Effective as of October 1, 2002, the Ministry of Foreign Trade and Economic Cooperation (MOFTEC), along with 5 other government departments, have changed the regulations for importing plant and equipment for certain approved foreign-invested projects. Amongst the various changes, the most important is concerned with the taxation of plant and equipment (设备) to be imported.

Under 1996 regulations, all equipment imported into China as part of the capital contribution (when establishing Joint Ventures or Wholly Foreign Owned Enterprises) to be used for production of export goods (only, was free from Value Added Tax (VAT) and Customs Duties.

However, with the latest adjustments to the policy on " Permitted foreign investment" (Foreign invested projects involving production of '100% directly exported goods'), "《外商投资产业指导目录》 中"产品全部直接出口的允许类外商投资项目", equipment and plant imported (for such projects) into China will now be subject to VAT and Customs tax under a specified payment system. Whilst this equipment may still be approved for "tax free" status, the schedule for upfront tax payment and refund is now specified in the new regulations.

The plant and equipment will now be immediately subject to taxation (both VAT and import duties) once it is imported into China, with the tax being paid back to the taxpayer over a 5 year period. Throughout this time-frame, officials from MOFTEC and other government departments will be required to inspect the project facilities to ensure that all goods being produced are used for direct export (only), and all equipment is installed as specified under the project approval.

Once these inspections are satisfied, 20% of the tax paid by the taxpayer will be returned on a yearly basis. If, however, these inspections prove that the facilities are not being used for (100%) export production or do not match the project approval regulations, the taxes paid may be withheld, and the related companies subject to punishments.

These new regulations will have a significant effect on projects producing export products as 'upfront' tax payments may now be required, resulting in delayed cashflows and, ceteris paribus, longer pay-back periods. For such projects, it is highly recommended that tax positions be clarified with MOFTEC and the State Administration of Taxation (SAT) before investment is made. Once this is finalised, business cases may need to be adjusted to incorporate the changes in tax policies.

Changes to the VAT system will become more frequent as the government introduces its proposed reform of VAT and business tax over the current 10 year plan. Please see the below for further foreseeable tax changes.

(1) What do you think will be the main changes on China's tax system 5 and 10 years from today?

China's tax law system experienced great changes in 1994. The changes have played an important role in boosting the country's economic development and encouraging foreign investment into China. However, with the dramatic evolvement of China economy over the past ten years, it seems that many tax laws become quickly outdated and do not suit the rapid economic development.

Also, China's accession to the World Trade Organization (WTO) provides a good opportunity to launch such reforms, as China needs to amend or revise many of its existing tax laws which do not currently conform with the requirements of the WTO.

According to Mr. Jin Renqing, Commissioner of the State Administration of Taxation, one of the main tasks for the 10th five-year plan (2001-2005) is to carry out a further reform on the current tax system. The objective of the tax reform is to establish an efficient tax collection and management system. The proposed tax reform shall include the following contents:

Value-added tax reform: The current VAT system is production-oriented and mainly covers imports and sales of movable/tangible goods. There are two aspects of the anticipated VAT reform: changing to consumption-oriented VAT and expanding VAT scope to cover activities originally subject to the business tax.

The government wishes to eliminate double taxation and thereby encourage investments by the shifting to consumption-oriented VAT, as it will allow input of VAT credit on purchase of capital goods.

(2) Do you foresee any changes in tax rates?

With respect to the enterprises income tax, there are presently two sets of laws, one for foreign invested enterprises (FIEs) and foreign enterprises, and one for domestic Chinese enterprises. There are current plans to unify the systems.

The reason for unifying the two tax regimes is: It is one of the WTO membership requirements that China treat foreign enterprises and domestic enterprises equally. Also, such unification will foster a more balanced economic growth. The expected changes include (a reduction of) tax incentives and statutory enterprises income tax rates.

Regarding individual income tax, the ultimate goal for reform in the PRC is to make proper adjustments on the classes of taxable incomes and tax rates, so as to lighten the tax burden on the individuals with lower incomes and to strengthen the regulations on the ones with higher incomes.

Whilst China currently maintains a "progressive" individual income tax system, the high degree of tax avoidance (especially amongst wealthier individuals) and problems with tax collection procedures results in a skewed burden of taxation towards "ordinary level" income earners. The government has recognised this problem and has implemented systems, such as targeting wealthier individuals, so as to more fairly collect taxes.

Another significant change we see may involve the convergence of individual income tax systems for local Chinese citizens and foreigner tax residents. At present there are a number of differences including a higher tax-free threshold and greater allowable scope and levels of tax deductions for 'foreigners' (compared to China-domiciled tax residents). Whilst China has benefited from this system for many years, by way of enticing "foreign experts" into the country, the growing dissatisfaction with these differences, along with political pressures, may result in a convergence. Whether this will be by lifting local-resident tax allowances, or lowering foreigner allowances, we are yet to see.

(3) Do you foresee any new taxes (for example, indirect taxes? capital gains tax? VAT? goods and services tax? customs duty?

Because of the VAT system reform, business tax shall be changed accordingly. In addition, the simultaneous operation of both taxes has led to a number of administrative problems for taxpayers and tax authorities. There still exists many difficulties and problems. The first is the necessity for reducing VAT rates as the difference between the current VAT rates (6, 13, and 17 percent) and the business tax rates (3, 5 and 20 percent) may lead to the increase of consumer prices.

Second, VAT is central government tax while business tax is a main source of tax revenues collected by the local governments. The increasing of the VAT scope will therefore decrease the business tax revenues, which will in turn reduce local government's income. This may create obvious problems with budget allocations and available revenues, especially for large infrastructure cities, such as Beijing.

The government may use consumption tax as a tool to reflect its industrial policy. With the rapid development of China economy, the proposed reform on consumption tax is on one hand to expand the collection scope and on the other hand to make proper adjustment on existing taxable goods. Some new goods or products which have not been regulated under the current consumption tax regime shall be imposed the consumption tax, while some goods which are already subject to consumption tax may be taken out of the lists of taxable goods.

(4) Do you foresee any existing taxes being abolished?

We do not foresee any existing taxes being abolished. However, there are some scholars suggesting a complete reform of the business tax and to apply VAT to all business taxable activities.

With the introduction of the new "Accounting System for Business Enterprises", Foreign Invested Enterprises (FIEs) now have greater autonomy in selecting accounting policies. In implementing new accounting policies, FIEs should attempt to provide greater transparency to report users and also ensure that their financial position and financial performance are accurately presented.

The seven areas where FIEs now have greater autonomy to adopt appropriate accounting policies include:

• Greater number (8 instead of 2) accounts for provisioning for impairment of assets.
  
  
• Entities able now able to choose appropriate levels of "bad debts" based on their estimates (instead of regulatory requirements of between 3-5%)
  
  
• Enterprises are now able to choose depreciation policies for Plant, Property and Equipment which more closely reflects their usage.
  
  
• Changes such as the provisioning for contingent liabilities ensures that report users have access to greater information and risk profile of future company performance.
  
  
• Through recognising losses from debt restructuring in their income statement but crediting gains from such restructuring to the Capital Reserve, entities are not able to over-inflate profits.
  
  
• Accounting for investments (using the equity method) is now standardised through the '20% control rule'.
  
  
• Greater requirements for financial statements and the notes to the statements allow report users to gain a better understanding of company position and performance, as well as predicting future earnings.

Professional Services

Financial Accounting

Management Accounting

Systems Solutions

Business Management