GT Alert

China to End Preferential Tax Rates for Foreign Companies

June 2005

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On May 30, 2005, it was announced that, effective for tax years after 2007, the Chinese government will, as part of its current tax reform considerations, repeal preferential corporate tax rates (an approximate 15 percent tax rate) available to foreign businesses doing business in China. Taxpayers eligible for the preferential rates before the new laws take effect will have a five-year transition period to slowly adjust to the higher rates. The preferential rates were originally enacted during the 1980s to promote foreign investment in China.

It is believed that the income tax rate for domestic Chinese companies averages approximately 33 percent. Although specific details have not yet been released, a new flat tax of approximately 25 percent, that would be applied evenly across the board, has been openly but informally discussed by taxation officials. This announcement comes on the heels of China’s entry into the World Trade Organization (“WTO”) in 2001 and is believed to be a part of China’s revamping of its tax code.

Practical Considerations

Many of our clients currently take advantage of the preferential rates in China, either directly with their own operations or indirectly as customers of companies/suppliers that are eligible for the preferential rate. In either case, an increase in the tax rate will either mean less after tax profit or higher costs from suppliers, as suppliers pass on the added tax costs to avoid deep reductions in profit margins.

With respect to clients with direct operations in China, business model adjustments and intercompany transfer pricing planning tools that we commonly use in international tax planning projects may significantly reduce, or eliminate, the impact of any tax rate increase in China.

With respect to clients that may be indirectly impacted by way of increased costs from suppliers, clients may want to consider options such as alternative suppliers (in Malaysia, Singapore, Taiwan, etc.), advanced negotiations regarding price increase caps, hedging, establishing their own manufacturing/supply operations in other similar but lower tax jurisdictions (i.e., Malaysia and Singapore (extensive tax holiday programs)), and other business price protection strategies they are familiar with. Clients can seek assistance with these and other alternative strategies from Greenberg Traurig’s Tax, Corporate and Securities, Global Trade, and Financial Institutions Practice Groups, to name just a few GT practice groups with direct experience in these matters.

This Alert was written by Frederic J. Adam in the Silicon Valley office. Please contact Mr.Adam at 650.289.7880 or your Greenberg Traurig liaison if you have any questions regarding the subject matter of this Alert.

© 2005 Greenberg Traurig

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