Australian companies have less than 30 days to address how a higher overall tax rate of 25% plus new withholding taxes will impact their investments in the region.

The new Enterprise Income Tax (EIT) law, which takes effect on January 1, 2008, also includes new provisions regarding tax on cash repatriation, transfer pricing, research and development concessions and a general anti-avoidance rule.

KPMG partner in charge of Asia markets Jason Chang said that while all businesses investing in the region need to look at what the tax reforms mean for their China strategies in the longer term, there are more pressing short-term concerns.

“Companies need to understand what actions they should be taking before the new regime comes into effect to minimise any negative impacts and harvest any opportunities that will be shortly unavailable,” Chang said.

“Many companies have not focused on the details of these changes and so haven’t planned a response, which means they will be hard pressed to act in time to take advantage of the window offered between now and 1 January 2008.”

Commenting on the longer-term impacts, Chang acknowledged that while the rise in corporate tax rates in the EIT law was obviously an additional cost for business, the changes also had a positive side.

“While China is obviously a powerhouse economy, some businesses have hesitated to invest significant funds into the country because of a lack of certainty regarding the regulatory environment,” he said.

“The introduction of a more robust taxation regime, which provides increased certainty around the taxation outcomes of investments, is welcomed.

“It is an important step towards addressing these concerns and establishing China as a foreign investment-friendly country.”

While the changes will raise some long-term strategic decisions for businesses, it is not too late to apply some tax planning to ensure 2008 is a year to remember.

Chang suggests reviewing your China profit scenario. If you are making profits this year, consider repatriating them now.

Also think about paying dividends out of China prior to January 1, 2008.

“It is not too late to make changes now,” he said.

Key developments under the EIT

Withholding tax - dividends repatriated to foreign investor

Foreign investors will be subject to a higher withholding tax, of up to 20%, on the dividends distributed by Chinese companies where previously there may have been none.

“Currently, reinvesting the profits means you can get a tax refund of up to 40 percent of the tax previously paid by the entity paying the dividend,” Chang said.

“If you do it from 1 January 2008, you may not get the tax credit/refund. Australian companies should consider repatriating any accumulated or current year Chinese profits to its foreign shareholder before the end of this year.”

Holding structure and new Chinese double tax treaties

Under current Chinese tax laws, an Australian company can still transfer the Chinese companies to a Hong Kong holding company without any tax cost by transferring the companies at cost. A tax-free rollover is likely to be repealed when the new tax law comes into effect on January 1, 2008.

Chang advises Australian companies to consider using an intermediate holding company resident in Hong Kong or Singapore or another country that has a favourable tax treaty with China.

Tax holidays revoked

The new laws will revoke the existing five-year tax holiday of two-year exemption and subsequent three-year 50% reduction of applicable tax rates.

However, companies that are subject to a reduced income tax rate under the existing law have a five-year transition period in which the tax rate will gradually increase to 25%.

General anti-avoidance provisions introduced

Under the new EIT law, where an enterprise carries out an ‘arrangement’ without reasonable commercial purpose or motive to reduce taxable income or revenue, the tax authorities have the right to make adjustments using reasonable methods.

Both incumbent and prospective investors in China will need to re-visit their tax planning strategies to consider the impact of the new anti-avoidance regime.

Reinvestment fund to be repealed

If Australian companies need the capital for further reinvestment or expansion in China, the dividends can be reinvested and may even qualify for a reinvestment tax refund, which could be up to 40% of prior year tax paid.

Again, this needs to be done before January 1, 2008, as this fund is likely to be repealed.

Australian investment in China is currently about $A2.275 billion. KPMG says this is likely to increase due to the strengthening Australian dollar.