The unity of China’s tax system for domestic and foreign-funded enterprises

State Council of Central People’s Government of China issued a notice regarding the Unification of the Urban Maintenance and Construction Tax (UMCT) and Educational Levy for domestic and foreign-funded enterprises on 18th October, 2010. Foreign enterprises, foreign-funded enterprises and foreign individuals will begin to pay UMCT and educational surtax in China with effect from 1st December 2010. The policy represents the last important step towards the unification of China's tax system of domestic and foreign-funded enterprises, following with the successive unification of vehicle and vessel tax, business income tax, farmland occupation tax and property tax of domestic and foreign-funded enterprises in 2007, 2008 and 2009.

The Chinese government had released the Tentative Regulations on UMCT and Provisional Regulations on Educational Surtax in 1985 and 1986 respectively, which successfully expanded the sources of fund for urban construction and education at that time. In the past 20 years, the UMCT and educational surtax were only imposed to Chinese citizens and domestically-funded enterprises. At the beginning of China’s reform and opening-up, such a preferential policy played an important role in absorbing foreign funds and introducing advanced foreign techniques. However, with the continuous deepening of reform and opening-up, the different tax treatment of domestic and foreign enterprises, which is contrary to the sprit of fair competition, can no longer meet new situations in today’s market economy. With the rapid economic development in China, the time has become ripe for a unification of the UMCT rates and educational surtax that applied to both domestic and foreign enterprises.

The UMCT rates for enterprises in cities, counties and other areas are 7%, 5% and 1% respectively. The rate of educational surtax is 3%. Local government entitles to decides whether to impose local educational surtax, the tax rate of which is 1% or 1.5%. The UMCT and educational surtax are calculated based on total amount of Value-added tax, Consumption tax and Sales tax paid by each tax player. Since most foreign-funded enterprises are manufacturing enterprises, they have to pay Value-added tax. They also have to pay Consumption tax for their products while some even have to pay Sales tax as well if they provide services in addition. Once the UMCT and educational surtax have been extended to foreign-funded enterprises, the tax base will then be increased.

Officials from Ministry of finance and the State Administration of Taxation said that imposing UBCT and educational surtax on foreign enterprises would not result in negative effects in attracting foreign investment for China. The policy does not aim to increase the burden of foreign enterprises. Instead it is targeted at building better investment environment and tax system for fair competition.

Regulations discussed in this issue:
Notice of the State Council on Extending the Urban Maintenance and Construction Tax and Educational Surcharges from Chinese to Foreign-funded Enterprises and Citizens, GuoFa [2010] No.35, (“Notice 35”), on 18 October 2010