The Enterprise Income Tax (hereinafter referred to as the “EI Tax”) is an important tax category for the organization of state financial revenue and the regulation on economics. Recently, as the further promotion of the reform and opening policy, the old EI Tax system can no longer satisfy the requirements of economic development, while the aspect which two tax system coexisted exposes more and more malpractices. It is deeply required by the refining of the Socialist market economic system, and the construction of the Socialist market legal system, to reform and refine the current EI Tax system, to integrate the EI Tax systems for domestic enterprises and foreign invested enterprises and to create a market for fair competition. The new EI Tax Law of the People's Republic of China was approved on 16th of March, 2007 and implemented formally since 1st of January, 2008, which becomes a milestone for the development of the EI Tax law.

I. Problems existed in the old EI Tax system

1. The coexistence of the EI Tax system for domestic enterprises and another for foreign invested ones will hardly lead to fair competition among different types of enterprises.

Under the old EI Tax Law, the tax burden was heavier for domestic enterprises than for foreign invested enterprises. Caused by different tax base, tax rate and tax preferential policies, domestic enterprises are facing a deeply unfair competition.

2. The legal status of EI Tax Law was not fully recognized and the statutory deduction system was not established.

The old EI Tax Law was introduced by the State Council in the form of interim regulation, whose implementing regulations were drafted by State Ministry of Finance and State Administration of Taxation. Low legislation layer, low legislative position and too much flexibility under the current policies lead to the loss of the seriousness of the EI Tax Law and to the violation of the lawful tax administration.

3. The old EI Tax system has many regulations which contradict the market economic principles.

The old EI Tax Law utilizes an unfair tax system which contradicts with non-discrimination principle and the fair competition principle under market economy. Furthermore, it increases the difficulty of the tax administration of domestic enterprises, which will result in tax loss.

II. Main improvements of the new EI Tax Law

1. Redefinition of “taxpayer”

The new EI Tax law has deleted relevant provisions under EI Tax law for domestic enterprise in respect of independent accounting standard for taxpayer. The new law further defines the scope of “taxpayer” as enterprises and any other organs that gain income, which is consistent with the current other tax laws. According to international conventions, the draft of the new EI Tax law first introduced the definition of “resident enterprise” and “non-resident enterprise” to further define different taxpayers. Resident enterprise shall fulfill general tax obligations, which means it shall tax all the income obtained from inside and outside the borders, while non-resident enterprise shall fulfill limited tax obligations, which means it shall tax all the income obtained from inside the borders only. The division of resident and non-resident enterprise is heading for better guarding of our country’s tax jurisdiction.

2. Four main concerns in the new EI Tax law

1) Integration of EI Tax laws
All domestic and foreign invested enterprises are now applied to by one integrated EI Tax law, which becomes a substantial and historical orientation during the last 30 years.

2) Uniform EI Tax rate
With reference to international conventions, the new EI Tax rate is 25%, while the average tax rate for 159 countries in the world that apply the EI Tax is 28.6%, and the average will be 26.7% for our 18 neighbors. The rate of 25% in our EI Tax law is a bit lower than international average level.

3) Uniform deduction standard
(1) According to the new EI Tax law, all enterprises shall apply pre-tax deduction on salary, which means that all the salary paid to employees shall be deducted before being calculated as the taxable amount, (2) The deduction rate for public welfare distribution is raised from 3% to 12%, (3) The deduction rate for research expense is unified and raised. Meanwhile, the new EI Tax law has uniform stipulations on un-deductible expenditures, all costs and all expenses that can not be calculated as depreciation and amortization.

4) Uniform tax preference
(1) The EI Tax on a small meager-profit enterprise that meets the prescribed conditions shall be levied at a reduced tax rate of 20%. The EI Tax on important high- and new-tech enterprises that are necessary to be supported by the state shall be levied at the reduced tax rate of 15%. Enlarge the preferences on startup investment enterprises and on environment maintaining, safe manufacturing. (2) Preferential tax policy shall be reserved for agriculture, forestry, grazing, fishing and infrastructure construction investment. (3) Substitutive preferential tax policy shall be applied to labor service enterprises, welfare service, resource utilization enterprises. (4) New borne important high- and new-tech enterprises that are necessary to be supported by the state in the economic zone set by law and other particular policy zones will be entitled to transitional preference and continue enjoying other income tax policies applied also to other encouraging enterprises. (5) The preference policy for productive foreign invested enterprises and export oriented enterprises that enjoy timely tax reducing and remitting.

3. Two transitions in the new EI Tax law

Of the two transitions, the first means that any enterprise, that were registered before the announcement of the new EI Tax law, are entitled to make transition to adopt the new tax rate within a certain period. If such enterprises enjoy timely reducing and remitting of the tax, they will continue to enjoy. The second transition means that high- and new-tech enterprises in particular trade zone and high- and new-tech enterprises supported by the state will be entitled to continue enjoying the policy of “two for-frees and three half-deductions”. Furthermore, preferential policy for West Development shall continue to be exercised after the effectiveness of the new EI Tax law.

4. Avoidance of double taxation by resident enterprise

According to the new EI Tax law, resident enterprise shall bear the tax obligation to tax the income earned from inside or outside of China. When such enterprises have taxed outside China, they shall bear the risk of double taxation. Therefore, the new law stipulated a deduction period of 5 years and that any of the resident enterprise’s operating organ outside China shall not deduct the benefit of the organ inside China with the loss of the organ outside China. Furthermore, the new law introduces indirect deduction which means for the dividends, bonuses and other equity investment proceeds derived outside China, which a resident enterprise obtains from its directly or indirectly controlled foreign enterprise, the portion of income tax on this income paid by the foreign enterprise outside China may be treated as the allowable tax credit of overseas income tax amount of the resident enterprise and be deducted within the limit of tax credit.

III. Effects of the new EI Tax law

1. Promoting fair competitions and harmonious development among domestic and foreign invested enterprises

The new EI Tax Law will establish a fair and ordered taxation and market competition environment, while it may act as a good tool for macro-control, adjust the preference for taxation, establish a new taxation preference mechanism of “first industry type, then district location”. The new EI Tax Law helps to realize benefit balance among administrations, local interest groups, transnationals and other parties; to coordinate different or even opposite value; and to realize benefit balance and coordination. Thus, substantial fairness on EI Tax would be realized.

2. Stimulating production growth and self-innovation.

The new EI Tax Law not only lowers the tax rate for the enterprises, but also stipulated the nation-supported and –encouraged industries and items with tax preference to which industrial policies act as a leading role. In this way, the enterprise would improve capital accumulation; purchase power, innovation ability and production growth.

3. Accelerating balanced development of our country’s regional economy

At the beginning of the reform and opening, our country applied a strategy called hierarchical development to the whole country including the EI Tax policies, which finally results in bigger and bigger economic gaps between each hierarchy. The unification of the EI Tax helps to orient from district preference mainly to industrial preference mainly, and further helps to accelerate the development in the West, thus narrowing the gap among the East, the Middle and the West.

4. Improve the effectiveness and quality of the utilization of foreign investment

As the international experience shows, there are several principal factors that shall take responsibility to foreign investment attraction, such as stable political environment, sound economic status, potential market, abundant labor force and better commercial facilities and government services. As our country is witnessing accelerating development of civilization and industrialization, and as capital shortage is no longer the main problem during the development, we have to not only abstract foreign investment, but also guarantee its quality, so that we can increase the industry competitiveness. Therefore, integrating the domestic EI Tax law and foreign invested EI Tax law, and adjusting the preferential policy will actively direct foreign investments, and thus promote the adjustment of economy and industry structure and the production growth, so that the way we use foreign investment will be of high quality and high competitiveness. Thus, we can handle new challenges at this new historical period.