Key Aspects | Key Changes in Unified CIT Law | Observations |
Concept of "Tax Resident Enterprise" ("TRE") | TRE concept is introduced whereby TREs are subject to China income tax on worldwide income, and non-TREs on China source income. FIEs registered in China are always TRE. Foreign Enterprise ("FE") whose effective management institute is based in China is regarded as a "TRE". This new concept goes beyond the current "Permanent Establishment" concept which taxes FEs only on their China source income. | The move towards taxing enterprises depending on their residency status may seem like a significant change to the taxing principles. First of all, this change is just to make China CIT regime consistent with many other tax jurisdictions and is consistent with tax treaties. DEs and FIEs are unaffected by the change because they are taxed in China anyway. An FE without its effective management institute based in China is taxed the same way as before depending on whether it has a PE or not. It is only in the cases where an FE may be considered to have its effective management based in China that will be caught under this new provision. The definition of "effective management institute" is not provided under CIT Law. FEs need to be careful about the "effective management institute" rule when they consider undertaking more regional management functions within China including regional headquarters. |
Tax Rate - FIEs | Standardised rate of 25%, with reduced rate of 20% for qualified small and thin-profit companies. 15% for encouraged high/new-tech enterprises. FIEs approved before the publication date of the CIT Law and currently taxed at 15% or 24% will be offered a gradual increase to 25% within 5 years. | High/new tech enterprises no longer need to be located within so called high-tech parks and can enjoy tax incentives wherever located. The definition of "high/new-tech enterprises" is not yet available. It is believed that the scope of eligible enterprises will be subject to adjustment from time to time in line of the economic development goals set by the State. |
Tax Rate - FEs | 20% withholding tax ("WHT") rate for passive income derived by Non-TREs. | The Law has not addressed whether the current provisional 10% WHT rate on passive income and the WHT exemption on FIE's dividends to their foreign investors may continue. CIT Law has a specific provision allowing for reduction / exemption of WHT. Hence, if China considers necessary to keep current treatment, there is a framework to grant such relief. Foreign investors may explore potential use of a Special Purpose Vehicle resident in treaty countries/regions to do WHT planning. |
Tax Incentive Policies | Tax reduction and exemption treatments are targeted primarily towards (i) agriculture, forestry and animal-husbandry, fishery projects, (ii) basic infrastructure projects; (iii) environment protection projects and energy/water conservative projects; (iv) qualified technology transfer. "Super deduction" is allowed for R&D expenses for new technology, new products, new craftsmanship. Taxable income may be reduced by a deemed deduction calculated as a percentage of investment amounts for venture capital businesses engaged in encouraged industries. Shorter tax depreciation life or accelerated depreciation is allowed for particular types of fixed assets due to advancement of technology. Reduction allowance may be allowed for revenue earned from products manufactured with comprehensive resources pursuant to the State industry policies. Investment tax credit is allowed on qualifying expenditures on plant and machinery for environmental protection, energy and water conservation, and production safety. | The tax incentive policy is shifting from "Geography-based" tax incentives to "Pre-dominantly Industry-oriented, Limited Geography-based" tax incentive policy. The new tax incentive policy is focused on high/new technology which is critical to China's future success. "Production FIEs" and "Export-oriented FIEs" in general industries may enjoy only limited incentives via qualifying R&D activities and capital investments, etc The scope of basic infrastructure projects eligible for tax preference is subject to further stipulation and adjustments by the State Council from time to time in line of the economic development goals. No details yet as to what are the incentives, and how to apply the new tax incentives, e.g. criteria, standards, proportion, or periods. Does not appear that the reinvestment tax refund benefit for FEs would survive. |
Grandfathering of previous preferential tax treatments | Unused tax holiday of FIEs approved to be established before CIT Law is grandfathered till the expiry. Where the tax holiday has not yet started because of tax losses, it shall be deemed to commence from the first effective year of Unified CIT Law. New FIEs which engage in high/new-tech industries encouraged by the State and located in SEZs and Pudong may enjoy transitional preferential treatments (to be defined). Enterprises in encouraged industries located in Western regions would continue to enjoy the existing tax incentives. | The forced start date of the holiday in 2008 appears to aim at bringing the transition period to a close as quickly as possible. It also deters FIEs from using various tactics to postpone profit-making year in order to leave the low rate to future years. It is unclear what transitional preferential treatments would be granted to new FIEs in high/new-tech industries located in SEZs and Pudong. |
Tax Deductions | Most rules similar to current law for FIEs. Charitable donation is limited with a cap. Non-deductible expenses have been expanded to include sponsorship expenses, and unverified provisions and reserves. | DEs will face less limitation in deducting expenses when compared to before. But FIEs will be subject to new deduction limitations, e.g. sponsorship fees. Definition of sponsorship fees is not available yet. CIT Law does not mention deduction caps for entertainment expenses which may be addressed in the Implementation Rules. |
Anti-avoidance Rules | Cost sharing is allowed in respect of intangible assets developed and shared among related parties, and for the provision and receiving of common services, as long as the sharing basis is on arm's length. More stringent requirements on filing and submission of related party information for TP enforcement. "Controlled Foreign Corporation Rules" ("CFC Rules") such that undistributed profits derived by CFCs located in low-tax jurisdictions may be taxed in China as a deemed distribution. "Thin-capitalisation Rule" such that excessive interest expense may be disallowed. General anti-avoidance provision for making adjustments to taxable revenue or taxable income where business transactions are regarded as arranged without reasonable commercial purpose. Tax adjustments made under the Anti-avoidance Chapter may be subject to interest levy. | China may not have much experience in implementing cost sharing arrangements ("CSA"). So it remains to be seen as to the practical aspect of this rule. Actual experience suggests that extra care and significant effort is required to negotiate, substantiate and sustain the tax positions of CSAs. Annual TP Documentation Requirements are expected to be introduced to echo to various TP provisions in the Law. CFC rules are introduced for the first time to tackle anti-avoidance arrangements of DEs as they invest and operate overseas. All the anti-avoidance provisions under this new Chapter are commonly seen internationally. Hopefully the forthcoming implementation rules will clearly establish the definitions of anti-avoidance activities and situations. Otherwise there could be disputes between taxpayers and tax authorities in practice over this matter. "Interest levy" on anti-avoidance adjustment will serve as "teeth" in the law. |
Tax Consolidated Filing for Groups of companies | Not allowed unless approved by State Council. | Tax consolidated filing is currently allowed for some domestic state-owned conglomerates under special approval of the State Council. It is uncertain whether FIE groups in the future may apply for consolidated tax filing in light of the "National Treatment" principle. |
Tax Filing Administration | Filing of annual tax return period is extended to 5 months (from 4 months now) after year end. Provisional reporting and payments may be made on monthly basis or quarterly basis. | Not clear who may be subject to monthly provisional filings. FIEs clearly prefer to continue quarterly reporting. |
