Notice of the State Council on Unification of the System of Urban Maintenance and Construction Tax and Education Surcharges

Issuing Body: State Council
Issuing Date: October 18, 2010
Effective Date:

In a continuing effort to unify China's tax system for domestic and foreign-invested enterprises (FIEs), the State Council has issued rules that for the first time in 16 years require FIEs to pay urban maintenance and school taxes. The Notice on Unification of the System of Urban Maintenance and Construction Tax and Education Surcharges (Urban Maintenance and Education Surcharge Notice) was issued on October 18, 2010, and became effective December 1. Following the prior unification of differentiated tax regimes for Value-Added Tax, Business Tax, and Enterprise Income Tax for domestic, foreign, and foreign-invested enterprises (FIEs), the Urban Maintenance and Education Surcharge Notice completes the unification of China's tax system for those varying types of businesses.

To attract foreign investment, China had for years given FIEs more favorable tax treatment than domestic enterprises. China's new Enterprise Income Law, which became effective on January 1, 2008, marked a milestone of sorts, as it granted equal tax treatment to domestic enterprises and FIEs. Prior issues of China Law Update have summarized that influential law (May 2007) as well as implementing regulations and related circulars in February 2008 (Implementation Regulations for the Enterprise Income Tax Law of the People's Republic of China; Circular on the Implementation of the Transitional Preferential Policies Concerning Enterprise Income Tax) and April 2008 (Circular on Relevant Issues Concerning the Implementation of Transitional Preferential Policies for the Enterprise Income Tax; Circular on Several Preferential Policies for the Enterprise Income Tax; Circular on Relevant Matters After Cancellation of Preferential Tax Policies for Foreign and Foreign-Invested Enterprises).

Background

The State Council first issued the Tentative Regulations of Urban Maintenance and Construction Tax (Urban Maintenance Tax Regulations) in February 1985, levying urban maintenance and construction taxes on individuals and entities—including both FIEs and foreign enterprises—that are subject to VAT, Business Tax, and China's now-defunct Product Tax. The Product Tax was cancelled in 1994; instead, entities and individuals subject to VAT, Business Tax and Consumption Tax were required to pay Urban Maintenance and Construction Tax. Local governments use urban maintenance and construction tax revenue for the maintenance and construction of public utilities and facilities, including streets, in urban areas.

The State Council also began levying Education Surcharges on individuals and entities—including FIEs and foreign enterprises—that are subject to VAT, Business Tax and Product Tax with issuance of the Tentative Regulations on Collection of Education Surcharges (Education Surcharge Regulations) in April 1986. As with the Urban Maintenance and Construction Tax, from 1994, with elimination of the Product Tax, entities and individuals subject to VAT, Business Tax and Consumption Tax were required to pay Education Surcharges. The Education Surcharge revenue is used to improve educational facilities and conditions in elementary and secondary schools.

In order to attract foreign investment, however, the central government decided in 1994 to exempt FIEs and foreign enterprises from Urban Maintenance and Construction Tax and Education Surcharges. FIEs and foreign enterprises have enjoyed favorable treatment since then.

Specific Provisions

In accordance with the Urban Maintenance and Education Surcharge Notice, as of December 1, 2010, FIEs, foreign enterprises and foreign individuals will be subject to both Urban Maintenance and Construction Tax and Education Surcharges. All the existing rules governing Urban Maintenance and Construction Tax and Education Surcharges will be applicable to foreign-invested enterprises, foreign enterprises and foreign individuals. Any provisions of existing law that conflict with the Urban Maintenance and Education Surcharge Notice are automatically repealed when the notice comes into effect.

As stipulated in the Urban Maintenance Tax Regulations, the tax basis for Urban Maintenance and Construction Tax is the amount of VAT, Business Tax, and/or Consumption Tax actually paid by a taxpayer. The Urban Maintenance and Construction Tax rate varies depending on the taxpayer's location. For a taxpayer in an urban area, the rate is 7 percent; in a county and town, the rate is 5 percent; in other areas, it is 1 percent.

According to the Education Surcharge Regulations and subsequent amendments thereto, the tax basis for the Education Surcharge is the amount of VAT, Business Tax, and/or Consumption Tax the taxpayer actually pays. The Education Surcharge rate is 3 percent for all taxpayers.

Urban Maintenance and Construction Tax and Education Surcharges should be declared and paid together with VAT, Business Taxes, and/or Consumption Taxes.

Conclusion

As a result of the two surtaxes, the tax burden for FIEs in China will increase by approximately 0.6 percent of gross taxable revenues. Even though the amount of additional tax in most cases will not be large, foreign and foreign-invested enterprises should factor the two into their accounting.

More broadly, the Urban Maintenance and Education Surcharge Notice, like the Enterprise Income Law, signals the State Council's determination to curtail if not completely end tax breaks for foreign and foreign-invested enterprises in China. Whether that continues or ultimately proves beneficial for China remains to be seen. Given the country's robust economic growth and enormous domestic market, however, it will be hard for foreign investors to disregard the investment opportunities in China—even with the increased tax burden.