Comparison of Chinese and U.S. Corporate Tax Systems found that if the Biden administration’s proposed tax increase measures are passed, the tax bias against U.S. domestic investment will further deteriorate
Source: American Tax Foundation
Compilation: Smart Finance International Tax Service Team
Recently, the Tax Foundation published a research report entitled “Comparing the Corporate Tax Systems in the United States and China ” (hereinafter referred to as the “Report”), which the report makes a detailed comparison of the corporate tax systems of China and the United States in terms of corporate tax burdens from China and the United States, depreciation deductions, R&D super deductions, and interest deductions for corporate income tax, international taxation, value-added tax and special zone policies (it needs to be explained in particular that, some Chinese tax policies in the report are incomplete).
By comparison, the report found:
1. Federal policy makers are debating a legislative package aimed at improving U.S. competitiveness against China; however, the package currently makes few improvements to the U.S. tax code.
2. The existing U.S. tax code favors capital investment and is expected to worsen over the next decade. The tax bias against domestic investment will worsen if the tax increases included in the Biden administration’s budget proposal are passed.
3. The U.S. federal corporate income tax rate is currently 21%, rising to 25.8% if state and local average corporate tax rates are taken into account. Profits from highly fixed intangible assets to support exports face a lower tax rate (13.125%) due to the foreign derived intangible income (FDII) deduction. The overall corporate income tax rate in China is 25%, with lower rates ranging from 5% to 15% for certain regions or industries.
4. Under current law, the marginal effective tax rate (METR) in the United States is 18.3%, compared with 4.8% in China, indicating that the United States has a higher burden on marginal investment than China.
5. In the area of fiscal policy, instead of focusing on subsidizing specific U.S. industries, lawmakers should consider improving basic tax incentives for domestic investment to increase U.S. competitiveness with China and other countries.
Comparison of the tax burden of Chinese and American companies
In the United States, the statutory federal corporate income tax rate is 21%. In the United States, 44 states and the District of Columbia also levy their own corporate income tax, taking into account the average tax rate of each state, and the combined corporate income tax in the United States reaches 25.8%. Profits from highly fixed intangible assets to support exports face a lower tax rate (13.125%, planned to rise to 16.406% after 2025) due to the deduction of foreign derived intangible income (FDII). Under President Biden’s fiscal 2023 budget proposal, which proposes to raise the federal corporate income tax rate to 28%, the combined U.S. rate would be 32.3%, higher than the average for China and the OECD (excluding the U.S.). The standard statutory corporate income tax rate in China is 25%, while certain regions and industries enjoy preferential rates ranging from 2.5% to 15% (see Table 1).
Table 1: Preferential corporate income tax rates in China
| Type of business, location or activity | tax rate |
| High-tech enterprises | 15% |
| Encourage the designation of key software companies and encourage designation of integrated circuit design companies | 10% |
| Qualified Technology – Advanced Service Enterprise | 15% |
| Small low-profit enterprises | 2.5-5% |
| Qualified Pollution Prevention and Control Enterprise | 15% |
| Encouraged enterprises in the western region | 15% |
| Enterprises established in Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone | 15% |
| Enterprises set up in Hengqin New District, Zhuhai | 15% |
| Enterprises set up in Pudong Comprehensive Pilot Zone | 15% |
| Enterprises registered in Hainan Free Trade Port with substantial operations | 15% |
| Enterprises engaged in manufacturing or R&D in key industries of Lingang New Area, Shanghai Pilot Free Trade Zone | 15% |
The report states that if the U.S. maintains 100% dividend depreciation, a one-time deduction for R&D and other policies in place in 2021, its marginal effective tax rate (METR) will be 11.2%, higher than China’s 4.8% METR. However, tax incentives for domestic investment will deteriorate over the next few years due to changes in predetermined U.S. policy.
Thus, using the current legal benchmark to reflect impending changes suggests that after all scheduled changes, the METR in the United States will reach 18.3%, well above the average for China and industrialized countries (Table 2). If the Biden administration’s proposal to increase corporate taxes is adopted, the effective tax rate would be higher. Raising METR and AETR in the United States reduces the incentive to increase existing investment and find new domestic investment.
Table 2: When dividend depreciation expires, the tax burden on businesses in the US will be significantly higher than in China
| Jurisdiction | marginal effective tax rate | average effective tax rate |
| China 2022 | 4.8% | 19.3% |
| US, current law plus maintaining 100% dividends, R&D expenses, EBITDA and FDII | 11.2% | 21.5% |
| Current U.S. law | 18.3% | 23.4% |
| US, Biden’s fiscal year 2022 budget proposal | 23.7% | 29.5% |
| OECD average | 15.5% | 22.9% |
Depreciation Deduction Policy Comparison
In the United States, purchases of tangible capital must follow the depreciation schedule set forth in the Modified Accelerated Cost Recovery System (MACRS). MACRS details payback periods of 3, 5, 7, 10, 20, 27.5 and 39 years, depending on the type of property purchased. MACRS properties with a payback period of 20 years or less are allowed a special deduction of 100% in their first year, known as 100% bonus depreciation, which provides full cost recovery for qualifying assets. However, the bonus depreciation plan will drop by 20 percentage points annually from 2023 until it is completely phased out after the end of 2026.
Depending on the payback period, faster depreciation methods may be permitted: 3, 5, 7, and 10 year properties may use the 200% declining balance method; 15 or 20 year properties may use the 150% declining balance method; and Other properties (most prominently investments in residential and commercial buildings) must use the straight-line method.
By preventing full capital cost recovery, the U.S. tax system increases the effective tax rate. The planned phase-out of dividend depreciation is the biggest driver of the higher effective tax rate the U.S. will experience in the coming years.
Likewise, for the purposes of Chinese corporate income tax, purchases of physical capital assets must be depreciated over a period specified by law. It is worth noting, however, that the longest payback period in China is 20 years, compared to 39 years in the US, both of which apply to buildings. Depreciation deductions generally use the straight-line method; however, certain types of assets, by their nature or related to favored industries such as manufacturing or research and development, allow the use of shorter life or accelerated depreciation methods.
In addition, from January 1, 2018 to December 31, 2023, newly acquired fixed assets with a unit value of not more than 5 million yuan ($762,000) other than real estate are allowed to be fully deducted in the year of acquisition.
Comparison of R&D Activities Policies
China supports R&D activities mainly through its tax laws, offering generous policy dividends of R&D super-deductions. The super deduction allows businesses to deduct more than 100% of their R&D expenses from their taxable income. Therefore, the super deduction is actually a subsidy for R&D investment. In 2021, China will extend the R&D super-deduction policy to 2023, increase it from 150% to 175%, and further increase the R&D super-deduction ratio for manufacturing enterprises to 200%. The U.S. requires R&D expenses to be amortized over five years through 2022, compared to China’s super-deduction. Since 1954, companies in the U.S. have been able to fully deduct their R&D expenses immediately, but due to a change included in the Tax Cuts and Jobs Act of 2017 (TCJA), starting in 2022, the deduction is changed to five-year amortization Expect. Research and development activities conducted outside the United States must be amortized over 15 years. The apportionment of the deduction can inhibit R&D investment over time because it means that companies cannot fully deduct their investments at their real value.
By comparison, the report notes that overall, the U.S. does not offer particularly large tax breaks for corporate R&D.
Comparison of Business Net Interest Deduction Policies
In China, loan interest can generally be deducted, but the deduction ratio of interest payments between related parties is limited by special rules: for financial companies, the debt-to-equity ratio of related parties must not exceed 5: 1, while the debt-to-equity ratio of other industries must not exceed 2: 1. Interest expenses exceeding the above debt-to-equity ratio shall not be deducted before tax.
In the U.S., the 2017 tax law is more restrictive on the interest deduction because it applies to all interest payments, not just related party payments. Net interest expense deductions are generally limited to 30% of earnings before interest, tax, depreciation and amortization (EBITDA) through 2021, and 30% of earnings before interest, tax, depreciation and amortization (EBIT) starting in 2022. Disallowed interest charges can be carried forward indefinitely. The change from EBITDA to EBIT further tightens restrictions on net interest deductions and increases the tax burden on business investments by making debt-financed investments more expensive for companies with higher depreciation and amortization expenses.
The report notes that while the limit is at least in part intended to reduce the tax code’s bias against debt-financed investments, the recent shift from EBITDA to EBIT could adversely affect companies engaged in domestic investments. It also runs counter to international norms; for example, most OECD countries limit their interest deductions based on EBITDA rather than EBIT.
Comparison of International Tax Policies
Another difference between the two corporate tax systems in China and the U.S. is that companies headquartered in China are taxed on their global income, while those headquartered in the United States face a hybrid system that exempts certain global income and exempts certain global income Certain returns are taxed on other worldwide income.
As part of the 2017 tax reform, the four main components of the U.S. international tax system are the participation exemption, GILTI, FDII, and BEAT. Participation exemptions shift the U.S. from a global system like China to a territorial one by exempting foreign profits returned to the U.S. from domestic taxation.
The two countries will also have to deal with a global agreement to change international taxation reached through the OECD, which consists of two pillars. Pillar one would introduce a new taxing power on a portion of the profits of large, high-margin businesses that sell goods or provide services or are located where consumers are located. Pillar two will introduce the lowest global tax rate of 15% for large, high-profit corporations.
Total Income and VAT Policy Comparison
Beyond the corporate tax system, other elements of China’s tax system may influence business investment decisions, particularly China’s consumption-based tax structure and local-based incentives. China implements a two-tier tax system on business income. China levies value-added tax or consumption tax. VAT is designed to tax the value added at each stage of the production process. Under a well-designed VAT, a company deducts the cost of acquiring inputs from the sale of goods to the next company down the value chain.
The U.S. has abandoned VAT at the national level, but most states and some local governments impose sales taxes. While such levies account for a smaller share of overall levies compared to China’s VAT, they do apply to B2B transactions, which could have a similar negative impact as Gross Revenue Tax (GRT). Estimates indicate that nearly 42 percent of the state sales tax base consists of business inputs.
Special Economic Zone Policy Comparison
China has also aggressively pursued a local-based economic development strategy, changing several policy levers (including taxes, but also land, regulation, and other governance options) to favor specific locations. In the area of tax policy, this approach entails reducing corporate tax rates for companies operating in specific cities or provinces—sometimes across the board, sometimes for specific industries of interest.
The United States has tried similar approaches to direct investment to targeted locations through programs such as the New Markets Tax Credit, Empowerment Zones, and, more recently, Opportunity Zones. U.S. projects have had mixed results, often incurring high costs, and delivering small gains at best, but it’s worth noting that U.S. policy is far smaller in scale than China’s, making direct comparisons difficult.
Influence on the United States
Overall, China tends to have a better approach in certain areas, such as lower corporate tax rates than the U.S. combined tax rate, shorter depreciation life for certain asset classes, and a relatively good VAT structure, but it also relies heavily on industrial policy and state-directed investments lead to costly misallocation of resources. Therefore, imitating all the tax policies used by China is not an effective way for the United States to improve its competitiveness.
Rather than adopting China-inspired industrial policies or raising the tax burden on private companies as the Biden administration has proposed, lawmakers should focus on removing elements of the current tax code that hinder domestic physical capital and investment in research and development, the report said. Other issues related to competitiveness and national security can be addressed through appropriate policies outside the tax system. In addition, the United States should seek to improve the competitiveness of its international tax system, rather than turning to international tax changes that would increase the burden on U.S. businesses.
Conclusion
The Chinese tax code contains many industry- and activity-specific components, and this approach has produced mixed results. The U.S. tax code should, first and foremost, avoid penalizing domestic industries and activities. In the short term, fully recovering R&D costs, designing better limits on net interest expense, and ensuring continued 100% bonus depreciation of machinery and equipment will be the most important improvements. At the same time, reject raising taxes on private business in President Biden’s budget proposal to prevent further deterioration of domestic investment incentives.