Intellectual Property Law

China's New Corporate Income Tax Laws and their Effects on Foreign Investment

By IBLS Editor

China's State Council approved the Detailed Implementation Regulation (DIR) on December 2007.  DIR's main goal was to implement China's new Corporate Income Tax Law (CIT) that entered into force on January 2008.  DIR and CIT are extremely relevant for foreign companies doing business in China because they determine how the China government will tax its income, establish withholding tax rules, eliminate taxes on qualified dividends, determine tax credits and exemptions, and set other significant corporate tax rules.  

Certainly, China's DIR and CIT produce global effects; they not only set key tax rules for domestic corporations but impact the vast foreign investment sector in China.  DIR and CIT set, among others, the following rules,

(a) they first define a "resident enterprise" (RE) as one registered under China law or a foreign company effectively managed in China.  CIT defines "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."   A RE is subject to CIT tax rules on worldwide income whereas a non-RE is subject to corporate income tax only on the China-sourced income.  This new rules makes it imperative for foreign businesses to carefully plan the management activities of their China's enterprises to avoid being subject to China's tax in their global corporate income;

(b) they introduced new withholding tax rules.  For instance, it introduced a 10% withholding tax on interests, dividends, rentals, royalties, capital gains, and other income earned by a non-RE in China.  China tax experts claim CIT rules, including this withholding rate, will increase Chinese tax burden on foreign investment to over 32.5%;

(c)  CIT introduced anti-tax avoidance rules similar to those applied internationally.  Enterprises as required to commercially validate their transactions, including financing, investments, contracts, etc.  CIT also brings in rules on transfer pricing and respective documentary information, thin capitalization rule, cost sharing arrangements, control foreign corporation rule, and the general anti-avoidance rule; 

(d) the regular income tax rate was reduced from 33% to 25%.  Additionally, CIT introduced a 20% tax rate for small-scale enterprises with reduce profits;

(e)  Tax deductions are allowed for reasonable expenses related to the production of income.  The new Chinese law significantly reduced deductions on expenses such as welfare, entertainment, advertising, donation and employee's education expenses.  Deductions for sponsorship expenses- not related to advertisement- were eliminated; management fees paid between enterprises are now prohibited; deduction or amortization of purchased goodwill is disallowed. Yet, CIT allowed a 200% tax deduction for salaries paid to disable workers; 

(f)  regarding tax credits, exemptions, and tax reductions, CIT allows foreign tax credit for the taxes paid by direct or indirect 20% owned foreign enterprises.  Technology enterprises were granted an introductory 15% reduced tax rate.  Likewise, other qualified investments were granted exemptions or tax reductions of up to 50% in tax rate; these include agricultural, forestry, fishery, animal husbandry, environmental protection, high technology enterprises, water saving project, and technology transfer industries;

(g) grandfathering treatment is provided to old investment enterprises (OIE) and new high tech enterprises.  This treatment is available to OIE registered in China on or before March 16, 2007, and it provides that OIE with a corporate tax rate of 25% or less have a five-year period to gradually increase their corporate income tax rate to 25%, as required under the new tax regime.  New high tech enterprises, established within specific regions after January 2008, will be granted grandfathering treatment as established by CIT, article 57.   These specific regions are six Chinese economic zones: Shenzhen, Zhuhai, Shantou, Xiamen, Hainan, and Pudong.  It is expected that the tax incentive for these new high tech enterprises would be as follows, 0% rate for the first two years, 12.5% for the next three years, and 15% thereafter. 

Full post as published by IBLS Internet Law Blog on September 01, 2008 (boomark / email).