China Introduces New Corporate Income Tax Law

By: SBA Stone Forest Corporate Advisory (Shanghai) Co., Ltd.
The 10th National People's Congress passed the new Corporate Income Tax Law ('New Law') on 16 March 2007. The New Law provides a single income tax regime for both domestic and foreign investment enterprises ('FIEs'). The New Law will take effect on 1 January 2008. The following summarises the key aspects of the New Law and its impact on foreign investors.
  • New CIT Rate
    The new standard corporate income tax ('CIT') rate is 25%. The reduced CIT rate of 20% would apply to small-scale and thin-profit enterprises and the preferential CIT rate of 15% is only available to high / new technology enterprises which require support from the State.
  • Taxpayers
    The New Law introduces the concepts of 'tax resident enterprise' and 'non-tax resident enterprise' to differentiate taxpayers:
Taxpayers Definition Taxable Income
Resident
Enterprise
  • Established in China under PRC laws
  • Established under foreign laws but has its place of effective management in China
Worldwide income
Non-resident
Enterprise
  • Established under foreign laws, and has its place of effective management outside China
China-sourced
income

Foreign enterprises established outside China without a 'substantive presence' in China will need to determine whether their place of effective management is based in China.

CIT Preferential Policies

The New Law grants tax preferential treatment on an industry basis rather than on a location basis. The main tax preferential polices in the New Law include:

  • 'Encouraged' high-tech enterprises are eligible for a reduced 15% CIT regardless of location in China;
  • CIT exemption / reduction remains for specific technology transfer and investments in infrastructure, agriculture, forestry, animal husbandry and fishery industries;
  • 'Super deduction' is allowed for R&D expenses and salary expenses for employment of handicapped workers;
  • CIT credit is granted to specific venture capital enterprises and investments in environmental protection, energy, water conservation and specific safety equipment.

Some CIT preferential policies currently available exclusively to FIEs will be revoked, including:

  • Five-year tax holiday for manufacturing FIEs;
  • Extension of tax holiday to export-oriented FIEs;
  • Reduced 15% / 24% CIT rate applicable to FIEs in special zones;
  • CIT refund on reinvestment;
  • 50% CIT reduction for additional three years after the tax holiday for FIEs qualified as 'technologically-advanced enterprises';
  • CIT exemption for after-tax profit repatriation by foreign investors.
  • Transition Period
    The New Law allows for a five-year transition period. The transition arrangement is as follows:
    • FIEs enjoying a 15% or 24% tax rate would be eligible for a 5-year transition period to move up to 25% tax rate. The New Law does not provide the details for the transition, but FIEs are expected to increase their 15% tax rate by 2% per year over the five-year transition period to reach 25%;
    • Manufacturing FIEs which have not fully utilised the five-year tax holiday before the effective date of the new tax law will continue to enjoy the remaining holidays, e.g.


      • Y2007: First profit-making year and first CIT exemption year
      • Y2008: Second CIT exemption year
      • Y2009: First 50% CIT reduction year (with applicable new CIT rate
        applied)
      • Y2010: Second 50% CIT reduction year
      • Y2011: Third 50% CIT reduction year
      • Y2012: The full CIT rate will apply

  • Manufacturing FIEs which have not started their tax holidays under the old law will have their tax holidays starting from the effective date of the New Law, e.g.
Year
Tax Situation under Old Law
Tax Situation under New Law
2007
No CIT liabilities due to accumulative lossN/A
2008
No CIT liabilities due to accumulative lossThe first CIT exemption year even if it is still in loss
2009
First profit-making year and first CIT exemption yearFirst profit-making year and second CIT exemption year
2010
Second CIT exemption year
First 50% CIT reduction year with the applicable new CIT rate
2011
First 50% CIT reduction yearSecond 50% CIT reduction year
2012
Second 50% CIT reduction yearThird 50% CIT reduction year
2013
Third 50% CIT reduction yearThe full CIT rate will apply
  • Withholding Tax Rate
    The New Law provides a flat 20% tax rate for dividends, interest, royalties, rentals, capital gains or other income derived by non-resident enterprises from sources in China. However, it is still uncertain whether:
    • Withholding tax on dividend remittance would continue to be exempted; and
    • Withholding tax on other income, e.g. interests, royalty and capital gain, would continue to be reduced to 10%
It has been speculated that the current withholding tax exemption on dividends may be revoked and be taxed at 10%. The implementation rules may give the answer.
  • Anti-tax-avoidance Measures

    Anti-tax-avoidance measures are tightened under the New Law as follows:

    • An enterprise must report the details of related enterprise transactions together with its annual tax return filing;
    • An enterprise under tax audit with respect to transfer pricing must provide relevant documents as required, whether from the enterprise or its related parties. Otherwise, the tax authority has the right to determine the enterprise's taxable income;
    • The advance pricing agreement can be negotiated with the tax authority. The enterprise will need to provide its pricing principles and computation methods in its business transactions with related enterprises.
    • The tax authority is empowered to make tax adjustments and impose interest surcharges if a transaction between an enterprise and its related enterprise does not comply with the arm's length principle;
    • Where the enterprise defers China tax on offshore profits parked in tax havens for non-operation purpose, the profits will be deemed to be attributed to the China resident enterprise even if profits have not been distributed or insufficient profits are allocated to the China resident enterprise;
    • The ratio of loans to capital (both received from the enterprise's related parties) should be capped within a specific rate. Excess interest expense shall not be deductible.
    The anti-tax-avoidance provisions above are very broad and general terms. More details are expected in the impending implementation rules.

  • Impact on Foreign Investors

    As the detailed implementation rules have not been released by the State Council, many points remain to be clarified. However, the New Law has provided the general principles which may change future investment strategies for foreign investors in China. Foreign investors are advised to re-examine their tax planning schemes to optimise tax preferential policies available under the old law prior to the effective date of the New Law to ensure their eligibility for tax benefits under the New Law.

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