Market will now shift focus to Washington as Barack Obama will be sworn in as the 44th President of the US on January 20. Will a new President save the US economy and restore banking stability? Although many plans are in the pipeline and will be launched as soon as Obama takes office, including a new round of fiscal stimulus, in the form of tax cuts and government spending, and financial stimulus, perhaps in the form of a bad bank to take over bad assets of banks, it will take time for these measures to take effect. In the mean time, bank and corporate earnings will continue to disappoint and economic conditions will deteriorate. Despite government efforts, the US unemployment rate could surge past 9%, from 7.2% at present. All these will bode badly for riskier assets and provide more room for the US dollar to score further gains against other majors in the first quarter of this year.

Interest Rates

The race to zero rates is still on. After the Fed cut rates to a range of zero to 0.25% and the Bank of Japan to 0.1%, other central banks are not far behind. The Bank of England and the European Central Bank reduced rates by 50bps in the past two weeks as their economies fell into deeper recession. Rates in the UK stand at 1.5% and that in the euro zone at 2%. Both central banks signaled that more rate cuts could be expected if the downturn accelerates. The decline in inflation as a result of falling oil and commodity prices also give monetary authorities more leeway for further policy easing.

With US rates near zero, the Fed is resorting to unconventional monetary policy to revive lending. It is using its balance sheet to purchase commercial paper and mortgage backed securities. Starting in February, the Fed will provide three-year term loans to investors against consumer and small business loans. If credit conditions do not improve, the Fed might consider purchasing longer term securities as a means to push down longer term interest rates.

As a matter of fact, the Fed’s action has already helped ease stress in money markets, as evidenced by a narrowing spread, from over 450 bps in October 2008 to around 100 bps in mid-January 2009, between interbank interest rates and Treasury Bill rates. Mortgage rates have also come down after its announced plan of purchasing mortgage backed securities in government sponsored enterprises. The average rate on a 30-year fixed mortgage dropped below 5% in mid-January 2009, from about 6.5% in the last week of October, 2008.

The Fed is determined to revive growth and there is no limit to how far it Fed could expand its balance sheet. But the Fed’s action will of course has long term consequences, including escalating money supply growth and inflation, if not handled carefully and promptly.

Assorts of stocks in stock market:

When you are buying stocks there are three different types that you may choose from: penny stocks, growth stocks and blue chip stocks.
Penny stocks are stocks from a company that has almost no chance of developing into a big company and the stocks are of very little monetary value.

Growth stocks are companies that have a high potential to achieve great success, but they can also be very risky investments because they not are well established.
The highest level of stock purchasing is buying blue chip stocks. These stocks are of companies that are very well established and have almost no chance of its’ stocks dropping drastically.

There is unprecedented interest in China’s stock market. This is not surprising given the astonishing growth rate of China’s economy in recent years.

There are three classes of Chinese shares:

A shares are the shares that denominated in RMB and listed on the Shanghai or Shenzhen stock exchanges

B shares are foreign-invested shares issued domestically by PRC’s companies; they are also known as RMB Special Shares

H shares are shares that traded in Hong Kong

The history and actuality of the china’s stock market:

The china’s stock market came into being in due form in 1990，taking the debut of the Shanghai Stock Exchange as a label.

In the history of china’s stock market, there’re seven sharp rise and drop, proving the fluctuate of the stock market:

1, from 1990/12/19 to 1992/11/16, the stock index hurricane from 100 points to 1429, then sharply dropped to 400 in five months.

2, from 1992/11/16 to 1994/7/29, 400 — 1536 — 333.

3, from 1994/7/29 to 1996/1/19, 333 — 1053 — 512.

4, from 1996/1/19 to 1999/5/17, 512 — 1510 — 1047

5, from 1999/5/17 to 2000/1/4 , 1047 — 1756 — 1361

6,from 2000/1/4 to 2004/9/13 , 1361 — 2245 — 1000

7,from 2004/9/13 to 2007/4/6 , 1000 — 3300

As you know, recent years, china’s stock market comes into a wondrous boom period. More and more people plunge into the stock market. One reason is that China’s middle class is expanding rapidly, but the state continues to provide negligible health and pension benefits for the elderly, which leads to high savings rates within the middle class; For various reasons, Chinese interest rates remain low, and will likely remain low for the near term. Thus, Chinese investors are encouraged to seek higher rates outside of traditional savings accounts and have easy access to credit. Also, there are limitations on foreign investments, making it difficult for individual investors to enter stock markets outside of China.

As a result, great bubble exists in china’s stock market recently. No wonder that many professional judge of the china’s stock market as “going crazy”.

The foreground of china’s stock market

About the foreground of china’s stock market, different people have different opinions. The pessimistic ones think that china’s stock market faces serious challenge in 2008

Five reasons cause Chinese stock market’s plunge in 2008.

(1), oversea cash outflow

(2), lack of enough cash to continue supporting the stock market

(3), fund redeem

(4), high CPI and real estate

(5), the recent natural disasters

However, there are also optimistic ones express confidence about the china’s stock market.

Guotaijun’an Securities has conducted a survey covering 372 investors, finding that nearly 90% of them believe no bear market will occur in 2008.

90% of the respondents feel optimistic about the conditions of A-stocks in 2008. 44.1% of them have strong faith in a continuous bull market, and 44.4% think it will enter box-concussion stage. Only 4.1% of the respondents express their worries of a bear market.

Type of tax Rate

Income tax 20% on rental income
Business tax 5% on rental income
City property tax 18% on rental income

The resident tenant has an obligation to withhold taxes upon the payment of rental to the foreign owner. On the other hand, the foreign owner can appoint a domestic tax agent to act for it. The tax agent will apply for a temporary tax registration on behalf of its principle, and obtain the tax invoices at the tax office upon payment of taxes.

Both the foreign owner and the domestic tenant shall also pay stamp tax respectively at a rate of 0.1% on the rental amount. In addition, the tenancy agreement shall be registered at the local administrative organs. Thirdly, the landlord shall ensure that it has got a lease certificate for the rented property.

TRANSFER OF PROPERTY
Non-resident foreign investor receiving consideration for the transfer of landed property located in the PRC will be subject to the following type of taxes: -

Type of tax Rate

Income tax 20% on consideration
Business tax 5% on consideration
Stamp duty 0.05% on consideration
Land value appreciation tax 30% – 60% depending upon the appreciated value
Land value appreciation tax is levied on 4 different brackets of the appreciated value, which is arrived at by reference to the selling price minus the direct cost and the statutory deductions including business and stamp taxes. The income tax rate will be reduced to 10% if the owner is a resident of a PRC treaty country.

The buyer, on the other hand, has to pay a deed tax at the rate of 3% on total consideration irrespective of whether he is a resident or a non-resident.

Tax sparing credit
A Foreign Investment Enterprise who is a resident of a PRC treaty country is deemed to have paid the income tax under the indirect tax sparing credit provision in respect of any PRC tax concession and tax breaks being granted.
However, there is no tax sparing credit provision in the treaty concluded between the PRC and the USA.

Major PRC treaty countries by geographic area

Asia
Australia, Cyprus, India, Indonesia, Japan, Malaysia, New Zealand, Pakistan, the Philippines, Singapore, Sri Lanka, Thailand, and Vietnam;

Europe
Austria, Britain, Belgium, Denmark, Finland, France, Germany, Greece, Luxembourg, Norway, Sweden, Ireland, Italy, the Netherlands, Portugal, Slovakia, Spain, Switzerland, and the Russia;

Africa
South Africa, Mauritius, Egypt, and Nigeria

America
Canada, USA, Brazil, Cuba and Jamaica

Hong Kong residents are entitled to benefits of avoiding double income tax under the Arrangements concluded between the PRC Central People’s Government and the Government of the Hong Kong Special Economic Region.

It has been a 13-year journey from the preliminary work in 1994 to the passing of thePRC Enterprise Income Tax Law (referred to as “the EIT Law” hereafter) on 16th March 2007, which marked the completion of the unification of two tax systems for  domestically funded and foreign funded enterprises in China. It is a system innovation in the process of building socialism and a harmonized society within the country. To reap the benefits of the new tax system depends very much on its implementation in an effective manner. A few days ago, the State Council announced the long-awaited  Implementation Regulations of the PRC EIT Law (referred to as “the Implementation Regulations” hereafter), which is to come into play with the implementation of the  EIT Law.

To enable the taxpayers and the tax administrators to better understand and  follow the spirit inside the Implementation Regulations, the reporter interviewed theofficials in charge of the State Administration of Taxation on certain questions about  the Implementation Regulations. The officials in charge made the remarks that the drafting of the Implementation  Regulations followed the principles of legality, practicality, global convergence,conservatism, and easy operability. The drafts have brought the existing tax policyinto the contents of the Implementation Regulations and demonstrated the continuity  of the tax policies, without stepping outside the scope of the EIT Law. The Implementation Regulations give details to the EIT Law taking into account the economic activities and the latest development of the economic systems, and this hasdemonstrated the scientific properties of the current policies. In addition, the drafting  committee borrowed the prevailing international income tax policies and learned from  the experiences of international tax reforms. The Implementation Regulations have  embodied international custom and shows the forward-lookingness of the tax policies.According to the officials in charge, the Implementation Regulations contain 8 chapters with 133 clauses, mainly giving details to the provisions in the EIT Law. The  officials in charge gave detailed elaborations on certain key policies and designs in  the EIT Law.

The definition of actual management organization is to protect tax sovereignty.

To share the international experiences, the EIT Law expressly lays down the legal person income tax system, adopting the defined concept of resident and non-resident   enterprises.

The key to define the taxpayer under the legal person income tax system is the  criteria for resident enterprises and non-resident enterprises. The EIT Law uses the  place of incorporation and actual management organization as the criteria todetermine the resident and non-resident enterprises. It is easier to understand and  apprehend place of incorporation but it is difficult to understand the criteria for placeof actual management. How is the place of actual management determined in theImplementation Regulations and what are the relevant considerations?

The officials in charge made the remarks that from the experiences of international practices in recent decades, the place of actual management is in general the place where the enterprise carries on its daily production and business activities. From a legal perspective, it also includes the place where important business decisions are made. From an administrative perspective, the tax law only lays down the principle or

does not lay down anything, leaving the detailed rules to be developed from decided tax cases. To protect tax sovereignty and the willful tax evasion, the Implementation Regulations have expanded the scope for place of actual management and provide that it is the place where the enterprise exercises actual and overall management and control over its production, staff, books of accounts and assets. That helps the issue of administrative decisions later with reference to the actual situations of the enterprises, better protect the tax sovereignty of our country. Detailed criteria can be developed by issuing ministerial rules from the practices in tax collections and administrations.

Budgeted fiscal appropriation is non-taxable income

The EIT Law introduces the concept of non-taxable income. Fiscal appropriation is one of the three items of non-taxable income. What about the various types of subsidies enterprises receive from local governments at the provincial levels or below? How is it provided under the Implementation Regulations?

The officials in charge remarked that the fiscal appropriation, defined as non-taxable income under the Implementation Regulations, is the funds appropriated to the institutions, social bodies and organizations administered under the budget of the local governments, with the exceptions that the State Council, the Ministry of Finance and the State Administration of Taxation provide otherwise. That in general excludes the subsidies and the rebates of local taxes that the enterprise receives from various local governments, and narrows down the scope for fiscal appropriations as an item of nontaxable income. The main considerations for these are (i) the various types of subsidies that the enterprise receives not only include exemption and reduction of turnover taxes, but also include special subsidies for the enterprises to carry on designated activities, both resulting in the increase in net assets and economic benefits flowing in, thus the imposition of income tax being lawful; (ii) the imposition of income tax on the enterprises that receive subsidies from local governments strength the dministration of tax exemption and reduction since the local governments offer various types of tax exemption and reduction in disguise in luring inbound investments, resulting in the erosion of the tax base at the national level; and (iii) the existing legal rules on accounting for government subsidies classify government subsidies as non-operating revenue. That tax rules should be consistent with the accounting rules on government subsidies.

Deduction of reasonable wages and salaries before tax

The EIT Law unifies the deduction of actual payments for various items of expenses,and provides that enterprises can claim deductions of actual and reasonable cost and expense before tax. The Implementation Regulations make specific provisions for the items to be deducted and the criteria for deduction before taxes.

According to the officials, in respect of deduction of wages and salaries, the Implementation Regulations provide that actual and reasonable wages and salaries can be deducted from income. It means that scrapping the limited deduction of wages and salaries for domestically funded enterprises in the past years relieve them of the tax burden. The amount of deducted wages and salaries must be reasonable. Obviously unreasonable amount is not deductible. To the employees in general, the remunerations that the enterprise pays should be considered to be reasonable. There

may be exceptions. Where the shareholders and their close relatives work as the employees in the company, the payment of excessive wages and salaries is thedistribution of dividends in disguise. Alternatively the wages and salaries of the management working for the state owned enterprises are raised in breach of the rules of the departments for the supervision and administration of state owned assets. All

these complicated cases relating to wages and salaries will erode the tax base of the enterprise income tax. To strengthen the administration over tax bases, the Implementation Regulations add the qualification “reasonable” to wages and salaries.The official revealed that the State Administration of Taxation shall issue the 5 “Administrative Measures for the Deduction of Wages” to clarify what is considered

to be “reasonable” wages and salaries in the Implementation Regulations.

60% of the incurred business entertainment expenses are deductible, not exceeding 0.5% on the sales (business) turnover for current year

The Implementation Regulations provide that 60% of the business entertainment expenses incurred in connection with production and business activities shall be deductible from income, but the maximum amount shall not exceed 0.5% of the sales (business) turnover for the current year. What are the policy considerations lying behind this rule?

The official said that the amount of business entertainment expenses is a mix of corporate entertainment and personal consumption. Among them, the personal consumption falls under non-business expenses that should not be deducted before tax. Therefore, there is a requirement to limit the amount of business entertainment to a certain percentage. However, it is difficult to distinguish between business entertainment and personal consumption. The international practice is to arbitrarily set

a relative percentage between the two. In Italy 30% of the business entertainment expenses is deductible before tax. In Canada, the amount is 80%. In the US and New Zealand, the amount is 50%. Taking into consideration of international practices and the existing practice of limiting the deduction of business entertainment to a percentage of the sales amount, we combine the two practices as per experts’ recommendations on the adoption of a strict policy: business entertainment is subject to a 60% deduction and not exceeding 0.5% of the sales amount (business turnover) for the current year.

Limiting the deduction of advising expenses to 15% on sales revenue, and remaining amount being carried over for deduction in future years

The Implementation Regulations consider the combined amount of advertising expenses and business promotion expenses, and provide that the amount of deductible advertising and promotion expenses shall not exceed 15% of the sales amount (business turnover), except for the provisions of the Ministry of Finance and the State Administration of Taxation to the contrary. The amount exceeding the prescribed 15%

can be carried over to future tax years for deduction.

The officials in charge explained that advertising expenses that possess the properties of one-off payment of a large sum and benefit the enterprise for a long period of time should be regarded as a capitalized payment and cannot be deducted in whole in the current tax year. Business promotion has similar properties and should be subject to limits on deduction. The Implementation Regulations permit the deduction of advertising and promotion expenses up to 15% of the sales amount (business turnover), and that the portion in excess of the 15% can be carried over to future tax

years for deduction. The administration has given due consideration to the advertising and business promotion expenses in some industry sectors that require specific

measures to be adopted. In the light of expert opinions and views from relevant departments, the qualification “except for the provisions of the Ministry of Finance and the State Administration of Taxation to the contrary” has been included in the Implementation Regulations with a view to making ministerial rules on the deduction of advertising and business promotion expenses for different industry sectors, in accordance with the provision for the delegation of rule making power in the EIT Law.

Indirect credit helps Chinese enterprises “go abroad”

In accordance with the EIT Law, the corporate income tax the resident enterprises bear indirectly on the dividend and bonus issues from equity investment outside China is eligible for indirect credit. The Implementation Regulations provide that the resident enterprise should hold 20% controlling interest in the equity of the foreign company. What are the policy considerations on this?

The officials said that the PRC EIT law retains the direct credit for tax paid on dividends and bonus issues at the shareholder level and it also introduces the indirect credit for tax on profits earned at the company level out of which the dividends and bonus issued are paid. The adoption of direct and indirect credits gives a helping hand to Chinese resident enterprises going international and increases their competitiveness

in international market. From the perspective of international practices, indirect credit are given on condition that resident enterprises should have actual equity investments in foreign companies. In accordance with the tax laws in the US, Canada, the UK, Australia, and Mexico, resident enterprises holding 10% or more voting rights in the equity investment in foreign companies are eligible for indirect credit. The tax law

requires the equity interest in foreign companies to be 25% for Japanese and Spain investors. It is the first time the PRC EIT law adopts the indirect credit method. The Implementation Regulations provide that the equity interest in foreign companies is 20% for resident enterprises to receive the indirect credit.

New and high technology enterprises by industry sectors

In the light of the requirement for national economic and social development,successful international experiences and the requirement for simple tax system, broad tax bases, low tax rates, and stringent tax collections and administration, the PRC EIT Law adjusts and integrates the tax preferential policies for both domestically and foreign funded enterprises, and gives effect to changes in two dimensions: the tax

policy changes from region-specific preferences to industry-specific preferences,which is to be supplemented by regional tax preferences; the form of tax preferential treatment changes from direct tax exemption and reduction to direct tax exemption and reduction, which is to be combined with reduction in tax bases for indirect taxes.The Implementation Regulations make clarifications on the scope, the conditions, and

the recognition criteria for tax preferential treatments as laid down in the EIT Law.

The officials in charge said that there are three important issues in the recognition of new and hi-tech enterprises. The first is the scope of new and hi-technology enterprises. The Implementation Regulations change the classification of new and high technology by products to classification of the new and high technology by sectors. The Implementation Regulations provide that the products (services) of new and hi-tech enterprises should fall under the scope of <the new and hi-technology industry sectors that receive prior supports from the State> so that it can avoid the problems that product listing and coverage under existing policies are too narrow and that the existing policy is not forward looking. The second issue is the recognition criteria. The Implementation Regulations provide those criteria in principle: the amount of research and development as a percentage to sales; the sales revenue of new and hi-tech products (or services) as a percentage of total revenue; the ratio of employees who possess technical qualifications to the total number of employees in

the company, and other conditions to be met. The Ministry of Science and

Technology, the Ministry of Finance, and the State Administration of Taxation shall formulate policies on this and give the detailed benchmarks with the flexibility to make adjustments for later development.

The third issue is the core proprietary IP rights. The Implementation Regulations lay down the primary requirement for getting recognized as new and high technology enterprises is the ownership in “proprietary IP rights”. In view of the fact that there is no official definition of “proprietary IP rights”, the inclusion of trademark rights, exterior design, copyright that may not have bearing on the core technological

competitiveness of the enterprise into the “proprietary IP rights” will make the scope too wide. The Implementation Regulations finally adopt the “core proprietary IP rights” as one of the criteria for getting recognized to be new and hi-tech enterprises. It is relatively easy to operate and has pointed out the direction for technological innovation. The key point is the IP rights that the enterprise owns and that give core

technical support to the main products and services of the enterprise.

Annual taxable income of small and low profit-making enterprise not exceeding

RMB300,000

The Implementation Regulations give the amount of annual taxable income, the number of employees and the amount of total assets as the benchmark for small profit-making enterprises. Specifically for production enterprises, the annual taxable income shall not exceed RMB300,000, total number of employees shall not exceed 100, and the total asset amount shall not exceed RMB 30 million; for non-production enterprises, the annual taxable income shall not exceed RMB300,000, the number of employees shall not exceed 80, and the total amount of assets shall not exceed RMB 10 million. The scope of the tax concession is larger and the magnitude of tax concession is higher than that as given under the old tax law for domestically funded enterprises.

The officials said that the dividing line that the annual taxable income is RMB300,000 drawn under the Implementation Regulations results from careful testing. About 40% of the enterprises shall be taxed at 20% given that this benchmark is adopted.

The business profits that non-profit making organizations earn are taxable

The PRC EIT Law provides that the income of qualified non-profit making

organizations is exempted from tax. Article 85 of the Implementation Regulations provides that the income of the qualified non-profit making organizations excludes the income derived from profit-making activities of the non-profit making organization. Why is it?

The officials in charge said countries all over the world make a distinction between profit-making and non-profit making activities and give tax preference to non-profit making activities. The relevant legal rules in China provide that non-profit making organizations cannot carry out profit-making activities. To regulate these organizations and plug the loophole that may arise from the profit making activities

carried out by these tax-exempt organizations, the Implementation Regulations expressly provide that the income derived from the profit-making activities would not be exempted from tax. Where some non-profit making organizations derive income from profit-making activities and use them in whole for charitable events, that should

be primarily encouraged under the national policies. Therefore, the Implementation Regulations include the qualification “except for the provision of the Ministry of Finance and the State Administration of Taxation to the contrary”.

Dividend and bonus issue derived from investment over 12 months being exempted from tax

The PRC EIT Law provides that dividends, bonus issues and income from equity investment are tax-exempt income if they are distributed by resident enterprises that satisfy prescribed conditions. What are differences between the conditions to be met by the resident enterprises and the provisions on the taxation of dividends and bonus issues in the old tax law for domestically funded enterprises? What are the policy

considerations?

The officials in charge said that the exemption of income tax on dividend and bonus issues that are distributed among resident enterprises is to eliminate double taxation. Under the old tax regulations for domestically funded enterprises, the distribution of dividends from an enterprise that pays tax at a lower rate to an enterprise that pays tax at a higher rate attracts additional taxes for the high-tax enterprise on the rate

differences. In order to make the tax preferential treatment available to enterprises created in the development of the Western region, the new and high technology enterprises, and the small and low profit-making enterprises, the new EIT Law scraps the practice of imposing additional tax on the rate difference and exempts the income tax on dividend and bonus issues that are distributed by unlisted companies and listed companies, of which the ownership in the investment in the listed companies is over

12 months. To encourage direct investment in production and business activities, the stock speculations in the secondary capital market that is characterized by short-term ownership (less than 12 months) without the primary objective of receiving dividends and bonus issues should not become targets for tax preferential treatments.

The tax exemption and reduction commencing in the year the first sales transaction is reported

The Implementation Regulations provide that enterprises deriving income from the investment in projects of public basic infrastructure that receive primary support from the state shall enjoy tax preferential treatment in the form of “three years’ tax exemption and three years’ tax reduction”, commencing from the tax year in which the first sales transaction for the project is reported. The old tax law for foreign

invested enterprises provided that the year for tax exemption and reduction commences from the first profit-making year. The EIT Law has changed the previous practice from the first profit-making year to the year the first sales transaction occurs. What is the reason for this?

The officials in charge said that the old tax law for foreign invested enterprises adopted the first profit-making year as the year in which the tax exemption and reduction period commenced. That would in practice encourage the postponement of the first profit-making year to avoid paying taxes and made the tax collection and administration a difficult job. The Implementation Regulations adopt a new method under which the tax exemption and reduction commence from the year in which the first sales transaction is recorded. On one hand, this policy change can avoid the

practices by the foreign invested enterprises of putting off the first profit-making year to later years. On the other hand, this policy change can address the issue that the investment scale is big with long period of construction. It is more realistic to the situation under which the domestically funded enterprises receive tax preferences from the date of incorporation. It also encourages the enterprises to shorten the construction period, make the project profitable at the earliest possible moment and improve the return on investment.

Tax adjustment to strengthen the anti-tax avoidance measures

To comply with the relevant provisions on special tax adjustments in the EIT Law and learn from international experiences, the Implementation Regulations expressly lay down provisions for the related parties or associated enterprises in the transactions

with related parties, the adjustment methods for related party transactions, the principle of arm’s length transactions, advanced pricing agreements, the obligations for providing information, collecting taxes as per prescribed profit margins, preventing the use of controlled foreign corporations, prevention on thin capitalization,

general anti-tax avoidance, and the imposition of additional interest on overdue taxes.

The officials in charge said that these provisions strengthen the measures to combat tax avoidance, help prevent and stop acts of tax avoidance and safeguard the interests of the nation. He specially emphasized that after tax adjustments taking effects, the taxpayer, in addition to the payment of additional tax, is liable to a penalty interest that is computed with reference to the bank’s lending rate plus 5% in the period for which additional tax is collected. Where the taxpayer can submit the information to

the tax authority on time, it can be exempted from the payment of additional interest on tax.

Separate rules to be made for filing consolidated tax returns

The EIT Law follows model of the income tax on legal persons. Organizations that are not legal persons should file income tax returns that forms part of the consolidated tax turn for the head office. The filing of consolidated tax returns by head offices would relocate the tax revenues between different regions in the country. Both the taxpayers and local governments are very much concerned about this issue. The Implementation Regulations only lay down one provision in principle. What are the

policy considerations for this?

The officials in charge told us that in accordance with the EIT Law, business organizations that are not legal persons should file tax returns to the tax bureau in the city where the head office is located. That will cause relocation of tax revenue among different regions in the country, and should be dealt with in a reasonable way. We have performed many studies in order to solve the problem of relocation of tax revenues among different regions in a reasonable and proper way and balance the

interests among them after the implementation of the EIT Law and the

Implementation Regulations. The detailed measures shall be formulated by the Ministry of Finance and the State Administration of Taxation, and submitted to the State Council for approval before taking effect. Therefore, the Implementation Regulations only state the principles in general.

Parent and subsidiary companies no longer file group tax returns

The EIT Law provides that except for the provisions by the State Council to the contrary, enterprises should not file group income tax returns. However, the Implementation Regulations do not make relevant provisions for group of companies to file tax returns on a group basis. How will this problem be solved in future?

The official in charge said that as from 1994, the State Council has given approval to 120 large groups of corporations/enterprises to file group tax returns on a trial basis. The policy objective at that period of time is to relieve the enterprises of tax burden and support the development for the groups of enterprises because the operating results of the parent and individual subsidiaries did not present the true information

and it is difficult to distinguish between the enterprises that are operated in accordance with commercial principle and the enterprises that form part of the governmental organizations. With the implementation of the EIT Law, the parent and subsidiary corporations that are legal persons shall file tax returns and pay tax separately. Where there is a requirement to file group tax returns, the State Council shall make separate regulations. Implementation Regulations need not deal with this again since the EIT Law has already made the provisions and delegated the authority on this.

Order of the President of the People’s Republic of China
(No. 63)

The Enterprise Income Tax Law of the People’s Republic of China, which was adopted at the 5th Session of the 10th National People’s Congress of the People’s Republic of China on March 16, 2007, is hereby promulgated and shall come into force as of January 1, 2008.

President of the People’s Republic of China Hu Jintao

March 16, 2007

Enterprise Income Tax Law of the People’s Republic of China

(Adopted at the 5th Session of the 10th National People’s Congress of the People’s Republic of China on March 16, 2007)

Contents

Chapter I General Provisions

Chapter II Taxable Amount of Income

Chapter III Amount of Payable Taxes

Chapter IV Preferential Tax Treatments

Chapter V Withholding by Sources

Chapter VI Special Adjustments to Tax Payments

Chapter VII Administration of Tax Collection

Chapter VIII Supplementary Provisions

Chapter I General Provisions

Article 1 Within the territory of the People’s Republic of China, the enterprises and other organizations which have incomes (hereinafter referred to as the enterprises) shall be payers of the enterprise income tax and shall pay their enterprise income taxes in accordance with this Law.

This Law does not apply to the sole individual proprietorship enterprises and partnership enterprises.

Article 2 Enterprises are classified into resident and non-resident enterprises.

The term “resident enterprise” as mentioned in this Law refers to an enterprise which is established inside China, or which is established under the law of a foreign country (region) but whose actual institution of management is inside China.

The term “non-resident enterprise” as mentioned in this Law refers to an enterprise established under the law of a foreign country (region), whose actual institution of management is not inside China but which has institutions or establishments inside China; or which has not any institution or establishment inside China but which has incomes sourced in China.

Article 3 A resident enterprise shall pay the enterprise income tax on its incomes derived from both inside and outside China.

For a non-resident enterprise with an institution or establishment inside China, it shall pay enterprise income tax on its incomes derived from inside China as well as on incomes that it earns outside China but which has real connection with the said institution or establishment.

For a non-resident enterprise without any institution or establishment inside China, or for a non-resident enterprise whose incomes have no actual connection to its institution or establishment inside China, it shall pay enterprise income tax on the incomes derived from inside China.

Article 4 The enterprise income tax rate shall be 25%.

The tax rate which applies to a non-resident enterprise’s incomes as mentioned in paragraph 3, Article 3 of this Law shall be 20%.

Chapter II Taxable Amount of Income

Article 5 The balance after deducting the tax-free incomes, tax-exempt incomes, all deduction items as well as the permitted remedies for losses of the previous year(s) from an enterprise’s total amount of incomes of each tax year shall be the taxable amount of incomes.

Article 6 An enterprise’s monetary and non-monetary incomes from various sources shall be the total amount of incomes, including:

(1)income from the sale of goods;

(2)income from the provision of labor services;

(3)income from the assignment of property;

(4)dividend, bonus and other equity investment proceeds;

(5)income from interests;

(6)income from rentals;

(7)income from royalties;

(8)income from accepted donations; and

(9)other incomes.

Article 7 The following incomes included in the total amount of incomes shall be tax-free incomes:

(1)The appropriations from the treasury;

(2)The administrative fees and the governmental funds which are charged according to the law and fall under treasury administration; and

(3)Other tax-free incomes as prescribed by the State Council.

Article 8 The reasonable disbursements which are actually incurred and in which have actual connection with the business operations of an enterprise, including the costs, expenses, taxes, losses, etc., may be deducted in the calculation of the taxable amount of incomes.

Article 9 With regard to an enterprise’s disbursements for public welfare donations, the portion which accounts for 12% of the total annual profits or less is allowed to be deducted.

Article 10 None of the following disbursements may be deducted in the calculation of the taxable amount of incomes:

(1)Dividend, bonus and other equity investment proceeds paid to the investors;

(2)Payment for enterprise income tax;

(3)Late fee for taxes;

(4)Pecuniary punishment, fines, and losses of properties confiscated;

(5) Disbursements for donations other than those provided for in Article 9;

(6) Sponsorship disbursements;

(7) Unverified reserve disbursements;

(8) Other disbursements that have nothing to do with the obtainment of revenues;

Article 11 When calculating the taxable amount of incomes, an enterprise is allowed to deduct the depreciations of fixed assets calculated under the relevant provisions.

No depreciation may be calculated for any of the following fixed assets:

(1)The fixed assets which have not yet been put into use, excluding houses and buildings;

(2)The fixed assets rented in by way of commercial lease;

(3)The fixed assets rented out by way of finance leasing;

(4)The fixed assets for which depreciation has been allocated in full amount but which remain in use;

(5)The fixed assets which have nothing to do with the business operations;

(6)The land which is separately appraised and entered into account as an item of fixed asset; and

(7)Other fixed assets for which no depreciation may be calculated.

Article 12 When calculating the taxable amount of incomes, an enterprise is allowed to deduct the amortized expenses of intangible assets calculated according to the relevant provisions.

No amortized expense may be calculated for the following intangible assets:

(1)The intangible assets, for which the self-development expenses have been deducted in the calculation of the taxable amount of incomes;

(2)The self-created business reputation;

(3)The intangible assets which have nothing to do with the business operations; and

(4)Other intangible assets for which no amortized expense may be calculated.

Article 13 The following expenses incurred by an enterprise shall, in the calculation of the taxable amount of incomes, be treated as long-term deferred expenses. Those amortized under the relevant provisions are allowed to be deducted:

(1)The expenses for the rebuilding of a fixed asset, for which depreciation has been prepared in full amount;

(2)The expenses for the rebuilding of a rented fixed asset;

(3)The expenses for the heavy repair of a fixed asset; and

(4)Other expenses that shall be treated as long-term deferred expenses.

Article 14 During the period of external investment, an enterprise shall not deduct the costs of the investment assets when it calculates the taxable amount of incomes.

Article 15 Where an enterprise uses or sells its inventories, it is allowed to deduct the costs of the inventories calculated according to the relevant provisions in the calculation of the taxable amount of incomes.

Article 16 Where an enterprise transfers an asset, it is allowed to deduct the net value of the asset in the calculation of the taxable amount of incomes.

Article 17 When an enterprise calculates its enterprise income taxes on a consolidated basis, it shall not offset the losses of its overseas business institutions against the profits of its domestic business institutions.

Article 18 The losses incurred by an enterprise during a tax year may be carried forward and subtracted from the incomes during subsequent years for a maximum carry-forward period of 5 years.

Article 19 Where a non-resident enterprise obtains incomes as described in paragraph 3, Article 3 of this Law, it shall calculate the taxable amount of income through following approaches:

(1)The taxable amount of incomes from dividends, bonuses and other equity investment proceeds, interests, rentals and royalties shall be based on the total amount of incomes;

(2)The taxable amount of incomes from the assignment of property shall be the balance of the total amount of incomes less the net value of the property; and

(3)The taxable amount of any other income shall be calculated by reference to the approaches as mentioned in the preceding items.

Article 20 The specific measures for the scope and criterions of revenues and deductions, as well as the tax treatment of assets as provided for in the present Chapter shall be formulated by the treasury and tax administrative departments of the State Council.

Article 21 When calculating the taxable amount of incomes, if the enterprise’s financial or accounting treatment method does not conform to any tax law or administrative regulation, the taxable amount shall be calculated in accordance with the tax law or administrative regulation.

Chapter III Amount of Payable Taxes

Article 22 The amount of payable taxes shall be the balance of the taxable amount multiplied by the applicable tax rate minus the tax amounts deducted and exempted as provided for in the present Law .

Article 23 An enterprise may deduct from the taxable amount of incomes of the current period the amount of income tax it has already paid overseas for the following incomes. The limit of tax credit shall be the payable amount of taxes on such incomes computed according to this Law. The part exceeding the limit of tax credit may, during the five subsequent years, be offset by way of deducting the limit of tax credit of each year from the balance after the deduction of the limit of tax credit of the current year:

(1)A resident enterprise’s taxable incomes derived from outside China; and

(2)Taxable incomes earned outside China by a non-resident enterprise with institutions or establishments in China, but which have no actual connection with the said institutions or establishments.

Article 24 For the dividends, bonuses and other equity investment proceeds derived from outside China that a resident enterprise obtains from a foreign enterprise that it controls directly or indirectly, the portion of income tax on this income paid by the foreign enterprise outside China may be treated as the allowable tax credit of overseas income tax amount of the resident enterprise and be deducted within the limit of tax credit as prescribed in Article 23 of this Law.

Chapter IV Preferential Tax Treatments

Article 25 Preferential in enterprise income tax treatments are granted to the important industries and projects whose development is supported and encouraged by the state.

Article 26 The following incomes of an enterprise shall be tax-free incomes:

(1)The income from treasury bonds;

(2)Dividends, bonuses and other equity investment proceeds distributed between qualified resident enterprises;

(3)Dividends, bonuses and other equity investment proceeds which a non-resident enterprise with institutions or establishments in China obtains from a resident enterprise and which have actual connection with such institutions or establishments; and

(4)Incomes of qualified not-for-profit organizations.

Article 27 The enterprise income tax on the following incomes may be exempted or reduced:

(1)The incomes incurred from projects of agriculture, forestry, husbandry and fishery;

(2)The incomes incurred from business operations of the important public infrastructure investment projects supported by the state;

(3)The income incurred from the projects of environmental protection, energy and water saving, which meet the relevant requirements;

(4)The incomes incurred from the transfer of technologies, which meets the relevant requirements; and

(5)The income as prescribed in paragraph 3, Article 3 of this Law.

Article 28 The enterprise income tax on a small meagre-profit enterprise which meets the prescribed conditions shall be levied at a reduced tax rate of 20%.

The enterprise income tax on important high- and new-tech enterprises which are necessary to be supported by the state shall be levied at the reduced tax rate of 15%.

Article 29 The autonomous organ of an autonomous region of ethnic minorities may decide the reduction or exemption of the local portion of the enterprise income tax to be paid by enterprises within the said autonomous region. The decisions of deduction or exemption made an autonomous prefecture or county shall be submitted to the people’s government of the province, autonomous region, or municipality directly under the Central Government for approval.

Article 30 The following expenses of an enterprise may be additionally calculated and deducted:

(1)The expenses for the research and development of new technologies, new products and new techniques; and

(2)The wages paid to the disabled employees or other employees whom the state encourages to hire.

Article 31 A startup investment enterprise engaged in important startup investments which are necessary to be supported and encouraged by the state may deduct from the taxable amount of incomes a certain proportion of the amount of investment.

Article 32 Where it is surely necessary to accelerate the depreciation of any fixed asset of an enterprise because of technological progress or due to any other cause, it may shorten the term of depreciation or adopt an approach to accelerate the depreciation.

Article 33 The incomes generated by an enterprise from producing products conforming to the industrial policies of the state by way of comprehensive utilization of resources may be downsized in the calculation of the amount of taxable incomes.

Article 34 The amount of an enterprise’s investment in the purchase of special equipment for environmental protection, energy and water saving, work safety, etc. may be deducted from the tax amount at a certain rate.

Article 35 The specific measures for the preferential tax treatments as mentioned in this Law shall be formulated by the State Council.

Article 36 Where the national economic and social development so requires, or the business operations of enterprises have been seriously affected by emergencies and other factors, the State Council may formulate special preferential policies concerning the enterprise income tax and submitted them to the Standing Committee of the National People’s Congress for archival purposes.

Chapter V Withholding by Sources

Article 37 The payable income taxes on the incomes as described in paragraph 3, Article 3 of this Law which a non-resident enterprise earns shall be withheld by sources, with the payer acting as the obligatory withholder. The tax amount shall be withheld by the obligatory withholder from each payment or payment due.

Article 38 For the payable income taxes on the incomes which a non-resident enterprise obtains from undertaking an engineering project or providing labor services inside China, the tax organ may designate the payer of the project price or remuneration as the obligatory withholder.

Article 39 For the income tax that shall be withheld under Articles 37 and 38 of this Law but which the obligatory withholder has failed to withhold or is unable to perform the withholding obligation, the taxpayer shall pay them at the place where the income has occurred. If the taxpayer fails to do so, the tax organ may recover the payable tax of the enterprise from its other income items inside China for which the payer should pay.

Article 40 A obligatory withholder shall turn over the tax payments which it withholds every time to the state treasury within 7 days after the date of withholding and submit to the local tax organ a form of report on the withheld enterprise income taxes.

Chapter VI Special Adjustments to Tax Payments

Article 41 With regard to a transaction between an enterprise and its affiliate, if the taxable revenue or income of the enterprise or its affiliate decreases due to inconformity with the arms length principle, the tax organ may make an adjustment through a reasonable method.

The costs of an enterprise and its affiliate for joint development or accepting the assignment of intangible assets, or jointly providing or accepting labor services shall, according to the arms length principle, be apportioned in the calculation of the taxable amount of incomes.

Article 42 An enterprise may file with the tax organ the pricing principles and computation approaches for the transactions between it and its affiliates, the tax organ and the enterprise shall enter into an advance pricing arrangement upon negotiations and confirmation.

Article 43 When an enterprise submits to the tax organ its annual enterprise income tax returns, it shall enclose an annual report on the affiliated transactions between it and its affiliates.

When the tax organ investigates into the affiliated transactions, the enterprise and its affiliates, as well as other enterprises relating to the affiliated transactions under investigation, shall provide the pertinent materials according to the relevant provisions.

Article 44 Where any enterprise refuses to provide the materials of transactions between it and its affiliates, or provides any false or incomplete materials which cannot reflect the true information about the affiliated transactions, the tax organ may decide its taxable amount of income upon check.

Article 45 With regard to an enterprise which is established by a resident enterprise or controlled by an resident enterprise or by a Chinese resident and which is located in a country (region) where the actual tax burden is obviously lower than the tax rate as prescribed in paragraph 1 of Article 4 of this Law, if the profits are not distributed or if less profits are distributed for a cause not attributable to reasonable business operations, the portion of the aforesaid profits attributable to this resident enterprise shall be included in its incomes of the current period.

Article 46 The interest disbursement for any credit investments and equity investments, which an enterprise accepts from its affiliates, in excess of the prescribed criterion shall not be deducted in the calculation of the taxable amount of income.

Article 47 Where an enterprise makes any other arrangement not for any reasonable business purpose, if its taxable revenue or income decreases, the tax organ has the power to make an adjustment through a reasonable method.

Article 48 If the tax organ makes an adjustment to a tax payment under the provisions of this Chapter and if it is necessary to recover the tax payment in arrears, it shall do so and charge an additional interest under the provisions of the State Council.

Chapter VII Administration of Tax Collection

Article 49 The administration of the collection of enterprise income taxes shall be governed by the Law of the People’s Republic of China on the Administration of Tax Collection in addition to this Law.

Article 50 Unless it is otherwise provided for in any tax law or administrative regulation, the tax payment place of a resident enterprise shall be the registration place of the said enterprise. But if its registration place is without China, the tax payment place shall be the place where its institution of actual management is located.

A resident enterprise which has established operational institutions without legal person status in China shall calculate and pay its enterprise income taxes on a consolidated basis.

Article 51 Where a non-resident enterprise obtains any income as described in paragraph 2, Article 3 of this Law, the tax payment place shall be the place where the institution or establishment is located. Where a non-resident enterprise has established two or more institutions or establishments within China, it may, subject to the examination and approval of the tax organ, choose to have its main institution or establishment pay the enterprise income tax on a consolidated basis.

For a non-resident enterprise which obtains any income as described in paragraph 3, Article 3 of this Law, the place where the obligatory withholder is located shall be the place for the payment of enterprise income taxes.

Article 52 Unless it is otherwise provided for by the State Council, enterprises shall not pay their enterprise income taxes on a consolidated basis.

Article 53 Enterprise income taxes shall be calculated on the basis of a tax year. A tax year commences on January 1 and ends on December 31 of the Gregorian calendar year.

Where an enterprise starts or terminates its business operations in the middle of a tax year so that its actual business operation period in this tax year is shorter than 12 months, its actual business operation period shall constitute a tax year.

At the time of liquidation of an enterprise, the liquidation period shall be a tax year.

Article 54 Enterprise income taxes shall be paid in advance on the monthly or quarterly basis.

An enterprise shall, within 15 days after the end of a month or quarter, submit to the tax organ an enterprise income tax return for advance payment and pay the tax in advance.

An enterprise shall, within 5 months after the end of each year, submit to the tax organ an annual enterprise income tax return for the settlement of tax payments and settle the payable or refundable amount of taxes.

When an enterprise submits an enterprise income tax return, it shall attach to it the financial statements and other relevant materials according to the relevant provisions.

Article 55 When an enterprise terminates its business operation in the middle of a year, it shall, within 60 days after the actual date of termination of its business operations, apply to the tax organ for calculating and paying the enterprise income taxes of the current period.

Before an enterprise goes through the deregistration formalities, it shall make a declaration to the tax organ on the liquidation and shall pay the enterprise income taxes.

Article 56 Enterprise income taxes to be paid under this law shall be calculated on the basis of RMB. For any income calculated on the basis of a currency other than RMB, the amount of taxes shall be calculated and paid after this income is converted into RMB.

Chapter VIII Supplementary Provisions

Article 57 The enterprises which have already been established prior to the promulgation of the present Law and enjoyed low tax rates according to the provisions of the tax laws and administrative regulations in force at that time may, according to the provisions of the State Council, continue to enjoy the preferential treatments within five years after the present Law is promulgated and gradually transfer to the tax rate as provided for in the present Law. Those which enjoy the preferential treatment of tax exemption for a fixed term may, according to the provisions of the State Council, continue to enjoy such treatment after the promulgation of the present Law until the fix term expires. However, for those that have failed to enjoy the preferential treatment due to failure to make profits, the term of preferential treatment may be counted as of the year when the present Law is promulgated.

Within the particular areas established by law for developing foreign economic cooperation and technological exchanges and the high- and new-tech enterprises that need the key support of the state newly established within the areas where the State Council has provided for the implementation of the abovementioned special policies may continue to enjoy transitional preferential tax treatments, with the specific measures thereof to be formulated by the State Council.

Other enterprises falling in the encouraged category as already determined by the State Council may enjoy the preferential treatment of tax reduction or exemption according to the provisions of the State Council.

Article 58 Where any provision in a tax treaty concluded between the government of the People’s Republic of China and a foreign government is different from the provisions in this Law, the provision in the said treaty shall prevail.

Article 59 The State Council shall formulate a regulation on the implementation of this Law.

Article 60 This law shall come into force as of January 1, 2008. The Income Tax Law of the People’s Republic of China on Foreign-funded Enterprises and Foreign Enterprises as adopted at the 4th Session of the Standing Committee of the 7th National People’s Congress on April 9, 1991 and the Interim Regulation of the People’s Republic of China on Enterprise Income Tax as promulgated by the State Council on December 13, 1993 shall be repealed simultaneously.

　　But before you liquidate your financial assets, buy gold bullion, and move to a cave in Montana, you may wish to consider that current predictions of global economic collapse may be simply hyperbole. It has happened before. Clinton’s quote above actually refers to the collapse of Long Term Capital Management in 1998 —— right before NASDAQ clocked an 88% gain in 1999. Nor does this global crisis stand up to the scrutiny of historic comparison. Remember the S&L crisis in the early ’80s? It cost the U.S. economy about 3.5% of GDP —— about 5x the size of subprime write-offs so far. Or how about the dark days of 1981, when the Federal Reserve drove its key interest rate to 19% in an effort to whip inflation? Bill Clinton’s “Great Depression of 1998″ doesn’t even merit mention.

　　Global Financial Crisis: The Current State of Play

　　Comparing economic statistics is inevitably a “glass is half empty” versus “glass is half full” kind of game. Both Pollyannas and Cassandras can marshal endless statistics to support their version of events. But since it’s the Cassandras’ views that are the flavor of the day, let’s look at some “glass is half full” statistics on the U.S. economy.

　　Companies in the U.S. private sector added 130,000 jobs in January and the unemployment rate eased to 4.9%. The Institute for Supply Management’s index of manufacturing activity rose to 50.7 in January —— back above the 50 threshold that indicates expansion consistent with GDP growth of roughly 2%. Nearly 93% （!） of purchasing managers said that turmoil in financial markets was having no effect on their companies’ ability to obtain regular or additional financing. That situation indicates that the turmoil is restricted to Wall Street and subprime households.

　　True, that after rip roaring performances in Q2 and Q3, the U.S. economy has stumbled. But a look behind the headline numbers is revealing. Good news came from the consumer sector （spending increased by 2%）, business investment （jumping 7.5%）, and exports （up 3.9%）. It was declines in residential investment （down 23.9%） and in inventory investment that almost wiped out those gains. All of this indicates that the economy stands less at the precipice of the next Great Depression than at a cyclical purging of excesses —— particularly in the housing sector.

　　Global Financial Crisis: Professor Bernanke’s Report Card

　　Aware that the financial crisis could spread to other sectors, the Fed has moved remarkably aggressively, cutting rates by 1.25 percentage points in eight days —— a rate-cutting spree almost unheard of in central banking history. The Fed now has cut rates five times by a cumulative 2.25 percentage points —— and there is no sign that the Fed is done. Thanks to the maneuverings of Hank Paulson, George Bush soon will sign a bill that will pump some $150 billion into the American economy for U.S. consumers to spend. That kind of coordination between fiscal and monetary authorities is as unprecedented as it is both prompt and impressive.

　　Sure, the Cassandras are vilifying the Fed’s actions. Bernanke has been criticized for everything from pandering to Wall Street traders to still being behind the curve. But opinions are like a nose —— everybody has one. The current din of criticism against Bernanke is a lot like baseball fans, screaming “throw the bum out” at the game or venting their frustrations on post-game AM radio talk shows. But it’s a lot easier to criticize than to step up to home plate and swing the bat. The reality is that few of Bernanke’s most vitriolic critics were even smart enough to make it into an introductory economics class taught by Bernanke at Princeton —— let alone to run the world’s most influential Central Bank. And to assume that Fed policy is based on responses to such criticism would be as absurd as for baseball star Alex Rodriguez to walk over and hand his bat to an obnoxious, beer-swilling critic in the bleachers of Yankee Stadium to take his place at home plate. Thankfully, airline pilots guiding a plane through rough turbulence play to a less vociferous crowd.

　　Here’s the reality. Neither Bernanke’s interest rate cuts nor the federal stimulus package likely will hit the policy nail right on the head. But no real-time decision making is perfect. As John Maynard Keynes, himself an academic with plenty of real world experience, observed: “It’s better to be approximately right than exactly wrong.” The Fed can’t stop a downturn, but it can help it be short and shallow. This is a complex, fast-changing situation. Let’s give the Fed and the U.S. government some credit for acting swiftly and decisively.

　　Global Financial Crisis: The Investment Strategy of the World’s Top Traders

　　So are things really that bad? What has gotten lost in the din is that credit markets have returned to normal. Foreclosures are at record levels, but aren’t as numerous as originally forecast. And even if policy responses by the Fed only slow the rate of decline in U.S. housing prices, that alone will already have a dramatic impact on U.S. economic growth. And the Fed has shown that it is willing to act quickly to reverse course and hike interest rates once it is clear that the economy is through this bout of weakness.

　　Uncertainty means that it is reasonable to pull your horns in a bit —— and diversify away from stocks, emphasizing a diverse group of assets that are less correlated to the stock market. The top hedge managers I know are more focused on playing defense until the dust settles. The most bullish signal is that investors are almost uniformly bearish. And it is precisely during periods of panic that the greatest fortunes are made.

    US treasury yields have again approached 4.5%, some 75 basis points below the cash rate, and at this level bond yields are attractive. For bonds to rally further requires a recession, but we believe the risk of an outright recession is very low. Though we expect global growth to moderate this year, we think it is likely to be mild as we do not expect significant problems in the global economy from either the US housing slow down or industrial activity. Whilst in the short term bond prices could remain strong as investors seek safety, we see this as an opportunity to adjust exposure for the medium term as we remain cautious on fixed income.
     Over the month, the yen was supported by better than forecast Japanese Gross Domestic Product, which boosted confidence in the economy. However, despite raising interest rates to 0.5%, the Bank of Japan’s comments that the outlook was for gradual future rises saw the Japanese currency give up some of its earlier gains. Over the month the yen was stronger against the dollar and the US currency also fell against the Euro which was supported by market expectations of an interest rate rise from the European Central Bank in March.
    Against the Euro and Sterling, we expect the US dollar to be range bound. But the Yen can continue to strengthen against the US Dollar as the Japanese economy is likely to be hold up in 2007. The low interest rates in Japan have prompted heavy selling of the Yen over the past year and its recent rebound indicates that investors are aggressively buying the currency back. Over the coming months, we will see high volatility in the currency markets. Asian currencies are fundamentally undervalued and we favour Asian currencies against the US Dollar

   Following the correction in February, the market will likely trade sideways until there is better clarity on government policy regarding possible measures to control property prices and excessive market speculation. Policy risk remains high over the short term. However, China’s strong economic fundamentals remain intact. The corporate income tax unification could translate into substantial tax reductions for many listed companies which in turn would boost corporate earnings growth. Further Renminbi appreciation, the expansion of the QDII scheme, corporate M&A and the implementation of management incentive plans are positive factors that would lead the market higher over the longer term.

        The Hang Seng Index (HSI) dropped 2.3% for the month, with a sharp plunge around the end of February. The fall was triggered by the sell-off in the China A-share market, the reversal of Yen carry trade as well as a rebound in the emerging markets credit spread. Finance was the worst performing sector as its performance was dragged down by the bell-weather HSBC which issued a profit warning regarding the increased provisions on its US mortgage books. The property sector also underperformed due to profit-taking whilst utilities and commerce and industrial sectors fared relatively better.
    Concerns over fund outflow and high market velocity will see the market entering into a consolidation period over the short term. As the underlying economic fundamentals continue to improve and stock valuations remain reasonable, any major correction would be a good buying opportunity. Positive management guidance in the forthcoming corporate reporting season will be the near-term catalyst for the market to resume its uptrend. We prefer property developers, retailers, hotels, selective industrials and China related stocks, while cautious on utilities, property investors and selective large cap banks.

   Whilst there isn’t enough evidence to prove conclusively that the unwinding of the Yen carry trade is a major cause behind the turmoil in markets, the perception of its significance to investors is apparent. Investors that borrowed cheaply in Yen (due to the low interest rate) to invest in higher yielding positions elsewhere, have now been settling their positions due to the strengthening of its currency. This has been cited as a key reason behind the sell-off in global equities, including Japan. Once this trend decouples, i.e. markets no longer react to movements in the Yen, risk aversion is likely to settle. Meanwhile as private consumption grows, the Bank Of Japan is likely to stay under pressure to raise interest rates. Last month the BOJ raised interest rates to 0.5%, but noted that this would not be followed by consecutive
moves to raise borrowing costs. Japan currently has the lowest interest rates among industrialized nations, and the government has been pressuring the central bank to keep rates low so as to not endanger the economic recovery. While the performance of Japanese equities in 2006 and at the start of 2007 has been disappointing, economic expansion has remained solid. As such, Japanese equities could outperform this year. Within equities, small caps underperformed in 2006, and may have significant potential upside.