USASBE 2008 Proceedings - Page 0566
If the US entrepreneur is not aware that in-country partners are engaged in transfer pricing practices, he or she may be at risk of being a party to illegal activities and/or experiencing a lower return on investment than entitled.
Income taxes are dependent on the determination of income. The differences between PRC GAAP and US GAAP, such as those illustrated above, indicate the possibility that a US entrepreneur may incorrectly estimate income tax expense if the estimate of income is materially incorrect.
The National People’s Congress (NPC) passed the unified enterprise income tax law on March 16, 2007, effective January 1, 2008.
Under the new law, the extent of income tax liability is governed by the residency status of the taxpayer. A resident taxpayer is defined as an enterprise that is incorporated under Chinese laws and regulations or has its place of effective management in China. However, the new law does not define the “place of effective management”. A non-resident enterprise refers to an enterprise which is established under foreign laws and regulations and which has its place of effective management outside of China (KPMG Primer, 2006).
The new law aims to unify the application scope, tax rate, tax deductions, and preferential tax policies for both foreign-invested enterprises (FIEs) and domestic enterprises. The primary objective of the law is to create a “level playing field” and a standardized and transparent fiscal environment that favors fair competition for all enterprises in China.
Entrepreneurs should be aware that the taxing authorities in developing countries sometimes exercise independence in awarding special tax discounts to favorite ventures. This practice can place less favored ventures at a disadvantage since income taxes can be a significant expense. The PRC is a developing country and entrepreneurs should not depend only on mere interpretations of the tax laws when they are conducting feasibility studies and valuation analyses concerning potential ventures. An act of due diligence would include scrutiny of the income tax expenses reported by competing ventures to understand their expense status.
Income subject to taxation in China is identified according to the source of the income. Resident enterprises will be subject to tax on their worldwide income. Non-resident enterprises will be subject to tax on income from sources in China, including income earned outside China that is effectively connected with the establishment or the place of business in China.
Tax rates are established according to the enterprise’s industry classification or the enterprise’s size. Income subject to tax on “encouraged” hi-tech enterprises, regardless of size, will be taxed at a rate of 15 percent. Small-scale enterprises earning a “small profit” will be taxed at a rate of 20 percent. All other enterprises will be taxed at a rate of 25 percent. The taxable income of US corporations is taxed on a graduated scale beginning at 15% of the first $50,000 of taxable income and increasing incrementally to 35% of taxable income in excess of $18, 333,333.