Machinery Industry Stops Implementing Income Tax Preferential Policies

Incident: On December 31, 2007, the State Administration of Taxation announced that starting from January 1, 2008, the preferential policy allowing enterprises to credit corporate income tax against the purchase of domestically-made equipment would be abolished. This decision marked the end of a nine-year initiative that had significantly encouraged Chinese companies to invest in local technology and equipment upgrades. Our opinion: 1. Over the past nine years, this policy played a crucial role in promoting domestic production and technological innovation among Chinese enterprises. However, due to the principles of WTO national treatment, the policy was eventually phased out under the new Corporate Income Tax Law. While this change may seem restrictive, it is possible that alternative policies encouraging domestic equipment purchases could be introduced in the future. 2. The notice clarified that newly purchased domestic equipment after January 1, 2008, would no longer qualify for tax credits. However, equipment approved for tax deductions before 2007 but not yet processed by the end of 2007 might still be eligible. Additionally, the status of equipment purchased within five years and whether remaining credits can be carried forward into 2008 or later remains unclear, creating uncertainty for businesses. 3. Currently, there are two main perspectives in the industry regarding the continuation of tax credits. One view suggests that Guoshuifa [2008] No. 52 only applies to equipment purchased after December 31, 2007, allowing for continued crediting. Another perspective argues that the tax credit for domestic equipment does not fall under the scope of excessive preferences outlined in Guofa [2007] No. 39, thus disqualifying further credits. We believe the first interpretation is more plausible, as the scope of No. 39 primarily applied to enterprises with low tax rates or regular exemptions, not those benefiting from equipment-based tax credits. 4. Although the general tax credit for domestic equipment has been removed, the policy has been restructured into a specific credit system. Under the new Enterprise Income Tax Law, 10% of the investment in special equipment used for environmental protection, energy efficiency, and water conservation can be credited against the current year's tax liability. If the credit is not fully utilized, it can be carried forward for up to five subsequent years. 5. The removal of this preferential tax policy may dampen companies' enthusiasm for purchasing domestically produced equipment. In the long run, we anticipate an increase in the demand for imported machinery, which could negatively impact China's domestic manufacturing sector. While the transition to a more targeted tax credit system is logical, the shift may require additional support to maintain the momentum of domestic industrial development.

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