In an attempt to stimulate innovation and entrepreneurship, China’s state council has recently announced tax cuts for small firms and high-tech companies. The intention is that the reduction in their tax burden will spur companies to spend more cash on R&D, hiring, and business expansion. These measures come in direct response to the ongoing trade tensions with the United States which directly implicate China’s high-tech sector.
Tax Cut Measures
Corporate Income Tax Change for Small Companies
Previously, businesses with an annual income of RMB 500 thousand were exempted from corporate income tax. This new measure raises that threshold to RMB 1 million. This will be effective until the end of 2020.
R&D Tax Deduction
R&D related purchases of equipment will be permitted a one-time tax deduction between RMB 1 million to RMB 5 million. Additionally, R&D expenses incurred overseas are now deductible.
Tax Changes for Technology Companies and Expenses
For high-tech companies, capital losses may be carried over for 10 years, as opposed to 5, under the previous rules. High-tech startups will now enjoy a 70% tax deduction from taxable income at the early stages of company development. The qualification criteria for the preferential 3% VAT rate have been greatly expanded to include many more high-tech and small companies.
The Importance of Indigenous Technology Capabilities
The announcement of these measures occurred on April 25 and come after increased scrutiny of China’s government-led industrial policies for the high-tech sector. The near collapse of ZTE due to its reliance on US technology drove home the message to the Chinese leadership that if it is going to continue to pursue a mercantilist economic agenda, it will need to better weather the scrutiny of other players in the global trading system for its unfair trade practices.
China also reduced taxes on the chip industry in March. The threat to ZTE was due in large part to the company’s reliance on US semiconductor technology. The tax cuts on the chip industry are in direct response. In general, the tax cuts for technology companies, startups, and R&D are part of an effort to increase economic self-reliance and the long-term feasibility of Chinese economic nationalism.
Impact on Investment Conditions
These tax cuts are intended to add stimulus to these industries that face pressure in a number of ways. If investors and entrepreneurs expect that China’s high-tech industries will be adversely affected in future global trading relations, they may deem it an unsafe investment, and capital and talent will then be directed towards industries deemed less risky. Tax cuts will help offset that risk premium, if you will, and encourage the growth of these industries.
Nonetheless, tax cuts by themselves will be sufficient in helping the industry overcome other challenges such as human resources limitations. The Chinese authorities appear to be aware of this and are developing a set of tools to attack the problem comprehensively. For example, China is actively encouraging the attraction of talent from overseas in strategic industries.
Made in China 2025
If the U.S., Europe, and Japan become increasingly determined to see China play by the rules of the global trading system, the Made in China 2025 plan will certainly be under threat. The Made in China 2025 plan requires the acquisition of technology from abroad. Advanced economies have reacted defensively, in the fear that the government led push will wipe out their industries. If these countries cut off China’s supply of assets with which to fuel the Made in China 2025, the authorities will need to be even more determined to generate domestic innovation.
This recent round of tax cuts demonstrates China’s ability to closely and quickly calibrate economic policy to the evolving political circumstances of the country. China has managed to implement policies designed to stimulate strategic sectors within mere weeks of inter-state political developments. Democracies are thoroughly unable to undertake such policy gymnastics due to the government’s accountability to stakeholders in the political system. These taxes serve a number of purposes including increasing the resilience of China’s mercantilist economic programs in the event of global policy shocks. They may also be seen as a kind of tit-for-tat countermeasure against the U.S. tax cuts, which may lower the cost of setting up a factory in the U.S. which could damage the future of China’s manufacturing industry.