Corporate Income Tax Aggressiveness in China: Regulatory Enviroment and Ownership Impact

Abstract

Purpose – Corporate income tax aggressiveness, via aggressive tax planning behaviour, involves utilising the tax regime to reduce income tax paid. In 2008 China implemented its new Enterprise Income Tax Law with several major effects. First, the tax rate was reduced from 33 to 25 per cent. Second, this rate was applied to all enterprises, including foreign enterprises and enterprises with foreign investments. Finally, the reforms included enforcement of tax scrutiny to match the application of the 2007 Accounting Standards for Business Enterprises No.18 - Corporate Income Tax Accounting. This study addresses two questions regarding potential corporate responses to the statutory changes in tax rates and greater scrutiny by the tax office in China. Have the changes to the tax regulatory environment had an impact on the corporate tax aggressiveness of listed companies in China? Does the structure of ownership of these companies – i.e., state-controlled, private or foreign-invested – impact on the response to the changes?

Design/methodology/approach – China’s 2007 implementation of its Accounting Standards for Business Enterprises No.18 - Corporate Income Tax Accounting and its 2008 implementation of its Enterprise Income Tax Law offer a ‘natural experiment’ opportunity involving both accounting standard and tax regime reforms in a transition economy. This study uses quantitative methods to examine the book-tax gap in light of the above research questions. It is based on effective tax planning, agency, tax avoidance and legitimacy theories. Data is comprised of a sample of 1900 companies listed on the Shanghai and Shenzhen Stock Exchanges with state-controlled, private or foreigninvested ownership characteristics. This provides 6287 firm-years of observations for the 2007 to 2010 period.

Findings – The results suggest that tax aggressiveness of listed companies as measured by the book-tax gap measure has reduced as a result of the 2008 Enterprise Income Tax reform. However, we find limited evidence to support claims that different ownership structures (state-controlled, private or foreign-invested ownership) have a significant relationship with tax aggressiveness in China.

Originality/value – Originality results from use of the ‘natural experiment platform’ and examination of changes in tax aggressiveness in China resulting from the introduction of its new accounting and tax regimes. The paper’s contributions are: to demonstrate the effectiveness of China’s 2008 tax reforms in limiting tax aggressiveness; and to add to the literature on the impact of ownership structure on tax aggressiveness. In the specific case of China this has received little attention to date. This information will be of use to tax regulators, investors and corporations.