China: Domestic Taxation
Domestic Corporate Taxation
Companies which are resident in China pay tax on their world-wide income. 'Resident' here means that their central management and control is located in China. Non-resident companies with a permanent establishment in China pay tax only on their China-source income, including 'effectively connected' income. Foreign-owned companies will normally qualify as non-resident, although if there are Chinese partners the situation may be complex.
As regards tax rates, under a 2008 reform, China has unified the income tax treatment of domestic and foreign enterprises with the new Enterprise Income Tax Law (the “New Law”). The New Law, which became effective January 1st 2008, provides for a 25% statutory rate that applies to both domestic and foreign-funded enterprises and, subject to transition relief, enterprises that have enjoyed preferential treatment. Many foreign-funded enterprises will face higher rates due to the new unified rate and the loss of tax holidays and certain other incentives, but new and high-technology enterprises may still benefit from a 15% rate.
Also included in the New Law are international taxation concepts wholly or partly new to China: the determination of residence under the “managed or controlled” concept; controlled foreign corporations; cost-sharing agreements; thin capitalisation; and deemed paid foreign tax credits. The New Law also strengthens transfer-pricing administration. The New Law only provides a framework of general tax provisions. Important details on the definition of numerous terms were left to detailed implementation regulations and supplementary tax circulars.
In addition to the loss of tax holiday and reduced rate benefits, some withholding tax ratesalso increase under the New Law.
Foreign-funded enterprises being taxed at 15% (or nil) usually benefit from a five-year transition to adjust to the new tax rate.
China has a large number of taxes - around 25 - although companies are not subject to them all. The most important taxes for a manufacturing operation are likely to be value added tax; industrial taxes, and enterprise income tax.
Foreign investment enterprises include equity joint ventures, cooperative or contractual joint ventures and entities wholly owned by foreigners. A foreign investment enterprise is subject to tax on its worldwide income.
Prior to 2008, PRC tax law already included transfer-pricing rules. Under these rules, all fees paid or charged in business transactions between related parties must be determined according to an arm's length standard. If the parties fail to meet this requirement, the tax bureau may make reasonable adjustments by using one of the following methods:
- Comparable uncontrolled price;
- Reasonable profit margin;
- Cost-plus formula with a reasonable markup; or
- Other methods deemed appropriate by the tax authorities.
For purposes of the transfer-pricing rules, related parties result from direct or indirect ownership, common control by a third party or a relationship with common interest. Intercompany transactions covered by the transfer-pricing rules include sales or purchases of goods, technology transfers, provision of services, financing transactions and other business transactions.
In January, 2005, China's State Administration of Taxation (SAT) Deputy Director Wang Li said it would intensify its efforts to crack down on tax evasion and would concentrate its efforts on large taxpayers and international taxation.
Wang was reported by Chinanews as stating that SAT will focus on improving administration and enforcement in the areas of international and foreign-related tax and will strive to strengthen cooperation with foreign institutions and tax administrators.
Wang also directed the tax authorities at all levels to carry out more assessments and audits on foreign enterprises and revealed that SAT will seek to integrate the administration of key taxpayers at the local level, while also establishing more effective monitoring systems for key foreign corporate taxpayers.
In a separate move to level the tax playing field between domestic and foreign-invested firms, the latter lost their exemption from paying land use tax. As part of a plans aimed at helping the government exert more control over the use of development land, land use taxes, which had remained static for almost twenty years, tripled, and both domestic and foreign companies now pay the same rates.
The new tax rates range from between 1.5 yuan to 30 yuan (US$0.20 to US$3.84) per square metre depending on the location of the land and its intended use.
Foreign companies operating in China will no longer be able to claim value-added tax rebates on purchases of locally-manufactured equipment under a reform which went into effect on January 1, 2009.
The move is part of structural reform to China's VAT system and was confirmed by China's Ministry of Finance and State Administration of Taxation in an announcement on December 29, 2008.
The new rules mean that foreign companies will no longer be able to claim VAT refunds on purchases made after January 1, although some rebates were still be permitted under a transitional arrangement which runs until June 30, 2009. However, from 2009, company spending on capital equipment is deductible for income tax purposes.
China is in the process of moving from a production-based VAT system to a consumption-based one, replicating a model in place in many other countries with VAT systems. The reforms permit companies to offset input VAT on investment in fixed assets against VAT payable to the government, a move that will benefit manufacturing and heavy industry in particular.
The government had already trialled the system in several areas of China but has now rolled out the system nationwide, not only to advance its tax modernisation agenda, but also to give the corporate sector a timely economic boost amid global economic uncertainty.
In September, 2009, China’s State Administration of Taxation (SAT) announced that taxes were being introduced on employee benefits, such as telephone and transport allowances.
If no other specific means exists to distinguish between corporate and personal usage, 20% of an employee’s telephone allowance and 30% of a car allowance are determined to be taxable.
Payments to an employee for insurance and redundancy are also be deemed to be taxable. The SAT also announced that companies would not be allowed to deduct employee pensions from their corporate profits, and it also augmented its controls over fuel tax payments.
These measures are seen as a tightening and a hardening of procedures by the SAT in the face of a recent decline in tax collections. In the past, a company has been able to increase its employees’ incomes by increasing their non-taxable allowances, rather than their taxable salaries or bonuses.
This has obviously reduced the country’s tax revenue and has, apparently, been more prevalent in government agencies and state-owned companies. Employees will now be liable to account for the additional taxes, when the regulations come into effect.
In January, 2010, the Chinese Ministry of Finance, acting through the State Administration of Taxation, issued a Circular to clarify corporate income tax provisions with regard to income earned abroad.
According to the Circular, if the tax paid abroad cannot be accurately verified, then the tax paid in the related country (region) should not be deducted from tax payable in the current period, nor deducted from the annual tax amount. The Circular clarifies terms that have been effective since January 1, 2008.
Item 5 of the Circular stipulates that corporate pre-tax income earned abroad should be calculated in accordance with Article 7 of the Implementation Rules of the Enterprise Income Tax Law and the amount of income tax payable for income earned abroad is as defined in Article 78 of the Implementation Rules.
The Circular also defines the amount of income tax that is deductible on income earned abroad as the tax payable and actually paid for the enterprise income earned abroad. The Circular specifies six types of taxes that do not fall into the category of deductible corporate income tax on income earned abroad.
A formula is given for businesses to calculate the amount of deductible tax. Two conditions are outlined in which taxation authorities approve the use of some simple methods for calculating the amount of income tax paid for income earned abroad.
The corporate income tax on income earned from Hong Kong, Macao and Taiwan is levied according to the Circular. If a tax treaty exists between Chinese government and the relevant foreign country prescribing rates that differ from the Circular, the treaty rates prevail.
The Circular also has a list of 15 countries with much higher statutory tax rates than China's, such as the US, France and Japan.
In February, 2010, China's Ministry of Finance and the State Administration of Taxation (SAT) issued a further Circular on the same subject.
The Circular sets forth the specific method for determining the amount of actually allowable overseas income tax as well as upper limits for tax credit by country for the current period, SAT announced on February 11.
The Circular further clarifies that such foreign taxes cannot be carried forward to subsequent years for deduction and exemption.
In April, 2010, China's State Council released new guidelines for foreign investment in China which include tax incentives and easier procedures, especially in the lesser developed 'West Delta' region.
At a press conference in Beijing, deputy director of the National Development and Reform Commission, Zhang Xiaoqiang, and Vice Minister of Commerce, Ma Xiuhong, launched new rules to encourage foreign investment towards the high-end manufacturing, hi-tech and eco-friendly sectors and to central and western China.
However 'environmentally unsound and energy-gorging projects in industries running at overcapacity' are to be discouraged.
Inward investment may also qualify for support under China's stimulus package for 10 key industries (a RMB4 trillion (USD586bn) package announced in November 2008). Companies in the "encouraged" category, would benefit from lower land prices.
Multi-national companies will be encouraged to establish regional headquarters, R&D centers, purchase centres, financial management centres and other functional departments in China.
By the end of 2010, imports for scientific and technological development at foreign R&D centers may qualify for exemption from tariffs, value-added tax, and goods and services tax, according to the regulations.
Foreign companies are especially encouraged to increase their investment in China's central and western regions, known as the 'West Delta', particularly in eco-friendly and labour-intensive businesses. The 'West Delta' comprises Chongqing Municipality, Sichuan Province and Shanxi Province. Existing tax incentives for qualifying foreign companies will continue for new investment in this region, and, in addition, existing foreign investment in China's coastal regions will be supported in moving west.
690,000 foreign companies have invested in China, creating 45 million jobs, said the Ministry. China has topped the list for attracting inward investment for the last 17 consecutive years, and by the end of 2009, had secured USD945.4bn in inward investment during this period.
On February 20, 2010, the State Administration of Taxation issued the Provisional Measures for Tax Collection and Administration for Foreign-Enterprise Representative Offices, applying retroactively from January 1, 2010. The Measures apply to all ROs, bringing their treatment into line with that of other corporate forms and making the continued use of the RO format much less attractive.
In June, 2010, the government introduced a 'Resource Tax' of 5% on coal, gas and oil production in Xinjiang province. In July the tax was extended to 12 more of its western provinces in an effort to inject finances in the poorest regions of the country, which are badly in need of investment in infrastructure and jobs. Among the biggest projects earmarked by the Chinese government are 13 solar power projects.
The new tax is levied on the selling price of the commodities rather than based on volumes produced. This is expected to increase tax revenues substantially.
China has reduced corporation tax for companies in the western regions for encouraged businesses by 10%, to 15%, from January 2011 to 31 December 2020 in a further attempt to provide incentives to businesses in the region.
The western regions of China are very rich in natural resources but in terms of wealth, they are years behind the affluent and booming eastern coastal regions of the country. The government has stated that it wishes to begin to close the divide between east and west and no doubt it also hopes that the injection of revenues in the western regions may placate those living in these remote areas of the country, where some civil unrest has reared its head in recent years, notably in Xinjiang province in 2009.
In August, 2010, the Chinese State Administration of Taxation (SAT) issued a public notice in relation to the corporate income tax treatment of corporate restructurings to clarify certain technical and procedural matters that had been left unclear in a circular released in April 2009.
The Public Notice seeks to resolve issues associated with Circular 59 published the previous year which discouraged corporate restructurings because of uncertainty of tax treatment.
The Public Notice elaborates on the definition of “equity consideration” and the documentation requirements for various types of corporate restructuring. It also elaborates on the continued availability of tax incentives after corporate mergers and de-mergers.
Other issues covered in the latest public notice include the importance of “fair value” of assets and liabilities and the necessity of valuation reports from recognized professionals, explanation of procedures for adoption and approval of special tax treatment, adjustments after breaches of special tax treatment criteria, the definition of “reasonable commercial purposes” as a prerequisite for special tax treatment; and transitional requirements for corporate restructuring which took place in 2008 and 2009
The Notice is effective for restructurings taking place since January 1, 2010.
In September, 2010, in a series of critiques of the Chinese taxation regime published by the European Union Chamber of Commerce in China (EUCCC), the Chinese business tax on services was described as a "critical obstacle to the growth of the service sector and other high-value knowledge industries in China".
The EUCCC also said that its detrimental effects on service providers had been "accentuated by the recent shift from a production-based to a consumption-based VAT regime".
Business tax is applied at a rate of 5% on the gross turnover derived from: the provision of services rendered in China; assignment and licensing of intangible assets; and sale or rental of real estate, provided that such activities are carried out within China.
The EUCCC said the structure of business tax could lead to double or even higher multiple levels of taxation. Business tax is mainly levied on gross turnover with no corresponding input credit for business tax paid along the supply chain as there is with VAT. As a flat tax on gross income, if a taxpayer has a very small profit margin, the imposition of the business tax can actually contribute to an economic loss.
The EUCCC also disapproved of business tax being imposed on services performed for foreign customers, whereas outside China, export of services is typically zero-rated under VAT systems.
Sales of goods, repair, replacement and processing services, as well as the importation of goods, are not subject to business tax in China, but instead to VAT levied at a standard rate of 17%. As a result of a recent change, the EUCCC said these taxpayers may now offset input VAT related to fixed asset purchases. The fact that VAT is not recoverable for payers of business tax clearly penalizes service industries, as compared to the manufacturing and trading sectors, according to the EUCCC. The Chamber also criticizes the repeal of the preferential tax treatments which aimed to compensate the non-deductibility of VAT on fixed asset purchases since January 1, 2009.
These preferential tax treatments consisted of VAT exemption on imported equipment or a refund of input VAT paid on domestically purchased equipment. They were enjoyed by foreign-invested as well as domestic enterprises pursuing an activity regarded as “encouraged” under various investment categories.
However, according to the EUCCC, enterprises engaging in activities for which business tax applies now face an increase in their fixed asset investment cost of 17% (corresponding to the non-exempted/refundable upstream VAT).
The EUCCC considers the situation to be especially harsh for equipment leasing and finance leasing enterprises. Such enterprises suffer from both an irrecoverable 17% VAT paid on equipment purchases and a 5% business tax levied on equipment rental fees, a tax burden which does not arise when the equipment is purchased.
The EUCCC recommended:
- Restoration of the previous VAT exemption and refunds of VAT on equipment purchases for certain service industries as well as R&D companies;
- Extension of these exemptions and refunds to equipment leasing and finance leasing businesses;
- Elimination of double business tax on subcontracting of labour, service and sublicensing of IPR activities by allowing deduction on subcontracting/sublicensing costs for business tax purposes; or
- Replacement of business tax with a VAT on service income and other items of income currently subject to business tax.
The EUCCC also said that foreign companies face 'major difficulties regarding tax registration and settlement' because of inconsistent practices among the local tax authorities.
According to an EUCCC report, tax administration for services of non-residents as promulgated by the Chinese State Administration for Taxation (SAT) on January 20, 2009 (Decree No. 19) has caused Non-Resident Enterprises (NREs) major difficulties in settling Enterprise Income Tax (EIT) and Business Tax (BT) and performing related tax formalities due to:
- The impracticability of making a tax settlement in Chinese yuan;
- Complications when a project is carried out in several locations in China; and
- Inconsistent practices regarding the timing of tax settlements.
The EUCCC said foreign exchange restrictions prevented NREs from settling taxes in foreign currency and foreign enterprises could not open CNY bank accounts in China. As a result, local tax bureaus could not enforce Decree No. 19 and, the EUCCC said, settlement of taxes mostly continues to be performed through withholding at source.
The EUCCC thought this generated a great deal of confusion regarding the way in which tax formalities should be performed. In practice, the requirements imposed on taxpayers varied greatly from one locality to another and even within the same locality from one project to another, the report observed.
The EUCCC was unhappy that no procedure existed for consolidated tax settlement of BT. This created a discrepancy in the place where EIT and BT were settled and obliged NREs to allocate income between various establishments in China making proper accounting records more difficult to maintain, the EUCCC said.
Service projects contracted by NREs often include two phases: a first phase where only offshore services are provided and a second phase where both offshore and onshore services are provided. To the EUCCC it was unclear where BT related to offshore services had to be paid in the first phase, if the place of the withholding agent and the performance of the onshore services in the second phase were different. This sometimes caused tax bureaus in both places to claim BT payment on offshore service income, said the EUCCC.
In practice, many local tax bureaus continued to levy EIT and BT at the time of payment of the related income (i.e. before completion of related foreign exchange formalities) despite the provisions of Decree No. 19 on quarterly EIT and BT monthly payments. The EUCCC thought this created additional uncertainty for NREs.
The EUCCC recommended:
- New foreign exchange rules permitting NREs to open CNY bank accounts to allow settlement of taxes in compliance with the requirements set out by Decree No. 19, or failing this, reversion to the former system of withholding taxes at source;
- Simplification of tax formalities for projects implemented in different locations, by permitting NREs to register only at the location of their main establishment in China and settle BT on a consolidated basis at that location;
- Clarification of which tax authority is competent for settlement of BT on offshore service income for projects involving the provision of both offshore and onshore services; and
Consistent implementation by local tax authorities of the provisions of Decree No. 19 on EIT quarterly and BT monthly settlements.