The Ambassador in China (Stuart) to the Secretary of State

No. 980

The Ambassador has the honor to forward a copy of a self-explanatory third person note dated August 21, 1947 from the Embassy to the Ministry of Foreign Affairs concerning certain provisions of the Income Tax Law—and the Regulations for the Enforcement of the Income Tax Law—which the Embassy considers discriminatory against foreign business having head offices abroad with branches in China and subject to the income tax. There is also enclosed a copy of a similar note on the same subject dated August 18, 1947, despatched to the Ministry of Foreign Affairs by the British Embassy, Nanking.1 Notes on this subject have recently also been sent to the Ministry by the Netherlands Embassy and the Swiss Legation.

For a number of months the Embassy has received strong objections on the part of American business groups in Shanghai and elsewhere to the discriminatory nature of the tax law. The American Chamber of Commerce made representations on this subject to the Consulate General in Shanghai, as reported in the Consulate General’s despatch no. 210 dated May 9, 1947 to the Embassy, a copy of which was sent the Department.1

In discussing the discriminatory and conflicting provisions of the Income Tax Law and Regulations with officials of the Direct Tax Bureau of the Ministry of Finance, the officials have pointed out the difficulties of fairly and equitably determining for tax purposes the capital of branches of foreign companies doing business in China. They have stated their inability to see any discrimination in the law. While, however, there may be a few Chinese firms with head offices abroad and branches in China, making them subject to the same treatment as foreign firms, their number is considered proportionately so small as to make the administration of the law, in effect, discriminatory.

[Page 1363]

In the most recent conversation on this subject with tax officials, an officer of the Embassy was informed that in January 1948 a revised Income Tax Law would be promulgated and that this law would combine the two categories—1A and 1B—to which objection is presently raised. It was stated that this new law, by effecting such a merger, would eliminate the problem at issue. It is to be hoped that this adjustment will be forthcoming, and the Embassy will attempt to remind tax officials from time to time of its expectations in the matter.

Despite these reported forthcoming adjustments, the Embassy considered it advisable to despatch the enclosed note to the Ministry of Foreign Affairs. As soon as a response from the Ministry is received the Department will be informed. It would be appreciated if copies of this despatch and of its enclosures might be made available to the Commerce and Treasury Departments.


The American Embassy to the Chinese Ministry for Foreign Affairs

No. 1095

The Embassy of the United States of America presents its compliments to the Ministry of Foreign Affairs of the Republic of China and has the honor to refer to the Revised Income Tax Law of China, promulgated and enforced as of April 16, 1946, and to the Regulations for the enforcement of that law promulgated and enforced July 3, 1946. It has been brought to the attention of the Embassy that the provisions of this Law and its Regulations may lead, in their application, to inequality or discrimination as between companies having their head offices abroad and doing business in China through branches, and companies having their head offices in and doing business in China.

Under Article 4 of the above mentioned Regulations, a limited liability company with its head office outside the territory of the Republic of China and carrying on business in China through branches is liable to income tax on its profits earned in China according to the rates laid down in Article 6 of the Income Tax Law. On the other hand, a limited liability company with its head office inside the territory of the Republic of China is taxed according to the rates laid down in Article 5 of the Income Tax Law. The result of such provisions is that companies having head offices in China are taxed at a rate determined by the ratio of their income in a particular year to their capital, while branches in China of companies having head offices abroad are taxed simply on their net income, without reference to the capital investment involved.

Such a split in the application of the income tax to companies [Page 1364] which in some cases may differ only in the location of their head offices appears to the Embassy to be in itself discriminatory. Also, while a Chinese company and a branch in China of a foreign company might have identical organizational structures as defined in Article 2, Category I (a) and be otherwise the same, and have identical income, they would not pay the same tax; under the Income Tax Law itself two such companies would fall into the same tax category, but because of the Regulations the foreign company would be taxed as if it were a Category I (b) company. Furthermore, it would appear that in a highly inflationary situation such as exists in China today companies taxed according to the ratio of profits to capital could reduce the burden of their income tax by an upward adjustment of declared capital, while those taxed according to their net income can make no adjustment to reduce the burden, which makes the law appear also discriminatory in effect.

The Sino-American Treaty of 1943 for the Relinquishment of Extraterritorial Rights in China and the Regulation of Related Matters2 provides that foreign nationals will be accorded national treatment in matters relating to the levying of taxes or requirements in connection therewith—i. e. foreign nationals taxable by the Government of China will be taxed on the same basis as Chinese. This provision is contained in the second sentence of Article V of the Treaty which reads as follows:

“…3 Each of the two Governments will endeavor to have accorded in territory under its jurisdiction to nationals of the other country, in regard to all legal proceedings, and to matters relating to the administration of justice, and to the levying of taxes or requirements in connection therewith, treatment not less favorable than that accorded to its own nationals.”

It would appear that the collection of income tax in accordance with present regulations is in contravention of assurances given in the Treaty regarding taxation.

The Embassy understands that according to Chinese law, administrative by-laws, rules, detailed rules, or measures cannot alter, modify, amend or conflict with statutes. Article 4 of the Regulations for the Enforcement of the Income Tax Law appears to conflict with the provisions of the Law itself in that the Regulations provide for a different basis of taxation for foreign as compared with Chinese corporations, a distinction apparently not contemplated in the Income Tax Law.

This matter has for some time caused concern among American [Page 1365] and other foreign companies doing business in China which are affected by the provisions of the Income Tax Law and has been brought to the attention of the Embassy a number of times by them and by the American Consulate General in Shanghai. The Embassy is thus now obliged to seek from the Chinese Government, on behalf of American businesses operating in China and on behalf of the Government of the United States, either a clarifying and explanatory statement which will serve to meet the seemingly valid objections of numerous concerned groups to the current provisions of Income Tax Regulations, or assurances that steps will be taken to revise the provisions of the Law and its Regulations to which objections have been raised.

Nanking, August 21, 1947.

  1. Not printed.
  2. Not printed.
  3. Signed at Washington, January 11, 1943; Department of State Treaty Series No. 984, or 57 Stat. (pt. 2) 767.
  4. Omission indicated in the original note.