Ke Zunhong, President of Chengdu Kanghong Pharmaceutical Group, cherishes an ambitious dream -- to expand his business from a local giant in southwest China's Sichuan Province into the biggest pharmaceutical enterprise in the country.

On December 23, Ke made a substantial step forward by signing a contract with a leading pharmaceutical business in the United States -- Sagent Pharmaceuticals -- to set up a joint venture. For sale on the global market, with an annual output of US$1 billion, the new plant will produce injections for curing tumors, anti-infection purposes and for daily clinic uses.

Boasting a registered capital of US$50 million and covering an area of 11.3 hectares, the 50-50 stake joint venture is to be constructed next year in an area exclusively reserved for export-oriented processing enterprises in the Chengdu New and High-tech Industrial Park. The new business is expected to profit from all the preferential treatments endowed by the Chinese government to foreign invested enterprises in the country.

However, one day after signing the contract, Ke had to cool down from sheer ecstasy and square up to a tough-minded fact. On December 24, the Standing Committee of the National People's Congress (NPC), China's top legislature, initiated a lawmaking process to discuss the draft of the Corporate Income Tax Law, which means a unification of the existing income tax laws for domestic and foreign-invested enterprises.

Ever since China began to open up to overseas investment in the 1980s, two income tax systems were gradually set up and applied to domestic and foreign enterprises respectively. Nominally, Chinese companies pay income tax at a rate of 33 percent, while their foreign counterparts, who benefit from tax waivers and incentives to boost investment, pay an average of 15 percent.

Through pre-tax deduction, preferential tax rates and tax rate differences, domestic companies are currently taxed at a rate of 24 percent on average, while foreign-funded firms only pay about 14 percent -- a gap that has sparked controversy in recent years.

Under the draft law, China would introduce a unified tax rate of 25 percent for all types of enterprises. In addition, a number of preferential treatments for foreign funded enterprises will be reneged. Such alluring policies included offering 2 years of tax exemption, followed by a 3 year 50 percent reduction in corporate income tax (a rate of 7.5 percent) to all foreign-backed manufacturing enterprises with an operational term of more than 10 years.

While foreign companies and joint ventures like Ke's expect to come off worse when the tax rate is leveled, domestic enterprises are in a buoyant mood.

Lu Honghua, general manager of Changchun Huaxin Food, a Chinese confectionary producer in northeast China's Jilin Province pointed out that, "For us domestic enterprises, the unification of the rates signal that all the enterprises have returned to the same starting point and that all market players are put on an equal footing."

On December 29, the Standing Committee of the National People's Congress concluded a six-day meeting and decided to submit a draft law, proposing to unify income tax rates, to the NPC plenary session for enactment in March 2007.

In accordance with China's legislative process, three rounds of deliberation are carried out in the NPC Standing Committee once the draft bill is submitted - the new income tax rate is expected to take effect in 2008.

"The unification of the income tax rate will play an important role in establishing just, unified and transparent market rules and promoting fair competition amongst enterprises," said Lu.

Tax unification: In the nick of time

Industry officials claim that, so far, China's generous tax incentives that have been given to overseas-funded companies over the past two decades, along with other preferential treatments including very low land rent and locally defined tax waivers, have helped the country to attract more investment, technology and expertise.

China has been one of the world top destinations for foreign direct investment (FDI), hitting US$60.3 billion in 2006 in terms of the amount actually used.

By the end of August 2006, 579,000 foreign invested enterprises had been set up in China, with an actually used foreign capital of US$659.6 billion.

However, China's current dual income-tax structures have long been the subject of intense debate.

Mei Xinyu, a research fellow with the Ministry of Commerce told China Features that, "Compared with domestic enterprises, the actual tax burden on foreign funded enterprises in China is about 10 percentage points lower. This runs counter to the principle of national treatment for foreign enterprises after China's accession to the World Trade Organization (WTO) and it will dampen the competitiveness of domestic enterprises."

According to Ma Yu, a researcher with China's Academy for Economic and Social Research, "If you want fair competition, you must first remove discriminative policies and then favorable ones."

The process of unifying the income tax rates for domestic and foreign funded enterprises has, however, not been progressing smoothly. Within the government, opinion divides. While some government departments call for a fair tax system, others fear a unified tax structure would cause FDI losses.

Finance Minister Jin Renqing commented recently that, "The current tax regimes are too complicated. A unified tax code will create a taxation environment that favors fair competition among all ventures registered in China."

Chinese legislators agree that the 25 percent tax rate is an appropriate level to maintain a reasonable overall tax burden for businesses, which compares favorably with other countries and regions and with international rates. Worldwide, 159 countries and regions levy corporate income tax at an average of 28.6 percent.

According to official calculations, the new tax rate for domestic companies, which constitutes the bulk of the tax base, will substantially drop -- income tax collected from domestic companies will shrink by 134 billion yuan (US$16.8 billion).

Despite an income tax increase for foreign companies of 41 billion yuan (US$5.1 billion), China's state coffers will still face a reduction of 93 billion yuan (US$11.6 billion) in income taxation.

China's fast growing economy, improved competitiveness of businesses and growth momentum of fiscal revenue have convinced tax and financial officials that the country can afford the loss and the new rate will not starve state coffers.

Jin Renqing stated that the government pushes corporate income tax reform under such circumstances. "It's a time that is favorable for reform as state finance and businesses have strong capacity to face the reform," he said.

In 2005, China's tax revenues, excluding tariffs and agricultural tax, rose to a record high of 3.1 trillion yuan (US$381 billion).

High-tech industries preferred

To offset the impact on foreign funded enterprises from the merger of the two tax rates, the draft law proposes a number of transitional measures in implementing the unified income-tax structure.

Among others, the bill allows existing foreign-backed enterprises to continue to enjoy tax incentives for five years after the new rate is enacted and gradually increase income tax payments.

The bill also extends some preferential tax policies to more businesses, such as all hi-tech companies will enjoy a 15 percentrate to boost innovation. At present, only those in state-owned hi-tech zones enjoy such a privilege.

Investment in equipment for environmental protection and water conservancy purposes and for production safety will be used to offset tax payable in the bill.

He Manqing, deputy director of the Ministry of Commerce's Multinational Research Center revealed to China Features that, "The new law will not add burdens on foreign capital enterprises in the country significantly. Large multinational companies will almost not be affected at all, particularly in the long-run."

Remain powerful magnet for FDI

According to Yang Yuanwei, an official with the State Administration of Taxation, "China's ability to attract foreign capital will not necessarily fade after unifying the tax rates. The removal of a favorable tax policy is a minor setback compared with China's huge market potential."

On Nov. 9, 2006, the Chinese government published its 11th five-year-plan (2006-2010) for utilizing foreign investment, giving priority to quality rather than quantity.

According to the document, China utilized US$383 billion of overseas investment during the 10th five-year-plan period (2001-2005), including US$286 billion in overseas direct investment, US$38 billion in stock issuances and US$46 billion in foreign loans.

The document states that priority will be given to the introduction of advanced technologies, management expertise and skills, rather than the use of foreign capital. More emphasis is also to be given to the protection of environment and efficient use of natural resources.

Furthermore, the document stresses the need for more foreign investment in areas such as research and development as well as sophisticated design, so that China could eventually become a major manufacturer of high value-added products -- mainly of the high-tech variety.

Despite the stress on quality, the document says that the government expects foreign investment to keep rising in the next few years. It also calls for more foreign investment in China's remote west and the northeast rust belt, which are currently lagging far behind the coastal regions in attracting foreign investment.

Supachai Panitchpakdi, Secretary-General of United Nations Conference on Trade and Development (UNCTAD) agrees that China remains a powerful magnet attracting billions of dollars in foreign direct investment.

"China's low-cost labor has enabled the country to become a production base for global markets," said Mr. Panitchpakdi, "the country has made long-term efforts in building domestic capabilities, improving its infrastructure and strengthening human resources."

Mr. Panitchpakdi also commented that, "China has fostered an environment that promotes the benefits of FDI as domestic firms become well equipped to collaborate with and learn from foreign companies."

Operating under such circumstances, the 10 percent tax increase for foreign businesses is no longer a serious drawback in terms of investment.

Quoting responses from an American counterpart, Ke Zunhong, President of Chengdu Kanghong Pharmaceutical Group said that, "For businesses, it's important to be in China. When making investment, foreign investors consider much of such factors as labor cost and market, while preferential taxation treatment ranks only the fifth place of their consideration."

Ke believes that China's vast market potential and operational cost advantages will continue to make China a favorable investment option for many foreign investors.

(Xinhua News Agency December 30, 2006)