The Enterprise Income Tax Law is expected to put an end to the taxation honeymoon period enjoyed by foreign investment in China by leveling the competition ground for domestic and foreign-funded companies (including Chinese-foreign equity joint ventures, Chinese-foreign contractual joint ventures, wholly foreign-funded enterprises and foreign enterprises) in paying income tax.

Currently domestic enterprises are required to pay a tax rate of 33 percent while foreign-funded enterprises in some special economic zones are levied at a preferential rate of 24 percent or 15 percent. Although domestic low-profit enterprises can also enjoy special rates of 27 percent or 18 percent according to their conditions, the advantage in taxation for foreign-funded companies is noticeably large. Statistics from the Ministry of Finance show that the average enterprise tax burden for foreign-funded enterprises is 15 percent, while for domestic enterprises it is 25 percent.

This inequality created by ownership-based incentives is inscribed in the current domestic enterprise tax law and foreign-funded enterprise tax law. Both laws were enacted in the early 1990s, when China was going all out to attract foreign investment to develop its economy.

Yet the last 15 years have seen a significant shift in the Chinese economic landscape. According to a UN report at the end of last year, China continued to be the largest foreign direct investment (FDI) destination in the developing world in 2006. Over the four years between 2002 and 2005, the FDI inflow into China grew at an average annual rate of 65.6 percent.

"Actually with the stewardship of the largest foreign exchange reserves in the world, China no longer faces the urgent task of attracting foreign capital," said Professor of Tibet University Zheng Weilie. "What China badly needs now is its own proprietary technology, which foreign companies are very reluctant to give to China."

Delivering an explanation of the draft tax law to the plenary session of the NPC, the Minister of Finance Jin Renqing said that unifying the two income tax laws will help to "promote improvement in China's economic structure and upgrading of its industries." One of the most important changes enacted by the new tax law is that it applies a preferential rate of 20 percent to small low-profit enterprises and 15 percent to hi-tech enterprises receiving priority support from the state. The law also grants incentives to enterprises investing in environmental protection, energy and water conservation and work safety.

To soften the impact of fattening tax burdens on foreign-funded companies, the new tax law will be implemented over a transitional period of five years. Although it may be seen to have a long-term impact on foreign investment growth momentum in China, a number of foreign companies have shown an understanding of the change.

Hao Jikuan is an NPC deputy and Chairman of Hong Kong-based Viction Group, which, with Japanese companies, co-owns a business in the Inner Mongolia Autonomous Region. Although his company will have to pay a higher level of income tax, he gives the new law his total support. "In the past, China implemented different taxation rates for domestic enterprises and foreign companies, which I think suited national conditions," he said. "Yet with economic development and a balancing of the economic situation at home and abroad, I think it is time to readjust the taxation rate for foreign companies. I think such a change would be understood and wouldn't exert noticeable negative impacts on economic growth."

NPC deputy Jiang Hongbin is also the president of a Heilongjiang-based joint venture between Thailand and China. He said the new tax law would nurture a fairer competitive environment between domestic companies and foreign-funded firms. "When we were given preferential treatment, it was for us to grow smoothly. Now it is time for us to stand back on the starting line with companies of different ownership," said Jiang. When asked whether he has given any suggestions on the law at the NPC session, he said, "I did. My suggestion was that the law should take effect as early as possible."