Withholding Tax Deferral for Foreign Investment in China
Foreign investors are now subject to a more relaxed criteria when applying for the withholding tax deferral system.
Withholding tax is a form of tax that applies to various China-sourced incomes derived by non-resident enterprises without establishments in China, or by non-residents enterprises with establishments in China, but whose income is not related to these establishments.
Originally, Circular 88 (Cai Shui [2017 No. 88]) stated that non-residents enterprises which incurred their income from January 1, 2017 onwards were able to defer withholding tax payments by reinvesting their equity investment incomes (such as dividends and bonuses) from resident enterprises into projects encouraged by the country.
These were projects that fall under the list of sectors encouraged either under the Catalogue on Industry Guidelines for Foreign Investment, or the Catalogue of Priority Industries for Foreign Investment in Central and Western China.
However, in October 2018, this legislation was repealed and replaced by a new circular.
Under the Notice on Expanding the Scope of Application of Withholding Income Tax Policy for Direct Investment by Foreign Investors to Distribute Profits (Cai Shui  No. 102) (“Circular 102”), non-resident enterprises are now able to defer withholding tax payments by reinvesting equity in any non-prohibited foreign investment projects and fields, removing the prior limitation of investing in encouraged sectors only.
In effect, this means that China’s withholding tax deferral system is now subject to a wider scope of application and can be more flexibly applied by foreign investors.
This treatment should help foreign investors with long-term development by encouraging continued investment in China.
However, foreign investors interested in WHT deferral treatment should continue to closely study the criteria, ideally with experienced local tax advisors that can liaise with authorities in China. Furthermore, foreign investors should work closely with the Chinese Tax Resident Enterprises (TRE) to ensure that they satisfy the necessary conditions to ensure smooth record filing.
Tax deferral treatment criteria
Under China’s Corporate Income Tax (CIT) Law, dividends are generally subject to 10 percent withholding tax, unless a more favorable rate can be accessed through a relevant tax treaty.
Foreign investors seeking to enjoy the WHT deferral treatment on dividends paid by Chinese TRE’s must satisfy all of the following conditions.
Foreign investors are required to use the profits distributed from the Chinese TRE to directly invest or re-invest in the following ways:
- Increase, or transfer, paid-up capital or capital reserves in Chinese TRE;
- Invest or establish a new Chinese TRE;
- Acquire equity of Chinese TRE’s from non-related parties; and
- Other methods acceptable to the authorities.
Investment into publicly listed companies is not permitted except where the foreign investor and the A-share listed company meet the requirement of a ‘strategic investment’, as stipulated in Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors (2015).
Nature of the distributed profits
The nature of the profits distributed must be equity investment income such as dividends, bonus issues, retained and realized by the foreign investor, and then distributed to the Chinese TRE.
The profits – both cash and non-cash forms – must be transferred directly from the profit-distributing enterprise’s account to the new investment. Transfers to any intermediate parties before being passed onto the new investment will not qualify.
Record filing procedures
The Chinese TRE that distributes the dividends should perform record filing procedures with the relevant in-charge tax authority for the purposes of deferring the WHT.
This should be done after the Chinese TRE affirms that the foreign investor is eligible to receive the WHT deferral treatment by submitting relevant documents.
Dividends derived by foreign investors on or after January 1, 2018 are eligible for the WHT deferral treatment and a refund for the tax already paid could be applied.
Eligible foreign investors can also apply for the treatment retrospectively within three years from the date the tax payment was made and claim a refund.
Deferred WHT settlement
If a foreign investor benefits from the WHT deferral treatment recoups their direct reinvestments – through equity transfer, equity buyback, liquidation, or other means – they should report and settle the tax deferral payments with the relevant in-charge tax authority within seven days from the receipt of the relevant payment.
However, if the invested enterprise restructures, and this restructuring meets all the conditions for ‘special restructuring’, and has met the requirements for tax treatment based on special restructuring, the foreign investor may continue enjoy the preferential deferred tax treatment and will not be required to pay the deferred withholding tax.
Local guidance advised
Foreign investors in China welcome the clarifications on WHT deferral treatment in Circular 102. Circular 102 grants more stability to foreign investors in China, who can now plan their long-term China investments with greater certainty.
However, new tax reforms require due diligence and planning on the part of foreign investors. Foreign investors interested in availing themselves of WHT deferral treatment need to ensure that they meet eligibility requirements, liaise with the appropriate tax authorities, and work closely with the TRE to ensure that record filing is executed properly.
Accordingly, foreign invested enterprises should consult with trusted local advisors before attempting to take advantage of this beneficial reform. Local advisors ensure your business employs best practices when coordinating between foreign headquarters, China-based business, and local tax authorities.
Editor’s Note: This article was originally published in January 2018, and has been updated to reflect the latest developments.