Pilot Tax Policies for Venture Capital Enterprises and Individual Investors in China
By Jake Liddle
Authorities recently announced tax incentives for venture capital enterprises (VCEs) and individual angel investors (AIs) making investments into tech startups. The incentives for VCEs and AIs are detailed in a joint circular detailing pilot tax policies produced by China’s Ministry of Finance (MOF) and the State Administration of Taxation (SAT).
Most notably, the circular provides similar tax incentives to both corporate and individual investors, irrespective of if individuals make investments as a partner of a limited partner VCE or as an AI. The preferential tax policies aim to promote and nurture venture capital investment.
While a part of China’s broader initiative to promote the development of small and medium sized enterprises (SMEs), the pilot program is a component of the US$55.2 billion in tax cuts approved by the government in April.
Pilot tax policies
The authorities will pilot the tax policies in the Beijing–Tianjin-Hebei area (Jing-Jin-Ji), Shanghai, Suzhou Industrial Park, Wuhan, Xi’an, Shenyang, Guangdong Province, Anhui Province, and Sichuan Province. VCEs and AIs that make investments into tech startups in these regions may avail of the tax incentives.
The CIT incentives came into effect on January 1, 2017, and the IIT incentives will come into effect on July 1, 2017. Investments made within two years before the implementation of the tax policies will also be eligible for the incentives.
Corporate VCEs, limited partnership VCEs, and AIs that make a direct capital increase (or equity investment) into a tech firm at the seed or startup stage for at least two full years are eligible. Eligible investors can deduct 70 percent of the invested amount from any taxable income amount (derived either directly, distributed by partnership enterprises, or from transfer of equity shares by) in the second year by the tech start up holding equity shares.
If its taxable income does not reach the 70 percent threshold for deduction, it may be carried forward onto the following years to offset further taxable income.
In cases where AIs make multiple investments, and deductions cannot be made because of deregistration and liquidation of a tech startup, the remaining amount can be deducted from taxable incomes derived within 36 months of the deregistration date of the tech startup.
Where a tech startup becomes a listing company in either the Shanghai or Shenzhen stock exchanges, AIs must follow relevant restricted shares regulation in order to sell the startup’s stocks, which then may be deducted from the tax payable arising from the sales of the stocks.
Such tax policies only apply to cash injections, and not investment through equity transfer from shareholders.
In order to enjoy the above preferential tax policies, investors and startups will need to meet the following qualification requirements:
- Should not be established for more than five years at the time of accepting investment;
- Should be registered in the respective pilot zones in China and subject to audit of accounts and tax collection;
- Employees should not exceed 200 personnel, and should be comprised by over 30 percent holding a bachelor’s degree or higher at the time of accepting investment;
- Total assets and annual sales revenue should not surpass RMB 30 million;
- Total costs of R&D should not exceed 20 percent of cost expenditure in the year of investment acceptance;
- Shares of the startup should not be listed on any stock exchange within two years of acceptance of investment.
- Should not be the initiator of the startup;
- Should be subject to audit of accounts and tax collection;
- Has completed filing with the National Development and Reform Commission or Asset Management Association of China under China Securities Regulatory Commission;
- Total equity held by the VCE in the startup should less than 50 percent within two years after the investment has been made.
- Should not be the initiator, employee, or relative of the startup;
- Should hold no labor dispatch relation with the startup;
- Total equity held by the AI in the startup should less than 50 percent within two years after the investment has been made.
Continued support for SMEs
The Chinese government has been making significant efforts to support SMEs and startups in recent times, having started with corporate income tax (CIT) incentives for VCEs in 2008.
In light of the increasing number of emerging startups, this round of preferential individual income tax (IIT) policies will further support not only provide further support to investment, but will also help to stimulate economic growth and employment opportunities.
Investors should consider the financial background of startups they wish to invest in, as the preferential policies will not be available in cases of non-compliance. Likewise, startups should be ensure that they reach the qualification requirements in order to attract potential investors.
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