On March 16, 2007, China's National People's Congress ("NPC") passed the long anticipated Unified Enterprise Income Tax Law of the People's Republic of China ("EIT Law"). The EIT Law will come into effect on January 1, 2008. At the same time, the current Foreign Enterprise and Foreign-Invested Enterprises Income Tax Law ("FIE Tax Law") will no longer be effective. Summarized below are a few highlights of the EIT Law:

New Tax Rates

Under the new EIT Law, a unified income tax rate of 25% and a top withholding tax rate of 20% will be applied to all enterprises, except for those that are classified as high-technology enterprises, to which a 15% rate will apply, and qualified small-scale enterprises, to which a 20% rate will apply. For enterprise income tax ("EIT") purposes, enterprises are classified into resident and non-resident enterprises. EIT is imposed on China – source income non-resident enterprises including dividends, royalties, rents, capital gains, consistent with China's tax treaty obligations.

Tax Incentives

A much-anticipated change is the elimination of tax holidays available under the FIE Tax Law, although certain tax holidays applicable to "key industries and projects that are supported or encouraged by the State" will continue. In contrast, under the FIE Tax Law, a foreign-invested enterprise engaged in production/manufacturing with a term of operation of at least ten years is entitled to two years of income tax exemption and three years of 50% income tax reduction afterwards, starting in the first profit-making year. Many foreign companies entering China to establish their manufacturing operations have taken advantage of these tax holidays. These across-the-board incentives will no longer be available under the new EIT Law.

Transitional Period

To ease the transition, the EIT Law grandfathers in the incentives available to enterprises that have already been established or are already enjoying a tax holiday under the FIE Tax Law. Companies established in special, lower-EIT zones before March 16, 2007 will continue to enjoy the preferential tax rates under the FIE Tax Law for up to five years, when the old rates are completely phased out; companies that are enjoying the "two year exemption and three years 50% reduction" may continue to enjoy these incentives until the tax holidays are used up; and companies that have not started to use these tax holidays because they have not started their first profit-making year must use their tax holidays during 2008. According to the EIT Law, further details regarding tax rates in various economic and technological zones will be provided in forthcoming implementing regulations.

Business Purpose Rule and Other Provisions

A new development in the EIT Law is the business purpose rule. It gives the tax authority the power to make adjustments if a company puts into place “arrangements with no reasonable commercial purpose” to reduce its taxable income. The EIT Law has other adjustment rules that deal with inter-company transfer pricing, interest deduction limit on related party financings, and deemed dividends from PRC resident-controlled corporations in a lower-tax-rate jurisdiction.