New Tax Law to Have Little Impact on Taiwanese Firms
While the new corporate income tax system will inevitably increase the costs that enterprises operating in China have to bear, the impact on Taiwanese companies will not be too severe. There are three main reasons why this is the case. Firstly, around 60% of Taiwanese-invested enterprises in China are small and medium enterprises, which, under the new tax system, will pay corporate income tax at a special rate of only 20%. The increase from the current rate of 15% to 20% will be phased in gradually over a five-year period with a one-percentage-point increase every year. Secondly, most of the Taiwanese firms operating in China are engaged in the ODM (Original Design Manufacturing) or OEM (Original Equipment Manufacturing) of hi-tech products; companies in the hi-tech sector will continue to pay corporate income tax at the preferential rate of 15%. In addition, those enterprises that have been granted a two-year exemption from corporate income tax followed by a 50% reduction for three years will continue to benefit from this tax break. Thirdly, China will continue to provide a 50% tax reduction for foreign-invested enterprises that are producing mainly for export. The maintenance of this preferential treatment will ensure that Taiwanese companies in China -which are usually manufacturing products for sale in other parts of the world -will still have the potential to achieve reasonably high profit margins.
Investigation of Tax Fraud to Become More Vigorous
The Chinese government will lose tax revenue from the increase in the deduction for employee salaries; it can be anticipated that the government will be seeking to claw this lost revenue back from high-earning foreign-invested companies. Many of the foreign-invested enterprises operating in China are registered as the subsidiaries of an overseas parent company created especially for the purpose. This method enables the enterprise to engage in international tax evasion by transferring profits from the subsidiary to the parent company, which is normally located in a jurisdiction where tax rates are lower. It can be anticipated that, once the new corporate income tax system comes into effect, the Chinese government will become more aggressive in investigating tax evasion of this kind by foreign-invested enterprises. As the integration of the information systems of different government agencies continues, and with China having started to sign taxation agreements with a growing number of foreign countries, the establishment of an overseas parent company as a strategy for tax evasion will no longer be as effective as it has been in the past.
Enterprises Seeking to Be More Environmentally Friendly
In the past, a wide range of tax breaks were available for foreign companies investing in eastern China and south China to stimulate foreign investment and boost economic growth. As China has become more competitive and its industrial structure has been upgraded, the government is reforming the tax system so that preferential tax treatment for enterprises is based on the industry to which the enterprise belongs rather than the regions in which it is located. The most attractive tax breaks will aim at those industries whose development has been made a key priority by the Chinese government.
In the future, the Chinese government will be focusing on the development of hi-tech, environmentally friendly, and energy and water conserving industries. The government will no longer be providing tax breaks for low-level manufacturing industries that create large amounts of polluting waste and cause serious harm to the environment; the government has even begun to ask companies in these industries to cease production. Unless companies are willing to move production to another low-cost manufacturing location, they will be forced to improve waste treatment and reduce pollutant emissions in order to conform to the Chinese government's increasingly stringent environmental standards.
In the past the Chinese government provided direct tax breaks such as a two-year tax exemption followed by a 50% reduction for three years. Now the government is moving towards indirect tax breaks, such as tax refunds for re-investment and accelerated depreciation. Foreign companies will no longer be able to view China as merely a low-cost manufacturing location. Those companies that have an eye on developing China's huge consumer market will need to think more in terms of developing marketing or R&D operations.
Taiwanese ICT Players Likely to Shift Production Bases
Land and labor costs in China are increasing rapidly, and the preferential tax treatment that foreign-invested enterprises had enjoyed in the past is gradually being whittled away. Given that other emerging economies are beginning to look increasingly attractive as low-cost production locations, the Taiwanese ICT industry clusters in China are likely to shift slightly to the west, and that some Taiwanese manufacturers will relocate production to other emerging economies.
A comprehensive value chain that integrates R&D, procurement, production, marketing, and logistics is gradually taking shape in China. Given the need to establish regional headquarters in China and the abundant resources of their existing interpersonal networks, Taiwanese companies are projected to relocate their manufacturing operations. These companies are more likely to choose smaller cities away from the coast (although still located in coastal provinces) where the additional transportation costs incurred by being inland will be offset by lower production costs.
By contrast to the rapidly increasing R&D and production costs in China, many other developing nations offer rising domestic demand, low production costs, and more attractive incentives for foreign investors. Taiwanese manufacturers are also uncomfortably aware of heavily concentrated in China their manufacturing operations are. It is thus highly likely that Taiwanese ICT manufacturers will begin to relocate production away from China to other emerging economies such as India and Vietnam. However, given the desire to recoup their investment on new plants and the administrative difficulties that local government could create for them, ICT manufacturers will mainly establish new factories overseas to achieve a significant increase in production capacity.