In March 2007, the Chinese government announced its Enterprise Income Tax Law. This law went into effect at the beginning of this year. Once a while, we still receive inquiries from our clients and friends on this topic so I thought I'd take a moment to explain the main points of the legislation. Of course this structure, like many tax structures in China, is very complicated and could merely be the flavor of the day. However, the main points are below.

Under the old version of enterprise income tax, Chinese domestic companies were taxed at 33% for their income; foreign companies were taxed at either 24% or 15%; and domestic, low profit companies were taxed at 27% or 18%.

According to the new enterprise income tax law, effective starting on Jan 1st 2008, all companies in China, domestic and foreign alike, are levied at 25% income tax rate. However, if a company can get approval to be a new/high tech company by the central government, it will then be taxed a more favorable rate, 15%. Location is also factor in with regard to a company's tax rate. Companies established in the five special economic zone cities (Shenzhen, Zhuhai, Shantou, Xiamen and Hainan) or Shanghai Pudong Development New Areas, then the company is taxed under a 2+3 referential tax regime.

Previously, the high tech companies were taxed at 15%, but they had to be located in the high tech parks across the country. Moreover, high tech / new tech status could be obtained after getting the approval from the local authority. Under the new arrangement of the enterprise income tax, the approved high tech / new tech companies can enjoy 15% rate regardless where their businesses are located. However, getting its status is much more difficult. A company must now meet a set of quantitative criteria and the approving authority is no longer regional, but it is the national level ministries who undertake a yearly review.

A lot of Chinese overseas listed companies are legally foreign firms, even though their businesses have a Chinese genetic makeup. Many of them are also in new/high tech industry. Therefore, before the new law, these companies were paying 15% income tax either for being a foreign firm or a locally approved high tech company located in a high tech park. With foreign company status in hand, such a company could also can enjoy the 2+3 scheme, starting at its first profitable year. Now, however, under the new law, the foreign firms are taxed at the standard 25%, unless the company can qualify itself in the 15% bracket as being a high/new tech firm under the new rule. For them, the 2+3 scheme no longer exists.

Note:

1. 2+3 scheme means: qualified companies pay zero income tax for the first 2 years and pay half of the required income tax for the following 3 years.

2. Company qualified for both the 2+3 scheme or high tech criteria will choose its most favorite one to follow.

3. The preferential tax arrangement 2+3 obtained under the old law will be carried into the future until it expires.