China publishes implementation rules for new corporate income tax
By Andy Scott
SHANGHAI, Dec. 14 – China’s State Council approved the long-awaited implementation rules for the country’s new corporate income tax law on December 6.
The Detailed Implementation Regulations, prepared by the Ministry of Finance and the State Administration of Taxation, contains eight chapters and 133 articles. Here we look at some of the more important changes and provisions that may effect foreign investment in China.
One of the most attractive incentive programs under the new tax law is the high/new technology enterprise incentive which offers a reduced tax rate of 15 percent. There is also a plan, subject to the State Council’s final approval, to extend the withholding tax exemption on dividends declared by high/new technology enterprises.
The bar to obtain new/high technology status has been set high however. Among the criteria is ownership of core proprietary intellectual property. While many MNCs are likely to balk at transferring IP rights to their Chinese subsidiaries, it is still hard to get a clear and concise meaning for “core.” As no legal definition has been provided as of yet, “core” could simply refer to economic ownership, as opposed to complete legal ownership of intellectual property. Regardless, companies will need to reassess their IP model if they want to qualify for the new incentives.
It is also important to note that high tech status under the old FEIT law does not apply to the new corporate income tax law, and FIEs that have attained high tech status will likely be subject to a re-assessment based on the criteria laid out in the new law.
The corporate income tax laws introduced the concept of tax resident enterprises, whereby enterprises with a tax residency that is deemed to be in China is subject to tax on worldwide income. A Chinese registered company is naturally considered a tax resident of China, as is a foreign company with its place of effective management located in China.
The implementation rules define the place of effective management as “the place where the exercising, in substance, of the overall management and control of the production and business operation, personnel, accounting, properties, etc of a foreign company is located.” The rule focuses on daily management from an operational standpoint, rather than strategic decision-making.
Those who will be affected by this rule are Chinese companies “round-tripping” their investment (Chinese investors setting up a foreign holding company to make investments back into China) and HK trading companies completely managed by personnel in China. Large multi-national companies that have set up their Asia/Pacific headquarters in China would also fall under this rule, but the authorities may choose to be more lenient towards regional headquarters of MNCs in order to encourage more to set up on the mainland.
Withholding tax on dividends
The new tax law stipulates that foreign companies are subject to a 20 percent withholding tax (WHT) on China-sourced passive income with a possibility for reduction or exemption. The implementation rules confirm that the WHT on dividend payment to non-residents is 10 percent. This means that the current WHT exemption for dividends derived by foreign investors will be abolished. With the removal of the WHT exemption, foreign investors will see their worldwide tax burden increase and their expected returns from investment in China diminish.
As stated in the new law however, businesses from countries with favorable tax policies and treaties with China will not be affected by the 10 percent WHT. Foreign invested companies should then begin to look at double tax treaty arrangements that China has with other countries. Hong Kong and Singapore for example, charge 7 percent WHT on dividends, while Barbados has 5 percent WHT on dividends. However, before WFOEs start moving their holding companies to Barbados, they need to consider the new law’s anti-avoidance measures.
While the implantation rules do not say how the new tax rate will be phased in for FIEs that were issued a business license before March 16, 2006, the tax authorities have on many occasions confirmed the following transitional tax arrangement:
Enterprise Income Tax
|New Corporate Income Tax||Transition period|
|33%||25%||January 1, 2008|
|24%||25%||January 1, 2008|
|15%||25%||2008: 18% 2009: 20% 2010: 22% 2011: 24% 2012: 25%|
One interesting note, while tax officers in Shanghai’s Pudong New Area have generally been giving all FIEs a 15 percent tax rate under the old system, in actuality, many do not actually qualify for this 15 percent tax rate. Under the new law therefore, they will not qualify for the transitional tax period and will see there tax rate increase directly to 25 percent come January 1, 2008. However, as with most things in China when it comes to taxes, the wording is vague and until the SAT issues a specific circular addressing this issue, it is likely that tax officers in Pudong will continue to apply whatever tax they deem appropriate.
The main purpose of the anti-avoidance rules is to prevent companies from abusing or avoiding paying taxes. They become applicable if it is deemed that a businesses main purpose for a transaction such as related party dealings, investment, restructuring, and financing, is to reduce, avoid or deter taxation. This then also rightly applies to treaty shopping, or looking for the best double taxation treaty country and setting up a holding company there. Therefore, you both need know where Barbados is and be able to prove to the tax authorities why you have set up a company there.
The interest levy for tax adjustments made by the tax authority for tax avoidance activities comprises two parts: a financing change for the delayed payment; and an additional 5 percent penalty interest. This will no doubt act as a deterrent for aggressive tax avoidance and treaty shopping schemes.