The Chinese Government has offered preferential tax policies primarily to foreign investors to encourage foreign capital inflows since 1978 when China initiated its reform and opening policies.

These tax incentives have played an active role in attracting foreign investment, increasing investment and improving the country's technical level, Ni said.

Statistics indicate that foreign investment in China grew at an average growth rate of 38 per cent between 1979 and 1997. The ratio of foreign investment to the country's total fixed assets investment rose from 3.6 per cent in 1985 to 13.3 per cent in 1996.

Foreign-funded companies contributed 12.7 per cent to China's economic growth and 50 per cent to the growth of the country's foreign trade.

"These preferential policies also led to a slow-down in domestic investment, a restriction on the purchasing and manufacturing of domestic equipment and a serious loss of the country's tax income," Ni said.

Statistics indicate the country lost tax income of 130 billion yuan (US$15.7 billion) in 1996 and 110 billion yuan (US$13.3 billion) in 1997 because of the tax incentives.

"The tax incentives resulted in more advantages than disadvantages, because the incentives co-existed with such non-tax trade barriers as higher tariffs and import quotas enjoyed by domestic companies," Ni said.

But China will have to gradually remove trade barriers after it accesses the World Trade Organization (WTO).

The liberalization of foreign trade and service trade will also be accelerated after the WTO accession. "Chinese companies will no longer compete with their counterparts on an equal footing if the Chinese Government continues to practice preferential tax policies," Ni said.

China's expected WTO membership is prompting an overall tax system reform designed to bring it in line with those used in other countries, Ni said.

An excessive reliance on indirect taxes, mainly business taxes, the value added tax and the consumption tax, would make China's tax revenues vulnerable to tax evasion and other challenges brought by e-commerce. This, analysts said, would affect indirect taxes more than direct taxes, or income taxes.

Ni said direct taxes could play a more effective role in fine tuning the economy, and their proportion in the overall tax mix should be improved to at least 50 per cent, which is still lower than levels in developed countries.

Indirect taxes account for more than 60 per cent of China's tax receipts.

On a related front, the WTO entry would revise the structure of China's tax revenues. It is expected to earn more income taxes from textile exports which will increase after China joins the world trading body and to suffer taxloopholes as the arrival of more multinational companies would make tax collection more complicated, Ni said.

Zhang Peisen, senior researcher with the Taxation Research Institute under the State Administration of Taxation, said an unification of the two income tax laws, respectively designed for domestic and foreign-funded enterprises, is an urgent task.

"The unification process must be sped up to create an environment for fair play," he said.

The virtual burden of enterprise income tax for Chinese enterprises stands at around 22 per cent while that for foreign-funded firms was 12-15 per cent, constituting a major gap of tax burden between domestic and foreign-invested businesses.

Meanwhile, other preferential tax policies such as taxes on importing foreign equipment and taxes for using land should also be adjusted.

(People Daily)