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Taxation in China

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Taxation in China Taxation in China I. Corporate Income Tax The long-awaited Corporate Income Tax (EIT) Law, passed by the National People's Congress in March 2007 and effective on January 1, 2008, brings the most significant change in China’s tax regime since the turnover tax reform in 1994. The new regime unifies two separate enterprise income tax regimes for domestic enterprises and foreign-invested enterprises (FIEs) into a single regime of 25% income tax rate. In addition, the law fundamentally changes China’s tax incentive scheme from one based largely on geography to one based on the country's latest industrial and economic development goals. 2009 was the year where the Chinese government spent more effort on EIT law enforcement. The new regime has a clear negative implication on FIEs. As most foreign investors enjoy preferential taxation rates of 24% or below, this will actually lead to increased EIT liabilities for foreign enterprises. Furthermore, tax reform will also mean the end of income tax “holidays” for foreign investors, and while preferential policies for those that invest in interior provinces or high-tech industries might remain, many foreign manufacturers along China’s coast will be impacted. Moreover, a new department, Large Enterprise Tax Administration Department ("LEAD"), was formed by the end of 2008 to focus on the tax administration of large enterprises, including many multinational companies which used to experience inconsistency in tax administration in different locations of China. Quick Glance • China’s new Enterprise Income Tax (EIT) Law stipulates a 25% income tax rate for both foreign and domestic enterprises. • The EIT Law eliminates many of the tax incentives available under the previous tax regime. • New incentives are largely based on preferences for certain industries. As the “grand-fathering” principle will apply, foreign investors that establish entities prior to the tax reform will continue to benefit from their preferential policies for another five years after the tax reform is implemented. These old FIEs will see their tax increasing in a phase-in schedule. Transition from Old to New Tax Rates Old rates New rates Transition 33% 25% Change took place on January 1, 2008 24% 25% Change took place on January 1, 2008 15% 25% The rates will gradually increase as follows: 2008 18% 2009 20% 2010 22% Taxation in China October 2009 | Page 1 2011 24% 2012 25% Under the old tax regime, FIEs could take advantage of several tax incentives, based on location, industry, size, and other criteria. The new regime eliminates many of these incentives and instead adopts a predominantly industry-oriented, limited geography-based tax incentive policy aimed at directing investments into industrial sectors and projects that the Chinese government encourages. The EIT Law clearly reflects the Chinese government’s focus on technological development, environmental protection, energy conservation, production safety, venture capital, and investment in agriculture, forestry, animal husbandry, fisheries, and infrastructure development. For the foreign invested High- and new-tech enterprises (HNTEs), for instance, there is a reduced tax rate of 15% instead of 25%. But, with the tightening of EIT, a set of working guidelines, detailing the six criteria for the assessment of NHTE was implemented in 2009. The NHTE, which used to be one of the key tax incentives established by China, was set with more hurdles and was much more difficult for foreign investors to get qualified than in previous years. Another key movement in the EIT regulatory system is that the tax authority is tightening control over cross-boarder transfer pricing activities in big multinational companies. Related party transactions with oversea parent company or intercompany are closely monitored by local tax bureau. Simple transfer of profit to tax saving vehicles in BVI or Hong Kong or other similar “tax heavens” (e.g. through payment of management fee) are far less effective and becoming costly when tax authority could charge double taxing on this type of activities. II. Withholding Tax (“WT”) FEs which obtain income through interest, rental (finance lease, operating lease), sales (land, buildings) royalties (trademarks, copyrights, patents) and other income are liable to Withholding Tax on that income at a rate of 10% (20% under the New Law). Gains on the sale or transfer of an investment in the PRC by an FE are also subject to withholding tax, and has implications for M&A. Dividends paid or profits distributed by an FIE to foreign investors are exempt from withholding tax. The Withholding Tax due should be identified on the invoice of the China based entity in order for them to “withhold” this tax and then remit it to the relevant tax authorities. FIEs should be careful when they are using sub-contractors: interests, rent or royalty charges payable to a FE pursuant to the related contracts or agreements that have been accrued in costs or expenses are considered to be a payment of the charges to the recipient for WT purposes. Accordingly, the liability of the FE to remit WT to the relevant tax authorities within the prescribed time limit would be triggered at that point, regardless of whether the amount of charges has actually been paid to the FE. WT is normally deductible against income in the home country based on double taxation treaties (Italy has a taxation treaty with China, signed on the 31st October 1986 and effective on the 1st January 1990). Taxation in China October 2009 | Page 2 III. Value Added Tax (“VAT”) In some more developed countries, Corporate and Individual Income Tax account for the majority of fiscal revenue. However, China relies heavily on indirect taxes, and thus FIEs, FEs and domestic enterprises pay either VAT or Business Tax depending on the nature of their business and the type of products involved. VAT is levied on the importation, production, distribution and retailing of “taxable goods”, and the provision of labor services in relation to the processing of goods and of repair and replacement of goods. “Taxable goods” refers to tangible goods and utilities (electricity, thermal power and gas), but excludes: equipment and machinery required to be imported under contract processing, contract assembly and compensation trade, certain products (contraceptive medicines and devices, self-produced agricultural products sold by agricultural producers, antique books), and imported materials and equipment directly used in scientific research, experiment and education. The normal VAT rate is 17%, but a reduced rate of 13% applies fro certain products. VAT payable is calculated on the basis of the value added to the taxable goods and services at each stage of a production chain, and equals the output VAT for the period minus the input VAT for the period, where output VAT refers to the VAT amount collected by the taxpayer from the buyer at the point of sale, and input VAT refers to the VAT amount paid by the taxpayer at the point of purchase, both calculated on the basis of price exclusive of VAT. If the output VAT for the period is less than, and insufficient to offset against the input VAT for the period, then the excess can be carried forward for setoff in the following period. One key development in China’s VAT system was the permission to credit VAT on capital investment against consumption VAT. Previously the capital investment such as purchase cost of fixed assets are excluded from the calculation of input VAT. The renewed VAT Interim Regulation was effective on 1 January 2009. Goods imported into China are subject to import VAT based on their combined CIF plus Customs Duty value. VAT liability arises on the date when import is declared, and collected by the customs office on behalf of the tax authorities. For the sales of “taxable goods” and “taxable services”, VAT liability arises on the date when the sales sum is received or the documented evidence of the sales sum obtained. Enterprises regarded as small businesses (annual production sales of less than RMB1 million or annual wholesale or retail sales of less than RMB1.8 million) are subject to VAT at the rate of 6%, but unlike other VAT payers, are not entitled to claim input tax credits for the VAT paid on their purchases. IV. Business Tax (“BT”) FIEs, FEs and domestic enterprises may be liable BT instead of VAT, depending on the business or assets involved. BT is payable by enterprises that provided taxable services, assign intangible assets, and sell real estate. Taxation in China October 2009 | Page 3 BT is levied on gross turnover at rates of between 3% and 20%. The most common rates are 3% (construction, cultural activities and sport, post and telecommunication, transportation) and 5% (assignment of intangible assets, sale of real estate, financial & insurance services, and other normal services). In addition, 10% is levied on some leisure services (dancing halls, bars, karaokes) and 15% on others (video game halls, billiard halls, bowling alleys, golf courses). In some areas (normally smaller towns), local government authorities may return part of the BT levied, similar to VAT. V. Consumption Tax (“CT”) CT is levied on manufacturers and importers of specified categories of consumer goods (tobacco, alcoholic beverages, ethyl alcohol, cosmetics, skin and hair care products, jewellery, fireworks, gasoline and diesel, automobile tyres, motorcycles and small automobiles) at rates ranging from 3% to 50%. CT is imposed in addition to applicable customs duties and VAT. In some areas (normally smaller towns), local government authorities may return part of the CT levied, similar to VAT and BT. VI. Customs Duties Products and raw materials imported into China are first subject to Customs Duties based on their CIF value. Duty rates vary depending on the classification of the goods, and these rates vary significantly, although they are normally between 10% and 20%.
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