Chinese Government Eyeing Offshore Tax Avoidance

Another example of healthy, global tax competition in action: the Communist Chinese government is reported to be examining the issue of offshore tax avoidance after new figures confirm once again that the bulk of investment by Chinese based companies is flowing to and from traditional low-tax or no tax offshore havens.

A crackdown on the offshore activities of Chinese companies may come after data released by the Chinese Ministry of Commerce showed that between January and May 2007, Hong Kong topped the sources of capital investment list, followed by the British Virgin Islands, Japan, South Korea, Singapore, the U.S.A., the Cayman Islands, Samoa, Taiwan and Mauritius. With the exception of Japan and South Korea, all of these countries are tax havens of some note. (The U.S. is a tax haven for foreign investors, but not U.S. citizens or residents). The report stated that the figures reflect the actual amount of foreign capital invested from the various jurisdictions, which accounts for 86.16% of China’s total foreign capital. Direct foreign inmvestment in China during 2006 exceeded US$60 billion.

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Under current law domestic Chinese firms pay a corporate tax at a rate of 33%, but foreign-owned firms can reduce their rate through various tax breaks down to as low as 13% in some cases and can also set up low tax operations in various Chinese Special Economic Zones. By "round tripping," in which Chinese citizens set up offshore international business companies in Hong Kong and elsewhere, domestic Chinese firms can use them as mainland investment vehicles in order to qualify for foreign rates of tax. This legal and low tax practice has inflated China's foreign direct investment figures for years.

As a first step towards the reform of its tax system, China will be introducing a sort of corporate "flat tax" rate of 25% on 1 January 2008 and this single rate will apply to both domestic firms and foreign-owned firms.