The Impact of the Potential Financial Innovation on Chinese Taxation System and an Analysis

The widespread use of innovative financial transactions in international financial market in recent years is primarily driven by the need for greater financial risk management by businesses and financial investors. Many related factors have contributed to the needs of business for more sophisticated financial instruments, as well as to the financial world’s technological ability to meet that demand. Developments in international financial markets that have influenced this dramatic change include the following: (i) Increased volatility of interest, currency exchange rates and commodity prices; (ii) Expansion in scope of multinational operations of corporations; (iii) Deregulation of financial markets; (iv) Elimination or liberalization of exchange controls; (v) Increasing speed and efficiency of transmission of information. In fact, Chinese financial instruments were generally limited to securities that could be classified as either debt or equity investments at the time being. Chinese taxation rules presumed a sharp distinction between these two forms of instruments. In particular, it was assumed that debt provide for a relatively fixed return of income and principal, whereas returns on equity investments are contingent on the performance of the issuing corporation. These classifications lead to tax rules reflecting differences in the timing and character of the income from these discrete classifications.