on the deduction of various business expenses, adopts the tax-exempt treatment for intercompany dividend distributions, retains the

consolidated tax filing for branches, and emphasizes transfer pricing issues. Therefore, foreign investors should not see a dramatic change from the existing EIT regime.