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Print articleChina: New Enterprise Income Tax Law
July, 2007 -
On 16 March 2007, the Standing Committee of the National People’s Congress promulgated the Enterprise Income Tax Law of the People’s Republic of China. The Law harmonises the tax laws applicable to foreign and domestic enterprises. The new law marks a major change in PRC tax policy. Effective 1 January 2008, both domestic enterprises and foreign-invested enterprises (FIEs) will be subject to income tax at the unified rate of 25%.
The Law repeals both the Income Tax Law of the People’s Republic of China for Foreign Investment Enterprises and Foreign Enterprises and the Provisional Regulations of the People’s Republic of China on Enterprise Income Tax. Implementing rules for the Law are to be drafted by the State Council before 2008.
Tax residency
While previous income tax laws distinguished between domestic enterprises and FIEs and foreign enterprises, the new Law introduces a distinction between “resident enterprises” and “non-resident enterprises”. Residency under the Law is largely determined by the “place of management” of an enterprise. This is a major change. Previously residency was determined by the place of registration. Resident enterprises are now defined as those registered or effectively managed in the PRC. Non-resident enterprises are defined as those registered and effectively managed outside the PRC but with PRC establishments or PRC-sourced income.
Resident enterprises are taxed on income originating inside and outside of the PRC. Resident enterprises can use foreign income tax paid on earnings from investments outside the PRC as tax credits. Non resident enterprises have limited tax obligations and generally only owe tax on income derived from China or connected to its establishment in the PRC.
Tax rate
The previous income tax rate of 33% has been lowered to 25%. An official Summary of the Enterprise Income Tax Law (Summary) released a week before the Enterprise Income Tax Law explains that this rate was chosen to be competitive with the average international tax rate (28.6%) and the average rates of the countries immediately surrounding the PRC (26.7%).
Qualified high-tech enterprises and small businesses with low profit margins are eligible to enjoy preferential income tax rates of 15% and 20%, respectively. Hightech enterprises no longer need to be located in a High-tech Industrial Development Zone to enjoy the preferential tax rate.
Grandfathering of preferential policies
Though many of the preferential policies which enabled both foreign and domestic enterprises to enjoy lower tax rates are being rescinded, some enterprises will be able to continue to enjoy their current tax rate concessions while transitioning into the new policy.
Enterprises that have received their business licenses prior to 16 March 2007 will be subject to a gradual increase in their tax rate from 15 to 25% over the five years following the implementation of the Law. Enterprises that were not approved prior to 16 March 2007 will immediately be subject to the new tax system in 2008. Enterprises established in special areas set up for foreign economic cooperation and technical exchange and newly founded high-tech enterprises established in the aforementioned areas will also enjoy a transitional rate. The Law does not state how these rates will be increased; this is likely to appear in the forthcoming implementing rules.
Enterprises currently enjoying tax holidays may continue to enjoy the concession. If an enterprise enjoys a tax holiday that has not yet commenced, its tax holiday will be deemed to commence when the Law goes into effect on 1 January 2008.
Enterprises in certain encouraged sectors may be able to continue to enjoy preferential tax policies. The Summary notes that this refers to encouraged sectors in the Western region of the country, though this is not specified in the Law.
Incentives
The PRC is moving away from location-based tax incentives and most of them have been rescinded. Incentives in the new Law are predominately intended to encourage the development of new technologies and furthering investment in certain industries.
As mentioned above, enterprises in certain encouraged industry sectors will continue to enjoy preferential tax policies and high-tech enterprises
will be eligible for a lower tax rate. The Law further states that venture capital enterprises investing in certain encouraged investment sectors will be eligible for certain tax deductions.
Proceeds from technology transfers, investments in environmental protection, energy and water conservation and safe production, amongst other sectors, may be subject to income tax reductions or exemptions. Investments in agriculture, forestry, animal husbandry and fishing projects, and the construction of infrastructure are also eligible for income tax reductions or exemptions.
Deductible items
Permissible deductions have been harmonised for both FIEs and domestic enterprises. Many of the tax deductions available to FIEs have been retained from previous income tax laws, although they are now generally subject to reasonableness limitations. Enterprises are still allowed to deduct charitable donations, though subject to a cap of 12%. Sponsorship fees and unverified provisions and reserves, both to be further defined by the implementing rules, are no longer deductible. In line with the push for the development of industry, the Law allows enterprises to deduct R&D incurred in the development of new technology, merchandise and methodologies. Enterprises may also deduct the wages of the disabled and other types of workers whose hiring is encouraged by the State.
Withholding tax
Non-resident enterprises without establishments in the PRC or whose earnings do not have any connection with their establishments in the PRC will be subject to a 20% withholding tax on all such income. The tax will be withheld at the source, and the payer will serve as the withholding agent.
Previous income tax laws allowed tax reductions or exemptions on dividends, royalties, interest earned on loans to the State and the development of technologies and certain industries. While the Law states that taxes may be reduced or exempted in certain circumstances for non-resident enterprises subject to withholding tax, it does not define the specific situations.
Anti-avoidance
The Law introduces several measures to combat the avoidance of taxes:
• If the tax authority believes that the reported result of a business transaction is irrationally low, it has the power to adjust the total taxable income.
• Undistributed profits from a foreign company in a jurisdiction with lower income taxes that is controlled by a resident enterprise (controlled foreign enterprises) must be included in the enterprise’s total taxable income.
• An enterprise must provide information on business transactions between it and its affiliates, as well as more in-depth information on the affiliates.
• On any adjustment resulting from anti-avoidance investigation, the tax authority has the power to add interest to the increased taxable income total.
The Law repeals both the Income Tax Law of the People’s Republic of China for Foreign Investment Enterprises and Foreign Enterprises and the Provisional Regulations of the People’s Republic of China on Enterprise Income Tax. Implementing rules for the Law are to be drafted by the State Council before 2008.
Tax residency
While previous income tax laws distinguished between domestic enterprises and FIEs and foreign enterprises, the new Law introduces a distinction between “resident enterprises” and “non-resident enterprises”. Residency under the Law is largely determined by the “place of management” of an enterprise. This is a major change. Previously residency was determined by the place of registration. Resident enterprises are now defined as those registered or effectively managed in the PRC. Non-resident enterprises are defined as those registered and effectively managed outside the PRC but with PRC establishments or PRC-sourced income.
Resident enterprises are taxed on income originating inside and outside of the PRC. Resident enterprises can use foreign income tax paid on earnings from investments outside the PRC as tax credits. Non resident enterprises have limited tax obligations and generally only owe tax on income derived from China or connected to its establishment in the PRC.
Tax rate
The previous income tax rate of 33% has been lowered to 25%. An official Summary of the Enterprise Income Tax Law (Summary) released a week before the Enterprise Income Tax Law explains that this rate was chosen to be competitive with the average international tax rate (28.6%) and the average rates of the countries immediately surrounding the PRC (26.7%).
Qualified high-tech enterprises and small businesses with low profit margins are eligible to enjoy preferential income tax rates of 15% and 20%, respectively. Hightech enterprises no longer need to be located in a High-tech Industrial Development Zone to enjoy the preferential tax rate.
Grandfathering of preferential policies
Though many of the preferential policies which enabled both foreign and domestic enterprises to enjoy lower tax rates are being rescinded, some enterprises will be able to continue to enjoy their current tax rate concessions while transitioning into the new policy.
Enterprises that have received their business licenses prior to 16 March 2007 will be subject to a gradual increase in their tax rate from 15 to 25% over the five years following the implementation of the Law. Enterprises that were not approved prior to 16 March 2007 will immediately be subject to the new tax system in 2008. Enterprises established in special areas set up for foreign economic cooperation and technical exchange and newly founded high-tech enterprises established in the aforementioned areas will also enjoy a transitional rate. The Law does not state how these rates will be increased; this is likely to appear in the forthcoming implementing rules.
Enterprises currently enjoying tax holidays may continue to enjoy the concession. If an enterprise enjoys a tax holiday that has not yet commenced, its tax holiday will be deemed to commence when the Law goes into effect on 1 January 2008.
Enterprises in certain encouraged sectors may be able to continue to enjoy preferential tax policies. The Summary notes that this refers to encouraged sectors in the Western region of the country, though this is not specified in the Law.
Incentives
The PRC is moving away from location-based tax incentives and most of them have been rescinded. Incentives in the new Law are predominately intended to encourage the development of new technologies and furthering investment in certain industries.
As mentioned above, enterprises in certain encouraged industry sectors will continue to enjoy preferential tax policies and high-tech enterprises
will be eligible for a lower tax rate. The Law further states that venture capital enterprises investing in certain encouraged investment sectors will be eligible for certain tax deductions.
Proceeds from technology transfers, investments in environmental protection, energy and water conservation and safe production, amongst other sectors, may be subject to income tax reductions or exemptions. Investments in agriculture, forestry, animal husbandry and fishing projects, and the construction of infrastructure are also eligible for income tax reductions or exemptions.
Deductible items
Permissible deductions have been harmonised for both FIEs and domestic enterprises. Many of the tax deductions available to FIEs have been retained from previous income tax laws, although they are now generally subject to reasonableness limitations. Enterprises are still allowed to deduct charitable donations, though subject to a cap of 12%. Sponsorship fees and unverified provisions and reserves, both to be further defined by the implementing rules, are no longer deductible. In line with the push for the development of industry, the Law allows enterprises to deduct R&D incurred in the development of new technology, merchandise and methodologies. Enterprises may also deduct the wages of the disabled and other types of workers whose hiring is encouraged by the State.
Withholding tax
Non-resident enterprises without establishments in the PRC or whose earnings do not have any connection with their establishments in the PRC will be subject to a 20% withholding tax on all such income. The tax will be withheld at the source, and the payer will serve as the withholding agent.
Previous income tax laws allowed tax reductions or exemptions on dividends, royalties, interest earned on loans to the State and the development of technologies and certain industries. While the Law states that taxes may be reduced or exempted in certain circumstances for non-resident enterprises subject to withholding tax, it does not define the specific situations.
Anti-avoidance
The Law introduces several measures to combat the avoidance of taxes:
• If the tax authority believes that the reported result of a business transaction is irrationally low, it has the power to adjust the total taxable income.
• Undistributed profits from a foreign company in a jurisdiction with lower income taxes that is controlled by a resident enterprise (controlled foreign enterprises) must be included in the enterprise’s total taxable income.
• An enterprise must provide information on business transactions between it and its affiliates, as well as more in-depth information on the affiliates.
• On any adjustment resulting from anti-avoidance investigation, the tax authority has the power to add interest to the increased taxable income total.
