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| Project Details |
| Funding Scheme : | Early Career Scheme | ||||||||||||||||||||||||||||||
| Project Number : | 24607815 | ||||||||||||||||||||||||||||||
| Project Title(English) : | Taxation and Development: Case Study of China | ||||||||||||||||||||||||||||||
| Project Title(Chinese) : | 稅收与發展：以中國為例 | ||||||||||||||||||||||||||||||
| Principal Investigator(English) : | Prof Xu, Yan | ||||||||||||||||||||||||||||||
| Principal Investigator(Chinese) : | |||||||||||||||||||||||||||||||
| Department : | Faculty of Law | ||||||||||||||||||||||||||||||
| Institution : | The Chinese University of Hong Kong | ||||||||||||||||||||||||||||||
| E-mail Address : | yanxu@cuhk.edu.hk | ||||||||||||||||||||||||||||||
| Tel : | |||||||||||||||||||||||||||||||
| Co - Investigator(s) : |
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| Panel : | Humanities, Social Sciences | ||||||||||||||||||||||||||||||
| Subject Area : | Social and Behavioural Sciences | ||||||||||||||||||||||||||||||
| Exercise Year : | 2015 / 16 | ||||||||||||||||||||||||||||||
| Fund Approved : | 548,016 | ||||||||||||||||||||||||||||||
| Project Status : | Completed | ||||||||||||||||||||||||||||||
| Completion Date : | 31-5-2018 | ||||||||||||||||||||||||||||||
| Project Objectives : |
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| Abstract as per original application (English/Chinese): |
Taxation is viewed as a developmental tool that is vital to both state capacity-building, the furtherance of social and economic development, and enhancement of well-being for the general public. For the most part, the literature to date follows one of two general paths. One school looks at the relationship between good governance in administration including tax administration and revenue raising capacity. The other looks into the ways in which a country uses tax laws to offer incentives to encourage investment in developing countries or to attract investment within its own borders. The proposed research project focuses on the second school of tax and development studies, using China as a case study given the enormity of Chinese tax concessions to attract foreign direct investment and the significant impact of the practice on neighbouring jurisdictions, in particular Hong Kong, and jurisdictions outside of the region. The objectives of the project are to examine how China has sought to use its tax law regime, particularly its international tax system, as a tool of economic development in terms of attracting inward investment, encouraging cross-border trade, and, more recently, facilitating outbound investment.
The study has two components. The first part looks at the question of tax incentives and development from a generic perspective to establish a framework for more specific analysis of Chinese initiatives. The second part examines the application of tax incentives in China, by reference to the benchmark framework established in the first part of study. The remarkable economic success in China within a comparatively short period has been viewed as primarily a result of foreign investment and international trade. The extent to which this investment has been made via tax incentives is, however, unclear. The study will evaluate the impact of China’s tax incentives and concessions on investment and hence development against the framework of international studies on this topic. The research findings will be of significant value to the evaluation of whether tax concessions should continue to be an element of China’s development programme or whether continuation or adoption of new concessions is providing unnecessary windfalls to investors without impacting significantly on China’s economic development. |
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| Realisation of objectives: | The four objectives envisaged in the research project have been completely fulfilled. The qualitative and quantitative research was systematically undertaken in line with the objectives. The realisation of each objective is summarised as follows. Objective 1: The analysis and conceptualisation of the relationship between taxation and development was the starting point of the research project. A thorough research documenting the development of the relationship was completed against the backdrop of the development of international tax norms. The research project documents three important findings on taxation and development from an international perspective. First, mobilising domestic resources for developing countries needs to focus on not only state building, accountability, and effective capacity development at macro level, but also improvement in specific tax rules such as rules to combat transfer pricing and the shifting of profits to low tax jurisdictions at micro level. It is also crucial for developing countries to enhance transparency in data reporting by multinational enterprises and in tax administration. Such findings benefit developed countries too, to the extent that they reflect their renewed awareness on the pitfalls of international and domestic tax regimes. Second, at international level, illicit capital outflows that are facilitated by tax systems susceptible to harmful tax practices and flawed tax administration have been identified as a key obstacle to revenue mobilisation for development. Solutions to this problem, however, rely on the joint efforts of both developing and developed countries but not individual countries alone. Third and last, in most recent years, the significant rise of the importance of taxation in the global and domestic political agenda has led to a notable paradigm shift in international tax practices and principles. In addressing the challenges of tax evasion and avoidance arising from cross-border trade and investment, the G20 and OECD have identified, among other things, that tax incentives and concessions to attract foreign investment, if used inappropriately, could harm the revenue interests of other countries and encourage aggressive tax avoidance. Against the general background, the project investigated and critiqued the literature discussing the role of taxation, in particular tax incentives, in attracting foreign investment for economic development in China over the last four decades. The literature has to date been rather limited, notwithstanding the extensive and frequent use of tax concessions in practice in China. By analysing and conceptualising the relationship between taxation and development with a China focus, this project generated a set of literature focusing on theories and empirical studies in general and in China in particular. This not only contributed to the scholarship in this area but laid a solid and necessary conceptual foundation for the research project. Objective 2: The objective of examining how China has used its tax law system as a development tool to encourage inward investment and facilitate outward investment was successfully fulfilled, which generated a comprehensive set of data. The set of data includes a subset of data of all currently effective tax incentives issued by the central government and a subset of tax sparing arrangements in all of China’s bilateral tax treaties concluded from the early 1980s to 2018. The first subset was carefully organised with a systematic categorisation of the types, functions, purposes and other key features of those formal incentives and concessions. Due to the constant changing of tax incentives and policies in China, the project made special effort to update the dataset through investigating and modifying relevant tax circulars providing the incentives and concessions at a 6-month interval during the research period. The dataset of tax incentives and sparing articles in tax treaties significantly extended the knowledge of the use of tax incentives in promoting economic development in emerging economies such as China. The dataset records various notable features of the use of tax incentives and concessions in China, such as the wide scope and the generosity of tax incentives on research and development (R&D) and the increasing emphasis on small and medium enterprises (SMEs), which to the best of my knowledge had never been formulated in a thorough and sophisticated way in any public or commercial database and in the existing literature. Objective 3: The evaluation of the effect of China’s tax incentives and concessions on development was fully achieved by way of qualitative and quantitative research. The former includes group discussions and individual interviews with government officials at central and city levels, tax practitioners, and selected resident and non-resident enterprise taxpayers. The latter primarily relied on existing landmark studies by international organisations, including the International Monetary Fund (IMF) and World Bank, and by tax researchers and scholars. The quantitative research also used the datasets collected in this project and official statistics on inward and outward investment to evaluate the correlation between the level of foreign direct investment in China and Chinese tax concessions targeting foreign investment. Such method was also applied to assess the link between tax concessions for outward investment and the level of Chinese investment oversees encouraged by China’s “Go Global” policy, typically the One Belt and One Road initiative (BRI) launched in 2013. Evaluating the role of tax incentives and concessions in investment, particularly foreign direct investment, has proved extremely challenging for scholars and policymakers. While the difficulty can be explained by many factors, this project focused on three aspects that are relevant to China’s context. First, tax law and policy operates not insolation but within a wider socio-economic framework. It is almost impossible to isolate the impact of particular strategies in a spectrum of developments as increased foreign direct investment could be driven by tax holidays and tax reductions, but could also be explained by other factors such as market size and easy access to skilled labour. Second, investment decisions are not made in static worlds, and changes in tax rules may be viewed by investors as valuable not in terms of after-tax monetary returns but in respect of their non-tax effect on protecting private investment in China given the country’s past history of nationalisation without compensation. Third, for cross-border investment, the impact of tax concessions in the host jurisdiction such as China depends as much as on the investor’s business structure and its home jurisdiction’s rules as it does on Chinese rules. Guided by this objective, the research project documented certain positive effects of the use of tax incentives on development in certain industrial sectors, but had not found conclusive evidence to prove such positive effects as a whole. Not surprisingly, the use of various tax incentives created many problems in tax administration and compliance. Objective 4: The research findings in realising objectives 1, 2 and 3 described above helped form a robust foundation for achieving the project’s final objective. In particular, the project highlights the importance of undertaking systematic and sophisticated research on tax incentives and concessions before putting them in use in the case of China. Absence or insufficiency of such research may result in costly operation and detriment to the rule of law in taxation in the country. | ||||||||||||||||||||||||||||||
| Summary of objectives addressed: |
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| Research Outcome | |||||||||||||||||||||||||||||||
| Major findings and research outcome: | The research findings are summarised below. First, while tax incentives and concessions were initially to attract inbound investment into China, there has been a surge of the use of tax incentives in promoting outbound investment from China in recent years. This feature coincides with the Chinese government’s development policy, which has been shaped by not only its own development needs but also changes in international investment environment. Second, the project identified the different purposes of using tax incentives to foster economic growth between developing and developed countries. Although both general and targeted incentives could be adopted to serve various purposes, a hybrid of targeted and general tax incentives may be an efficient approach for developing countries, including China, to adopt in designing their tax policy to facilitate cross-border investment and trade. Third, legal documents on tax incentives need to be as much clear, detailed, and certain as possible. In China’s case, tax circulars providing tax incentives have been very fragmented and subject to constant change. The ambiguity of the rules has left too much discretion to tax administrators. The frequent change and ambiguity of tax rules have caused uncertainty and non-transparency problems to taxpayers, and increased administration costs. The centralisation of tax policy-making power at the national level and the competition for foreign investment between local governments has led to illegitimate tax practices at the local levels. Unless the tension between central and local fiscal relations is resolved, the illegitimate practices would continue in China. Fourth, the tax incentives may be exploited in tax avoidance and evasion schemes. Inappropriate use or manipulation by investors may cause significant revenue losses to jurisdictions involved in abuse activities. As a result of the globalisation and free trade had been a race-to-the-bottom competition between governments in using tax incentives to attract and retain foreign investment. The most recent reform on international taxation principles has attempted to prevent this phenomenon. The design of Chinese tax incentives must be in line with the new principles. Fifth and last, the project makes several recommendations on specific international tax rules in China. One such recommendation is to reform the current complex foreign tax credit (FTC) rules. The lack of efficient FTC rules to relieve double taxation has put Chinese enterprises in a disadvantageous position in the international market. A participation exemption for dividends may be a good approach in revising the FTC rules. | ||||||||||||||||||||||||||||||
| Potential for further development of the research and the proposed course of action: |
The current project has largely focused on tax incentives and concessions offered at the central level. Further research could be undertaken to explore the use of tax incentives and concessions at the local levels to gain more in-depth understanding on how tax incentives have actually been applied by different levels of government in practice. What are the differences in the local practices, and why such differences, given tax policies are all centrally made with prohibition on local modification? Further research can also be taken to exam specific areas or activities for which tax incentives and concessions are frequently provided, such as R&D, SMEs, and development of financial and capital markets. To what extent do the application of tax incentives on these activities generate positive results? Are there any other non-tax factors to explain the results? If no obvious positive effects, why such case? The collected dataset on tax incentives and literature in the area can be used to conduct the further research to address the research questions described above. | ||||||||||||||||||||||||||||||
| Layman's Summary of Completion Report: | Tax incentives have been widely used to promote foreign direct investment, and in some cases to facilitate outward investment, by many government for economic development. The research project uses China as a case study to examine the relationship between taxation and development, given the enormity of Chinese tax concessions to attract foreign direct investment. China has used its tax law regime, particularly its international tax system, as a tool of economic development to encourage cross-border investment and trade. This research project evaluates the impact of China’s tax incentives and concessions on investment and hence development against the framework of international studies on this topic. The projects finds there is no affirmative evidence to prove significant impact of tax incentives on China’s economic development. It suggests that the adoption of tax concessions needs to be carefully studied and designed before they are put in operation as many concessions have merely provided unnecessary windfalls to investors without obvious positive impact on development. The introduction and application of tax concessions may lead to unintended consequences to government revenues and the development of rule of law in taxation. | ||||||||||||||||||||||||||||||
| Research Output | |||||||||||||||||||||||||||||||
| Peer-reviewed journal publication(s) arising directly from this research project : (* denotes the corresponding author) |
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| Recognized international conference(s) in which paper(s) related to this research project was/were delivered : |
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| Other impact (e.g. award of patents or prizes, collaboration with other research institutions, technology transfer, etc.): |
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| Realisation of the education plan: | |||||||||||||||||||||||||||||||
| SCREEN ID: SCRRM00542 |