CTax L1 - 9

AF4222 China Tax Framework Lecture No.
1 Overview of China Tax System
September 2011
AF4222_L1 Overview of China Tax System
Legal and Administrative Framework of China Tax

Tax reform background Tax collection Sources of law Types of law Interpretation of law Tax policy and administration Current PRC tax regime Overview of taxes
AF4222_L1 Overview of China Tax System 2
September 2011
Tax reform background

Current tax system developed since 1980s, levy tax on both domestic individuals/enterprises and foreign enterprises/individuals Unification of income tax for both domestic and foreign-invested enterprises with effect from 1/1/2008
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Tax collection (data from SAT [www.chinatax.gov.cn])

items total VAT CT CT&VAT on imports BT EIT FEIT IIT VAT refund
September 2011
2005 ($M) 3,086,583.17 1,069,828.57 163,431.36 422,005.23
2006 ($M) 3,763,627.43 1,289,460.33 188,566.94 496,710.62
2007 ($M) 4,944,928.79 1,560,991.01 220,681.90 651,328.24
423,142.48 436,313.29 114,769.32 209,391.36 (337,157.35)
512,888.97 554,587.81 153,481.61 245,232.44 (428,488.54)
658,297.25 772,373.49 195,120.10 318,498.01 (527,328.68)

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Tax collection (data from SAT)

items total VAT CT CT&VAT on imports BT EIT
2007 ($M) % of tax collection 4,944,928.79 1,560,991.01 220,681.90 651,328.24 658,297.25 772,373.49
100% 31.56% 4.46% 13.17% 12.90% 13.31%
FEIT
IIT VAT refund
September 2011
195,120.10
318,498.01 (527,328.68)
3.95%
6.44% (10.66%)
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Tax collection (data from MOF [www.mof.gov.cn])

items total VAT CT CT&VAT on imports BT CIT
2008 ($100M) % of tax collection 54219.62 12140.21 2558.59 7391.07 7626.33 11173.05
100% (+9.6%) 22.4% (-9.2%) 4.7% (15.9%) 13.6 (+13.5%) 14.1 (+15.8%) 20.6% (+15.5%)
IIT
3722.19
6.9% (+16.9%)
September 2011
items
Tax collection (data from 1st Half of 2009 ($100M) MOF [www.mof.gov.cn])
Growth rate (Corresponding period) -6.0% -3.0% +63.1%*
(*including fuel tax reforms)
total VAT CT
29530.07 9201.6 2196.43
CT&VAT on imports BT CIT
3373.67 4309.2 6820.44
-14.9% +6.4% -13.8%
IIT
September 2011
2152.02
+0.7%
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Tax collection (data from SAT and MOF)

Tax Revenue 2006: RMB 3763.627 billion (GDP: USD 2,645 billion) 1st half of 2007: RMB 2494.731 billion 2007: RMB 4944.273 billion (GDP: USD 3,242 billion) - Increase by RMB 1180.60 billion, or 31.4% (22.5%) - 2007: Tax / GDP: 4944.273/3242@6.85, or 22.26% st half of 2008: RMB 3255.3 billion 1 - Increase by RMB 760.6 billion, or 30.5% 2008: RMB 5421.962 billion - Tax revenue (January November 2008): RMB 5200.075 billion (up 20.2% of the corresponding period of 2007, but the growth rate was down by 14.4%) st half): RMB2953.007 billion 2009 (1 - Decrease by RMB302.3 billion, or 9.3% 2009: RMB6310 billion (up 9.1%) 2010 (1st half): RMB3860 billion 2010 (1st 3 quarters): RMB5595.737 billion (IIT: 6.89%, EIT: 20.22%, and TT: 52.6%) 2010 (as announced by SAT on 9 January 2011): RMB7739 billion 1st half of 2011: RMB5002.8 billion (+29.6%) (GDP + 9.6%)
September 2011
Tax Reforms
2008 onwards Implementation of new Corporate Income Tax Law (transitional arrangements, removal of tax incentives, and anti-avoidance provisions) Increase of the monthly deduction to RMB 2,000 in IIT and RMB3,500 in IIT on 1 September 2011 Reduction of IIT in bank deposit interest Reform of VAT (extending the input credits on fixed assets with effect from 1 January 2009) Reform of BT (redefining the locality of provision of services) Introduction of Fuel Tax with CT Reform of Resource Tax (from quantity to price) Introduction of a new Property Tax (January 2011) Introduction of a new Carbon Tax
September 2011
Major Development Trends

Possible major development trends in 2011 and in the 12th Five-Year Plan A fiscal and tax system adapted to economic development transformation Individual Income Tax stay tune for development of rate, income groups etc Value-added Tax and Business Tax merge with VAT? Real Property Tax curb down the overheated real property market Tax audit targets and focuses large and specific industries Taxation on China-based multinational corporations and Large Enterprises Taxation on non-residents scope of activities e.g. R.O., PE Transfer pricing management good quality documentation Tax risk management commercial reality on proposed transactions Anti-avoidance provisions e.g. General anti-avoidance rules (more cases) Mergers and acquisitions (tax free arrangement) Others
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Current PRC Tax Regime

Turnover Tax * Value-added Tax (VAT) (1/2009) Consumption Tax (CT) (1/2009) Business Tax (BT) (1/2009) ) indicates the effective date of the related Provisional Regulations * Provisional Regulations on VAT, BT and CT (1/1994) were all recently revised on 1 January 2009. I. 1. 2. 3. (
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II. Income Tax 4. *Enterprise Income Tax (EIT)* (1/1994) 5. Income tax for Foreign Investment Enterprise and Foreign Enterprise (FEIT)* (FEITL 7/1991) * Have been unified as a new Corporate Income Tax wef 1 January 2008 6. Individual Income Tax (IIT) (IITL 1/1994, 8/1999, 7/2011 etc revised) September 2011 AF4222_L1 Overview of China Tax 12
System
Current PRC Tax Regime (Contd)

III. Wealth/Property Tax and Other Behaviour Taxes
7. Urban Real Estate Tax (10/1986) 8. Urban Land and House Tax (8/1951) (abolished on 1 January 2009) 9. *#Vehicle and Vessel Use Tax (10/1986) 10. #Vehicle and Vessel License Tax (9/1951)
(#According to Decree No. 482, wef 1 January 2007, these two taxes are consolidated in regulations as Vehicle and Vessel Tax and are applicable to owners or managers of vehicles and vessels rather than enterprises and individuals that own and use vehicles and vessels.
11. Stamp Duty (10/1988) 12. Slaughtering Tax (12/1950) 13. Deed Tax (10/1997)

IV. Special-purpose Tax 14. Land Value Appreciation Tax (1/1994) 15. Banquet Tax (9/1988) 16. *City and Rural Area Maintenance and Construction Tax (1/1985) 17. Capital Investment Regulatory Tax (already abolished) (1/1991) 18. Vehicle Purchase Tax (1/2000) 19. Farmland Use Tax (4/1987)
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V. Resource Tax
20. Resource Tax (1/1994) 21. Urban and Township Land Use Tax (1/1988) (Note: From 1 January 2007, Decree No. 483 expands the scope of this tax to FIEs and FEs, and it increases the tax rate per square metre to three times the current rate.)
VI. Agricultural Tax

22. Agricultural Tax (6/1958, abolished w.e.f. 1 Jan 2006) 23. Animal Husbandry Tax (local authority rules)
VII. Custom Duties

24. Tariff on Imports and Exports (3/1992 revised)
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Taxes NOT Applicable to FIEs or FEs*

* City and Rural Area Maintenance and Construction Tax * Vehicle and Vessel Use Tax *(Domestic) Enterprise Income Tax ()
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Overview of taxes
Individual income tax Foreign enterprise income tax* Enterprise income tax* (* To be unified on 1 January 2008. New CIT (corporate income tax) law promulgated on 16 March 2007 and DIR (Detailed Implementing Rules) approved by SC on 6 December 2007) Turnover tax Value-added tax Consumption tax Business tax Property and behaviour taxes
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Individual income tax (1.1.1994 Present)

Chinese nationals and foreign individuals reside/are domiciled in China and derived China-sourced income (11 categories: employment income, business income, etc)
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Summarized Position of Expatriates IIT Liability on Wages and Salaries Income

Length of
Services rendered in China Services rendered outside China
residency
Income paid/borne by establishme nt in China Taxable(2) Taxable(1)
Income paid by overseas entity & not borne by establishmen t in China Non-taxable Taxable(1)
Income paid Income paid by by overseas establishment entity in China
< 90/183 days 90/183 days<x<1 year 1<x<5year >5 years

September 2011
Non-taxable Non-taxable
DIDO Circular 148
Non-taxable Non-taxable
DIDO Circular 148
Taxable(3) Taxable
Taxable(3) Taxable
Taxable(3) Taxable
Non-taxable
DIDO, Cir. 125
Taxable
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Allowable Deduction for Wages and Salaries

Monthly standard deduction local employee RMB800* [1,600]** [2,000]# [3,500]@ expatriate RMB4,000 [4,800]** [4,800]#[4,800]@ * Some cities allow a higher deduction for local employees e.g. additional deduction allowance of RMB1,700 and RMB1,260 in Shenzhen and Guangzhou respectively. ** On 23 August 2005, the draft amendment which included lifting the tax collection starting line from RMB800 to RMB1,500 (subsequently amended to RMB1,600) and forcibly asking high-income groups to file tax returns and pay taxes themselves was submitted to the Standing Committee of the NPC for deliberation. The new amendments have been implemented on 1 January 2006 as it was then approved in October 2005. ** Non-domiciles are allowed an additional deduction of RMB3,200. Hence, the new level of personal expense deduction for non-domiciles is raised to RMB4,800. # On 29 December 2007 (Saturday), in the 31st session of the 10th NPC Standing Committee approved to raise the IIT threshold from RMB1,600 a month to RMB2,000 and the amendment will go into effect on 1 March 2008. Correspondingly, RMB5,200 (namely 2,000 + 3,200) should apply to non-domiciles, but eventually only 4,800 remained unchanged. @ On 19 July 2011, the State Council revised the Implementing Rules to IIT Law to change the monthly deduction for local employees to RMB3,500 and expatriates will have the same RMB4,800. This will be effective from 1 September 2011.
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Allowable Deduction for Wages and Salaries (contd)

Statutory contributions to basic pension insurance premium, medical insurance premium, unemployment insurance premium and housing reserve fund* by both employers and employees are deductible against taxable income (with effect from 1 January 2006) * According to Caishui [2006] No. 10 (27 June 2006), contribution to the housing fund by both employer and employee are non-taxable and deductible respectively. The condition is that the contributions do not exceed 12% of the individuals monthly average salary for the previous year. Monthly average salary cannot exceed three times the monthly average wage prevailing in the local city (e.g. Shanghai, RMB2,235) Donation to educational and other welfare undertakings up to 30% of taxable income
Applicable Tax Rates and Quick Deduction (1 January 1994 31 August 2011)
Taxable Income (RMB) 0 - 500 501 - 2,000 2,001 - 5,000 5,001 - 20,000 20,001 - 40,000 40,001 - 60,000 60,001 - 80,000 80,001 - 100,000 Above - 100,000
September 2011
Tax Rate 5% 10% 15% 20% 25% 30% 35% 40% 45%
Quick Deduction
0 25 125 375 1,375 3,375 6,375 10,375 15,375
Grossed-up Taxable Income (RMB) 0 - 475 476 - 1,825 1,826 - 4,375 4,376 - 16,375 16,376 - 31,375 31,376 - 45,375 45,376 - 58,375 58,376 - 70,375 Above - 70,375 Tax-borne case 22
Applicable Tax Rates and Quick Deduction (With effect from 1 September 2011) (As per State Councils approval on 19 July 2011)
Taxable Income (RMB) 0 - 1,500 1,501 - 4,500 4,501 - 9,000 9,001 - 35,000 35,001 - 55,000 55,001 - 80,000 Above - 80,000
Tax Rate 3% 10% 20% 25% 30% 35% 45%

The revised IIT Law reflects a policy of mitigating the tax burden of low and middle income individuals. To a certain extent, it shifts the tax burden to high income individuals.
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Foreign enterprise income tax (1.7.1991 31.12.2007)

Foreign Investment Enterprise (FIE), world-wide sourced basis FIEs include Chinese foreign equity joint ventures (EJVs), cooperative joint ventures (CJVs), wholly foreign owned enterprises (WFOEs) FIEs are resident companies in China Foreign Enterprise (FE) with establishment in China, China-sourced income connected to PE taxable FEs are non-resident companies in China FEs w/o establishment but have China-sourced income (subject to withholding tax)
Enterprise income tax (1.1.1994 31.12.2007)

Domestic Enterprise (DE), world-wide sourced basis - DEs include state-owned, collectively owned, private enterprises - DEs are resident companies in China
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Turnover taxes (1.1.1994 Present)

Value-added tax (VAT) sale of goods, provision of processing services, repairs and replacement services within China, importation of goods into China generally at 17% Business tax (BT) provision of taxable services (either the provider or recipient of services located in China), transfer of intangible assets and sale of immovable property within China generally at 5% Consumption tax (CT) manufacturing, commission processing or importation of specified non essential or luxury goods within China generally at 20%-40%
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Property and behaviour taxes

Stamp duty documents for transfer of property, accounts, business books Deed tax assignment/transfer of land use right @ 3-5% on value of property, within China Land Value Appreciation Tax gain realized on assignment of land use right, buildings, and associated structures within China Urban real estate tax charged on owners on the appraised standard value of the land and buildings Resource tax extraction of certain mineral products
Tax liability of individuals

Individual Income Tax Law (IITL), Individual Income Tax Implementing Rules (IITIR), tax circulars Foreign individuals, PRC nationals and local entrepreneurs Tax liability Tax rates
Wages and salaries 3-45% seven tax brackets Business income 5%-35% five tax brackets Standard rate 20% for other income
Register with tax authorities as soon as liable Withholding basis primarily Future reform unification of all categories of income
Foreign enterprise income tax (1.7.1991 31.12.2007)
Foreign Enterprise Income Tax Law (FEITL)*, Foreign Enterprise Income Tax Implementing Rules (FEITIR)*, circulars, notices FIE or FE with establishment in China (Worldwide income v. China sourced income), FE without establishment in China be taxed on withholding basis on China sourced income Taxable income: income from production, business operation and other sources Deduction: expenses incurred for generating taxable income Tax rates: 30% (national) + 3% (local), tax benefits, such as special economic zones Tax registration with local tax authorities w/in 30 days after issue of business licence Provisional Tax filing and payment on quarterly basis, final tax filing w/in 4 months after year end and payment w/in 5 months after year end, late payment surcharge Tax authorities can investigate tax evasion/avoidance, and impose penalty Reform on unification of income tax between foreign-invested enterprise and domestic enterprise (wef 1/1/2008) (See Lecture No. 2)
FEITL and FEITIR were effective on 1 July 1991 but repealed on 1 January 2008.
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Enterprise income tax (1.1.1994 31.12.2007)
Provision rules on enterprise income tax (PREIT)* and Provisional rules on enterprise income tax implementing rules (PREITIR)* Income of the following enterprises is taxable
State-owned enterprise Collective-owned enterprise Private enterprise Cooperative enterprise Joint stock enterprise Other organizations
Income from production, business operation and other sources are taxable Expenses incurred for generating taxable income is deductible Tax rate: 30% (national) + 3% (local), not much tax benefits Tax filing and payment same as foreign investment enterprise Reform on unification of income tax between foreign-invested enterprise and domestic enterprise (wef 1/1/2008) (See Lecture No. 2) PREIT and PREITIR were effective on 1 January 1994 but repealed on 1 January 2008.
AF4222_L1 Overview of China Tax System 30
September 2011
Value-added tax
Provisional rules on value-added tax and Provisional rules on value-added tax implementing rules Sale of goods, provision of processing, repairs and replacement services within China or importation of goods into China VAT = output VAT input VAT Monthly tax filing commonly, within 15 days after month end
Consumption tax
Governing rules:
Provisional rules on consumption tax, Provisional rules on consumption tax implementing rules, and Notices of Ministry of Finance and State Administration of Taxation on Adjusting and Perfecting Consumption Tax Policies
Levy on
Manufacture taxable consumer goods in China Commission the processing of taxable consumer goods in China Import taxable consumer goods into China
Tax rates: 14 categories of taxable item, on ad valorem fixed rate or fixed specified amount Tax filing and payment normally on monthly basis within 15 days after month end
Business tax
Governing rules
Provisional rules on business tax Provision rules on business tax implementing rules
Levy on
Provision of taxable labour services (either the provider or recipient of services located in China), transfer of intangible assets or sale of immovable properties within China On gross turnover, certain deduction may be available
Tax rate: 3% to 20% Tax filing and payment commonly on monthly basis within 15 days after months end
Enterprises liable to corporate income tax (applicable to FEITL and new CITL)
Foreign Investment Enterprises (FIEs) Sino-foreign equity joint ventures (EJVs), limited liability company with at least 1 foreign investor holding 25% at least equity interest Profit/loss sharing based on capital contribution Profit distribution in cash only Governed by Law on Sino-foreign Equity Joint Venture Sino-foreign cooperative joint ventures (CJVs) Separate legal entity OR not separate legal entity Profit/loss sharing based on investment agreement Profit distribution can be in kind or in cash Governed by Law on Sino-foreign Cooperative Joint Venture
Enterprises liable to corporate income tax

Foreign Investment Enterprises (FIEs) Wholly foreign owned enterprises (WFOEs) Limited liability company, foreign investors hold the entire equity interest Restricted or prohibited under State Policy or Catalogue Foreign Investment Industrial Guidelines
Chinese holding companies

Foreign investment holding companies Wholly foreign owned or JV
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Foreign Enterprises (FEs) with establishments or permanent establishments (PE) in China, e.g.
Business agents Provision of services through employees or other personnel Representative offices
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Foreign Enterprises (FEs) without establishments or permanent establishments (PE) in China, e.g.
Income from dividends, interest, royalties, rental etc. Withholding tax as applicable under the tax treaty
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Tax implications for FE and FIE

FE
withholding on investment income
net profit
Some special treatments on computing taxable income

NO PE EST/PE (branch, RO, )
Overseas /HK
China
FIE
ALL (EJV,CJV profit )

September 2011
taxable
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Tax Status of Foreign Investment Enterprises (before New CITL on 1 January 2008)
Applicable tax rates
Generally 33%
Standard rate 30% Local surtax 3%
Geographical preferential tax rates

15%
24%
Common Tax Incentives under old FEITL

Tax rate reduction, e.g. geographic preferential tax rates for FIEs and FEs in SEZs, ETDZs etc. Tax holidays, e.g. 2 year exemption and 3 half rate reduction (special incentives for export-oriented enterprises and technology-advanced enterprises) R&D super deductuon Tax refund, e.g. 40% or 100%
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Tax administration
Administrative Law on the Levying and Collection of Taxes , (28 April 2001), effective 1 May 2001 Regulations on Implementation of Administration of Tax Collection (17 September 2002), effective 15 October 2002
Overdue tax surcharge

Tax payment can be deferred, if there are special difficulties (e.g. natural disaster, theft of cash, etc) and approved by tax authorities 0.05% daily on overdue tax payment
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Enforcement of tax payment

Failure to register and pay tax seizure of goods, goods be sold if payment is not made w/in 15days Suspected evasion Order for tax payment before deadline by tax authorities Order of guarantee for tax payment With approval from head of tax bureau at county level, frozen bank account and seizure of goods and commodities Failure to pay tax Withdraw tax amount from the frozen bank account Sell off seized goods
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Priority of tax claims

Tax collection has priority over unsecured credits and even secured debts Creditors should conduct tax due diligence checks before making any credit decision
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Tax Refund and undercharged

Tax refund application be made within 3 yrs, overpaid tax together with interest at prevailing rate be refunded Tax under-charged due to errors of tax authorities, tax may be demanded within 3 yrs and no overdue tax surcharge Tax under-charged due to evasion, tax can be demanded without time limit
Objection process
Tax disputes Tax imposition Settle tax+surcharge Apply for administrative review w/in 60days from receipt of tax
September 2011
Tax administration
Apply for admin. Review w/in 60days Tax Administrative review (Superior Tax Authorities) Legal proceedings AF4222_L1 Overview of China Tax (Peoples Court)
System
Instigate legal proceedings w/in 3 months from date of receiving penalty decision or from implementation of enforcement measure
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Penalties for taxpayers

Late tax payment
0.05% daily surcharge, 50% to 500% of tax unpaid/underpaid as fine, criminal liability for under-payment of tax possible results in imprisonment
Non compliance
Tax authorities order to remedy the situation w/in specified time limit + a fine of RMB10,000 at max
Misuse of tax registration

A fine from RMB2,000 to 50,000
Penalties for withholding agents

Non compliance (keeping books and records)
Order to comply + a fine of RMB5,000, a further fine of RMB10,000 if can not comply with by stipulated time limit
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Penalty for tax evasion under Criminal Law

Evasion
Forgery, revision, concealment or unauthorized destruction of account books or supporting accounting vouchers Overstatement of expenses, omission or understatement of income Refusal to file tax returns following notification from tax authorities or filing fraudulent tax returns

Quantum of penalties
Seriousness of offence Tax evaded above RMB10,000 but below RMB100,000 and % of tax evaded is above 10% but below 30% of total tax payable; or 3rd tax evasion offence Level of penalty A fine ranging from 100% to 500% of amount of tax evaded and imprisonment for 3 years or below (Criminal Law, Art 201)
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Seriousness of offence tax evaded is above RMB100,000 and % of tax evaded is above 30% of total tax payable Level of penalty A fine ranging from 100% to 500% of amount of tax evaded and imprisonment for 3 years to 7 years (Criminal Law, Art 201)
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Seriousness of offence Other tax evasion cases not constitute criminal offence Level of penalty A fine ranging from 50% to 500% of amount of tax evaded
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Penalty for non-payment of tax by concealment of property

Seriousness of offence Tax in arrears above RMB10,000 but below RMB100,000 Level of penalty A fine ranging from 100% to 500% of amount of tax in arrears and imprisonment for 3 years or below (Criminal Law, Art 203)
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Seriousness of offence tax in arrear is above RMB100,000 Level of penalty A fine ranging from 100% to 500% of amount of tax in arrears and imprisonment for 3 years to 7 years (Criminal Law, Art 203)
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Seriousness of offence Other cases not constitute criminal offence Level of penalty A fine ranging from 50% to 500% of amount of tax in arrears
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Refusal to pay tax by violence or menace

In addition to surcharge, and a fine ranging from 100% (starting point for normal late payment of 50%) to 500%, t/p be prosecuted for criminal liability with imprisonment penalty of up to 3 years or from 3 years to 7 years for serious cases.
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AF4222 China Tax Framework
Lecture No. 2 Corporate Income Tax
Outline
I. II. III.
New law for unification of corporate income taxes Detailed implementing rules for the new Corporate Income Tax Law New Corporate Annual Income Tax Return and Related Party Transaction Annual Reporting Forms
AF4222_L2 Corporate Income Tax
September 2011
I.
New law for unification of corporate income taxes
September 2011
Evolution of Chinas Corporate Income Tax Law
Prior to 1 July 1991

Chinas first Income Tax Law for Sino-foreign JVs (10 September 1980) Chinas first Income Tax Law for WFOE (1 January 1982)
Foreign Enterprise Income Tax Law (FEITL) (1 July 1991) (Repealed) Domestic Enterprise Income Tax Law (EIT) (1 January 1994) (Repealed) Chinas CIT Law (16 March 2007) a unification of both FEITL and EIT (wef 1 January 2008)
AF4222_L2 Corporate Income Tax September 2011
Drivers for the Unification
Tax policies driven by different sets of economic and development goals of China
High GDP growth Worlds second largest forex reserve Post WTO Accession and open market access for most services Investors making and repatriating profits Adverse impact from tax reform believed to be within absorbable range
New Corporate Income Tax Law

Promulgated on 16 March 2007 Uniform CIT rate 25%, over 5 years for old businesses and wef 1.1.08 for new businesses PRC resident if either having effective management in PRC or incorporated in PRC New source definition:

PRC resident, world-wide source income taxable Non PRC resident with establishment in PRC, PRC source income and non-PRC source income connected to PRC establishment taxable Non PRC resident without establishment in PRC, Only PRC source income taxable
Residence and Source
Old CIT law (both FEITL and DEITL): incorporated in China, with head office located in China New CIT law enterprise incorporated in China PRC Tax Resident Enterprise incorporated outside Enterprise China but with effective management in China (TREs) Non PRC Tax Resident Enterprise incorporated outside China and with effective (NTREs) Enterprise management outside China
Residence and Source

PRC sourced income Non PRC sourced income Connected w/ PRC EST PRC resident Non PRC resident w/ PRC EST w/o PRC EST Y Y Y (w/h) Y Y N/A NOT connected w/PRC EST Y X N/A
September 2011
Guoshuifa [2009] No. 82 (22 April 2009) Recognition of Chinese-controlled Overseas Incorporated Enterprises as PRC Tax Residents
Circular 82, following the principle of substance-over-form , indicates that an overseas incorporated domestically-controlled enterprise that satisfies all of the following conditions shall be determined to have its place of effective management in the PRC, and accordingly be recognized as a PRC tax resident (namely a TRE):
Senior management are in charge of day-to-day activities and the place for senior management to execute their duties is mainly located in China; Strategic management over finance and personnel decisions are made or approved by an establishment(s) or individual(s) in China; The enterprises major asset, accounting records, corporate seals and minutes of board of directors and shareholders meetings are located or maintained in China; and At least 50 percent of the board members with voting rights or senior management habitually reside in China.
(1)
(2)
(3)
(4)
Guoshuihan [2010] No. 266 (2 June 2010) CIT Withholding on PRC-sourced Interest Income Derived by Overseas Branches Banks in China

The SAT issued Circular 266 on 2 June 2010. It clarifies that the overseas branches of China resident banks would be treated as China tax residents. Thus, interest income of the branches is not entitled to the treaty benefits entered by China and the countries/jurisdictions in which the branches are located; no matter whether the interest income is paid by Chinese residents or establishments in China of residents of other countries. The branches should calculate and report the CIT related to the interest income according to China tax regulations, i.e., Circular Guoshuihan [2008] 955 concerning strengthening CIT withholding on interest income derived by non-resident enterprises.
September 2011
SAT Public Notice [2011] No. 45 (27 July 2011) Administrative Measures for Overseas Registered Chinese-capital Controlled TREs (Trial)
Following Circular 82 (April 2009), the Measures, effective from 1 September 2011, cover the major tax matters concerning Deemed TREs (namely the Chinese-capital controlled foreign companies, or CCCFC) including application procedures of TRE status, documentation requirements, CIT treatments, administration and collection matters and application of double tax treaty provisions. Based on CIT Law, these Deemed TREs shall be entitled to tax exemption on the dividend income derived from another TRE once recognized as Chinese TREs (see following slides).
September 2011
SAT Public Notice [2011] No. 45 (27 July 2011) Administrative Measures for Overseas Registered Chinese-capital Controlled TREs (Trial) (contd)
The scope of Deemed Overseas TREs is the same as that defined in Circular 82 foreign incorporated company (with Chinese-capital control) effective management located in China Chinese tax authority may determine the application for a Chinese TRE status or initiate investigation on a CCCFC to determine whether it should be regarded as a Chinese TRE. Deemed Overseas TREs shall follow the tax filing and compliance requirements in line with those imposed on domestic TREs (including the TP documentation under Guoshuifa [2009] No. 2 see slides later) The status shall be subject to on-going supervision of both tax residency and tax compliance.
Pros Comprehensive guidance for CCCFCs (e.g. Chinese-capital controlled Red Chips) on both China tax implications and compliance status Passive income from domestic TREs (e.g. dividend, interest, rent, royalties and income derived from property transfer) to Deemed Overseas TREs exemption from withholding procedures and obtaining tax certificate from the local in-charge tax authorities for remittance purpose Proper protection to the Deemed Overseas TRE as a Chinese resident for the purpose of applying treaty benefit under the tax treaty between China and other country/region, such as the issuance of TRE certificate and initiation of MAP (mutual agreement procedures)
September 2011
Cons Based on place of residence, income derived from equity transfer in a Deemed Overseas TRE shall be viewed as China-sourced because of the Chinese TRE status of the investee leading to a WHT at 10% on the capital gain (unless the treaty protection is available) Additional burden of tax compliance requirements for the Deemed Oversea TREs close to those for domestic TREs Report CIT on the world wide income tax consequences as a Chinese TRE Claw back of benefits e.g. tax exemption on dividend income if deemed to be a round-tripping structure Report on other transaction taxes (such as BT upon provision of service outside China) Uncertainty of retrospective date e.g. 1 January 2008? Need clarifications.
September 2011
Highlights of New Corporate Income Tax Law

Introduce new tax benefits: encouraged industries, super deductions, investment credits, etc Eliminate most of existing tax benefits and incentives for FIEs (e.g. tax holidays and reduced tax rates) Reinstate withholding taxes on passive income (up to 20%, likely no exemption but may be reduced to 10% - actually reduced to 10%) Tighten transfer pricing governance (e.g. contemporaneous transfer pricing documentation) Introduce new anti-avoidance rules:

Controlled Foreign Corporation rules (e.g. undistributed profit of overseas subsidiaries at significant lower tax rate be taxable in China), Thin-capitalization rules (safe harbour measures - excessive interest expense be disallowed), General anti-avoidance rules (GAAR) (without business substance)
Administrative rules: monthly/quarterly provisional return filing, yearly filing be done within 5 months after year end
Old Tax Preferences that are to be eliminated
Tax holidays and preferential income tax rate for FIE of

Production oriented enterprises Technology and knowledge intensive enterprises Technologically advanced enterprises (i.e. TAEs) Export oriented enterprises (i.e. EEs) Service oriented enterprises in SEZs High-New-Technology Enterprise in Hi-Tech Zones (i.e. HNTEs)
Reinvestment tax refund (e.g. 40% or 100% for EEs and TAEs) Reduced tax rates in SEZ, ETDZ, Pudong New Area, Suzhou Industrial Park, Open Coastal Cities (i.e. 15% or 24%)
September 2011
Direction of New Tax Preferences

From geographically-based to industry/project/product based Encouraged industries/project/products include

High-new-technology enterprises Environmental protection Farming, forestry, animal husbandry and fishery Comprehensive utilization or resources Infrastructure Energy saving, water saving, safety production Venture capital enterprises
Incentives may be a combination of tax holidays, lower tax rates, etc Preferential treatment for projects in autonomous regions
September 2011
New Tax Preferences an overview

Types of enterprises
High-new-technology enterprises Enterprise engaging in farming, forestry, animal husbandry, fishery or infrastructure projects Enterprise engaged in encouraged industries/project approved by State Council Enterprise in autonomous regions
New rules
Reduced tax rate to 15% Tax holidays
CIT preferential treatment
Reduction/exemption of local portion of the CIT
Small scale enterprise with minimal profit
Reduced CIT rate to 20%

September 2011
New Tax Preferences an overview

Types of items R&D expenditures Salary for disabled employees VC investment into certain encouraged industries/projects Depreciation of certain fixed assets Income derived from products manufactured from comprehensive utilization of resources Investment on energy and water saving, environmentally friendly and safety production equipment Taxable income reduction Investment cost tax credit Taxable income reduction accelerated Income Deduction Super deduction Super deduction CIT reduction
September 2011
Grandfather Provisions
Existing enterprises Existing enterprises currently enjoying tax holiday Existing enterprises with lower CIT rate Existing enterprise with higher CIT rate Grandfather treatment Continue to enjoy tax holiday till end of the holiday CIT gradually increased to 25% over 5 years CIT @ 25% wef 1/1/2008
Existing enterprise entitled to, but, Tax holiday deemed to start not yet commence, tax holiday from 1/1/2008 due to loss
Grandfather Provisions (contd)

Existing enterprises New enterprises established before announcement of New CIT Law (on 16/3/2007) Grandfather treatment Same as existing enterprises
New enterprises established No grandfather period, new rule after announcement of New CIT apply wef 1/1/2008 Law
September 2011
Summarized Key Points of the New CIT

Headline tax rate: 33%/24%/15% 25% Tax Holidays (3+3) limited to encouraged infrastructure, environmental protection and energy/water conservation projects Less geography-based incentives 15% only applicable to High / New Tech Enterprises Dividend WHT exemption abolished More tax compliance burden
September 2011
II. Detailed Implementing Rules for the new Corporate Income Tax Law
September 2011
Detailed Implementing Rules for the New CIT

Since 16 March 2007, many versions of draft DIR prepared by MOF and SAT; One version reviewed by relevant State ministries and local governments; and public sounding by limited public DIR approved by State Council on 6 December 2007 Grandfathering treatment and transitional policies clarified various circulars to be issues e.g. Circular No. 39 and No. 40 CIT Law becomes effective on 1 January 2008
Overview of Major Concerns

Topics Concerns
Preferential Will withholding income tax rate to be tax treatments reduced or exempted (for dividend) in the DIR? What are the qualification requirements for High/New Tech Enterprises and Small and Thin-profit Enterprises?
Expense deduction Any cap for deduction of business entertainment expense and advertising expense? Deductibility of management service fee for related parties
Tax residence enterprise (TRE)
What is the definition of place of effective management?
September 2011
Overview of Major Concerns (contd)

Topics Concerns
Anti-tax avoidance provisions
What will be the contemporaneous TP documentation requirements look like? How to apply for cost sharing arrangement? Will the Thin-cap rule affect taxpayers financing model? What is meant by arrangements without reasonable commercial purpose in the General Anti-avoidance Rules (GAAR)
Grandfathering treatment
Definition of Old Enterprises? Scope of existing treatments eligible for grandfathering? Phasing in of preferential tax rate and tax holiday? Any more geographical benefits for 5+1 Areas (i.e., SEZs and Pudong new area) and western region? Will taxpayers current tax attributes be allowed to transit over to 2008 transitional issues?
September 2011
Impact
to Foreign Investment Enterprises
September 2011
Key Preferential Tax Treatments

Forms of Incentives (1) Tax reduction or exemption Industrial sector / activities Dividend between TREs
Detailed treatment and criteria in the DIR
Exempted except for dividend paid by publicly shares of TREs and held for a period of less than 12 months
Agriculture, forestry, animal husbandry and fishery projects

Exempted or half-reduced depending on the specific activities
Income from Exempted for income portion < RMB5M qualified technology Half-reduced for income portion > transfer RMB5M Only applicable to TRE transferors
Key Preferential Tax Treatments (contd)

Forms of Incentives (2) 3+3 tax holiday Industrial sector / activities Income from basic public infrastructure projects (see the Catalogue of
From 1st incomegenerating year Only applicable to profit Public Infrastructure Projects Qualified for CIT Preferential Treatment, Caishui [2008] derived from the No. 116, 8 September 2008) encouraged project Income from Unutilized tax holiday energy and water conservative projects may be inherited by transferee and environmental protection activities

Forms of Incentives (3) Reduced tax rate Industrial sector / activities High/New Tech Enterprises (HNTEs)
Detailed treatment and criteria in the DIR 15% Applicable to the whole companys income Criteria for qualification include: - Ownership of core proprietary intellectual property rights - Products/services fit into specified scope - Ratio of R&D expenditure against total income - Ratio of high/tech income against total income - Ratio of no. of technical staff against total no. of staff Rules for assessment to be released jointly by Ministry of Science and Technology, MOF and SAT later
September 2011

Forms of Incentives Industrial sector / activities Detailed treatment and criteria in the DIR
(3) Reduced tax rate (contd)
Small and Thin-profit Enterprises
20%* Conditions for qualification: - Annual taxable income < or = RMB300,000 - No. of staff: < or = 100 (industrial) or 80 (others) - Total assets: < or = RMB30M (industrial) or RMB10M (others)
* Caishui [2009] No. 133 allows qualified smallscale companies to enjoy a 50% reduction of the 20% in year 2009. On 6 May 2010, the SAT issued Guoshuihan [2010] No. 185 to provide guidance on how these companies should prepare their CIT returns in order to enjoy a 50% reduction as prescribed in Cir. 133 when reporting for provisional CIT for year 2010.
September 2011

(4) Super deduction
R&D expenditure
An Extra 50% deduction of actual
expenses Not clear whether out-sourcing expenses deductible If capitalized in an intangible asset, amortization based on 150% of the actual costs incurred Took effect retrospectively on 1 January 2008 Not applicable to non-resident enterprises
September 2011

(4) Super deduction
R&D expenditure (contd)
Guoshuifa [2008] No. 116, Administrative Measures of R&D Expenses Deduction for CIT Purposes (Trial), 10 December 2008 stipulates the relevant conditions and scope of qualified R&D expenses for additional deduction, and allows R&D expenses to be allocated within group companies.
September 2011

(4) Super deduction
Qualified R&D Expenses Circular 116 lists out 8 categories of expenses incurred directly for the qualified R&D projects eligible for super deduction of R&D expenses: (1) Design fees for new products, expenses for formulating procedures relating to new skills, and expenditures for technical books and information and translation fees directly related to R&D activities. (2) Materials, fuel and power consumed directly for R&D activities. (3) Salaries, wages, bonuses and allowances of employees directly engaged in R&D activities.
September 2011

Qualified R&D Expenses (contd) (4) Depreciation expenses or rentals for apparatus and equipment exclusively used for R&D activities. (5) Amortization expenses of intangible assets such as software, patent rights, non-patented technologies exclusively used for R&D activities. (6) Development and manufacturing costs of equipment and moulds exclusively used for intermediate testing and experiments. (7) On-site testing expenditures for exploration technology. (8) Expenditures for verification, assessment and recognition of R&D results.
(4) Super deduction
September 2011

(4) Super deduction
Conditions for qualified R&D expenses:
R&D activities shall fall within the categories listed in High and New Technology Areas with Key Support by the State and Guidance for Development of Prioritized Key Areas of High Technology Industries (2007 edition). R&D expenses should be incurred for continuous R&D activities with the explicit objective of acquiring new knowledge of science and technology (excluding humanities and social science) a substantial improvement. Accurately classify and record the relevant R&D expenses. Follows Guokefahuo [2008] No. 362 Working Guidance on the Recognition of HNTEs (see later) Carried forward for 5 years Losses caused by the additional deduction of 50% of R&D expenses may be c/f and offset against profit over the following 5 years (see Guoshuihan [2009] No. 98 (27 February 2009)
September 2011

Forms of Incentives Industrial sector / activities Wages paid to handicapped employees
(4) Super deduction (contd) (5) Reduction of taxable income
Extra 100% of actual expenditure
Venture capital investing in unlisted small & medium high/new tech enterprises
70% of investment creditable against its taxable income, with indefinite carry-forward Not clear on definition of small and medium high/new tech enterprises?
September 2011

Forms of Incentives Industrial sector / activities Investment in capital goods that enhance environmental protection, energy and water conservation and production safety (see the
Detailed treatment and criteria in the DIR 10% of investment creditable against tax payable, with 5-year carry-forward and claw-back provision
(6) Investment tax credit
Catalogue of Production Safety Equipment Qualified for CIT Preferential Treatment, Caishui [2008] No. 118, 20 August 2008, the Catalogue of Energy and Water Conservation Equipment Qualified for CIT Preferential Treatment, and the Catalogue of Environmental Protection Equipment Qualified for CIT Preferential Treatment, Caishui [2008] No. 115, 20 August 2008)
September 2011

Forms of Incentives Industrial sector / activities Comprehensive utilization of resources (see the Catalogue for Recycling Business Qualified for CIT Preferential Treatment, Caishui [2008] No. 117, 20 August 2008)
Detailed treatment and criteria in the DIR 10% of qualified income generated could be reduced
(7) Reduction of income
September 2011
Catalogues, Measures and Guidelines on Preferential Tax Treatments

Preferential Tax Policies Basic public infrastructure projects Catalogues and other details Catalogue of Public Infrastructure Projects Qualified for CIT Preferential Treatment, Caishui [2008] No. 116, 8 September 2008 Catalogue of Energy and Water Conservation Equipment Qualified for CIT Preferential Treatment, and the Catalogue of Environmental Protection Equipment Qualified for CIT Preferential Treatment, Caishui [2008] No. 115, 20 August 2008 Guokefahuo [2008] No. 172 (14 April 2008) administrative measures on HNTE recognition and Catalogue of Key HighNew Technological Territories Supported by the State Guokefahuo [2008] No. 362 (8 July 2008) guidelines on HNTE recognition and management
Energy and water conservative projects and environmental protection activities
Hi-New Tech Sectors specially supported by State
Comprehensive utilization of resources
Catalogue for Recycling Business Qualified for CIT Preferential Treatment, Caishui [2008] No. 117, 26 August 2008
Catalogue of Production Safety Equipment Qualified for CIT Preferential Treatment, Caishui [2008] No. 118, 28 August 2008
Investment in capital goods that enhance production safety
September 2011
Grandfathering Treatments under the CITL
Guofa [2007] No. 39 Notice on the Implementation Rules of the Grandfathering Relief under the CIT Law (26 December 2007) by the State Council With effect from 1 January 2008, old enterprises (performed business registration on or before 16 March 2007), the CIT rates will increase to 18%, 20%, 22%, 24% and 25% starting in from 2008 to 2012 respectively if their current reduced rate is 15%. If the current rate is 24%, it will transit to the CIT rate of 25% from 2008. Examples include: - FIEs in SEZs - Manufacturing FIEs in ETDZs - Production FIEs in FTZs etc. Note: Not applicable to HNTEs or non-manufacturing FIEs in Pudong of Shanghai.
September 2011
Grandfathering Treatments under the CITL (contd)
According to Circular 39, tax holidays will be treated as follows:

(a) (b)
Unutilized tax holidays can continue until expiry Tax holidays will be deemed to start from 1 January 2008, even if the company is not yet turning a profit.
Examples include: - 2+3 tax holiday for manufacturing FIEs - 5+5 tax holiday for foreign invested infrastructure projects in some specific locations - Tax holiday for HNTEs - 1+2 tax holiday for service FIEs in SEZs etc.
Example: Unexpired tax holiday to be applied at the phasing-in rates under Circular 39
2007 2008 2009 2010 2011 2012
Tax rate
15%
18%
Exempt
20%
22%
24%
25%
Tax holiday
Exempt
Standard reduced reduced reduced 10% 11% 12% 25%
Final tax 0 rate
September 2011
Grandfathering Treatments under the CITL (contd)
According to Circular 39, the following old incentives which are not eligible for the grandfathering relief: - Extended tax holiday for export-oriented FIEs and advanced technology FIEs - Reduced tax rate and tax holiday for foreign-invested banking institutions - Discretional extended tax reduction for FIEs engaged in agriculture, forestry or animal husbandry, or FIEs located in remote underdeveloped areas Furthermore, no duplicate entitlement in respect of tax incentives in the new CIT Law (i.e. no duplication of benefits is allowed). Unchangeable once a choice is made
September 2011
Caishui [2008] No. 21 (4 February 2008) Half-rate Reduction during the Unutilized Tax Holiday Period under Circular No. 39
2008 2009 2010 2011 2012 and beyond
Tax rate
18%
20%
reduced 10%
22%
reduced 11%
24%
reduced 12%
25%
reduced 12.5%
Half-rate reduction reduced Final net tax rate 9%
September 2011
Caishui [2008] No. 21 (4 February 2008) Half-rate Reduction during the Unutilized Tax Holiday Period under Circular No. 39

The net rates will depend on the year in which the half-rate reduction will apply. For those FIEs subject to 24% or 33% under the old FEIT regime, then the half-rate reduction during the unutilized tax holiday period, if any, should be calculated based on 25%, namely the net rate will be 12.5%.
September 2011
Grandfathering Treatments Geography-based Tax Incentives under the CITL
Guofa [2007] No. 40 Notice on the Implementation Rules of the Grandfathering Relief in respect of High and New Technology Enterprises in Special Economic Zones and Shanghai Pudong New Area (26 December 2007) by the State Council According to Article 57 of the CIT Law, High/new Tech Enterprises newly established on or after 1 January 2008 in six zones (5 SEZs and Pudong New Area) can enjoy a 2+3 tax holidays with the following: Half rate reduction period: 25%/2 25% From the 1st income generating year Only applicable to profits generated in these areas (separate accounts for income and expenses from businesses inside and outside the zone)
September 2011
Grandfathering Treatments Geography-based Tax Incentives under the CITL (contd)
For Western region, the incentives are: Valid until 2010 15% reduced tax rate for encouraged projects 2+3 tax holiday for certain infrastructure projects Catalogue of Foreign Investment Advantageous Industries in Central and Western China (2008 version), jointly issued by the National Development and Reform Committee (NDRC) and MOFCOM on 23 December 2008, effective from 1 January 2008 - fall within the industries listed in the Catalogue; and - derive more than 70 percent of their revenue from their main business activities
September 2011
Guoshuihan [2009] No. 411 (31 July 2009) Incentives in Western Region

Effective on 1 January 2001 and under grandfathering, 1 January 2008 Sectors affected: Transportation infrastructure projects for highways, railways, aviation, harbours and pipelines Newly established transportation enterprises in the western region may enjoy CIT holidays of 2 year exemption and 3 year 50% reduction provided the relevant conditions are satisfied Such enterprises are confined to those that invest in and operate the abovementioned infrastructure projects
September 2011
Caishui [2011] No. 58 (27July 2011) Notice on Tax Policies in Relation to Further Implementation of the Western Development Strategy

Effective retrospectively from 1 January 2011 The key message of Circular 58 is that the incentives contained in Caishui [2001] No. 202 and various follow-up circulars will basically continue to apply The CIT incentives stipulated in Circular 202 came to an end on 31 December 2010. Circular 58 will pick up where Circular 202 left off, taking effect from 1 January 2011 to 31 December 2020
September 2011
Caishui [2011] No. 58 (27July 2011) Notice on Tax Policies in Relation to Further Implementation of the Western Development Strategy (contd)
CIT For those Western regions enterprises and those encouraged enterprises (namely enterprises whose main business falls within the scope of Catalogue of Encouraged Type Industries in Western Regions), during 1 January 2011 to 31 December 2020, the CIT rate will be reduced to 15%. (CIT holidays are thus removed.) For those Western regions enterprises newly established on or prior to 31 December 2010 and engaged in transportation, electric power, water conservation, postal services and TV broadcasting, starting from 1 January 2011, they can continue to enjoy 2+3 tax holiday until expiry.
September 2011
Caishui [2011] No. 58 (27July 2011) Notice on Tax Policies in Relation to Further Implementation of the Western Development Strategy (contd)
Customs Duty For those Western regions encouraged type projects of domestic and foreign investments and projects of advantageously positioned industries, starting from 1 January 2011, if equipment imported within quota of the total investment for self use, they can be exempt from import duty. It means that import VAT exemption is removed.* * With the VAT transformation rolled out nationwide on 1 January 2009 (see slides later),
all input VAT (including import VAT) for equipment are now creditable by VAT taxpayers. As a result, all previous incentives on import VAT exemption have been revoked nationwide since January 2009 as the import VAT will no longer be a cost to such VAT taxpayers.
September 2011
Transitional Issues Distribution of Pre-2008 Profits: A Challenge

Case 2007 2008 2008 WHT
Case I
FIE declares pre-2008 profits as dividends and remits -
WHT exempt
Case II
FIE declares WHT? pre-2008 profits as dividends and remits Remitted WHT?
Case III
FIE declares pre-2008 profits as dividends
September 2011
Caishui [2008] No. 1 (22 February 2008) Special Tax Concession for WHT on Dividends
Circular No. 1 clarifies the Case II and Case III scenarios and states that the pre-2008 retained earnings of an FIE shall be exempt from Withholding Tax when they are distributed to its foreign investor in 2008 and beyond. For this special concession of WHT exemption, it is reasonably expected that there will be an application and examination procedure in 2008 for tax authorities to verify the amount of such undistributed retained earnings up to the end of 2007.
September 2011
Caishui [2008] No. 130 (25 September 2008) Computation of WHT on Passive Income
New CITL charges FEs without an establishment in Mainland China but receiving China-sourced passive incomes to a withholding CIT rate at 20% The WHT rate is reduced to 10% by the CITL Implementing Regulations The new CITL states categorically that unlike the former treatment under the repealed FEITL, WHT is to be applied on the total amount of passive incomes (e.g. dividends, interest, rental, royalties, capital gains and so on) without any indication on the continuance of the deductibility of Business Tax in the WHT calculation Circular 130 further reiterates that no other taxes or expenses (not limited to BT) can be deductible in calculating the WHT for nonresident companies (retroactively) effective from 1 January 2008
September 2011
Guoshuihan [2008] No. 897 (6 November 2008) Withholding Tax Implications of Investing in H-Shares
Circular 897 clarifies the WHT treatment of dividends paid by a China-resident company to a nonresident company shareholder holding offshore H-shares under the CITL from 1 January 2008. Under Circular 897, H-shares issuers generally need to withhold tax at a rate of 10% for dividends paid in and after 2008 to foreign corporate shareholders. For foreign individual shareholders, according to Guoshuifa [1993] No. 45, dividends received from investments in H-shares were temporarily exempt from the repealed FEITL and IITL however, Circular 897 may have an impact on shares owned by foreign individuals through a trustee arrangement (such as shares registered through HKSCC Nominees Limited or broking firms)
September 2011
Guoshuihan [2009] No. 47 (23 January 2009) Withholding Tax Treatment of Dividends and Interest to the QFII
QFIIs may purchase (1) shares, bonds and warrants listed/traded on the Shanghai and Shenzhen stock exchanges; (2) securities investment funds; and (3) other financial instruments approved by the China Securities Regulatory Commission. Circular 47 provides that Chinese-source dividends and interest received by QFIIs are subject to a 10% WHT in accordance with the EIT Law. QFIIs may be eligible for a reduced WHT under an applicable tax treaty/arrangement. (QFII vs. beneficial owner?) Doubtful whether gains on the disposal of investments also are subject to the 10% WHT?
September 2011
Guoshuifa [2009] No. 3 (9 January 2009) Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Nonresident Enterprises

Took effect retrospectively on 1 January 2009 A non-resident enterprise that derives capital gains from an offshore share transfer must fulfill its tax filing obligation with the local tax authorities where the domestic enterprise whose shares are transferred. The non-resident enterprise (i.e. the transferor) is the taxpayer in an offshore share transfer. The domestic enterprise (the Chinese entity being transferred) must provide a copy of the share transfer agreement to the tax authorities in charge and to assist the tax authorities in the collection of tax from the non-resident enterprise in an offshore share transfer transaction. See Cir. 114 and Cir. 698 later.
September 2011
Guoshuihan [2010] No. 183 (6 May 2010) Strengthening CIT Administration on Dividends Derived by Non-resident Companies from Chinese Listed Companies
Given the recent discovery of non-compliance with WHT compliance on B shares dividend distribution to foreign shareholders, the SAT issued Guoshuihan [2010] No. 183 on 6 May 2010. Following Guoshuifa [2009] No. 3, Circular 183 aims to strengthen the administration and collection of CIT on dividends repatriated to nonresident companies from Chinese listed companies. The main points are: (1) To ask local tax authorities to carry out comprehensive tax inspection on dividends repatriation occurred in year 2008 and thereafter from the listed companies including A shares, B shares, H shares and other overseas shares listed companies. (2) To force the Chinese listed companies to withhold CIT on the aforesaid dividends before a due date for any failure cases.
September 2011
Guoshuihan [2009] No. 394 (24 July 2009) Withholding Tax on Dividends on A, B and Overseas Shares

Circular 394 affects sectors of funds, financial institutions and investors Resident enterprises are required to withhold income tax at 10% when paying dividends to non-resident enterprises where: (1) The dividends are on A shares, B shares or overseas listed shares; and (2) The dividends are related to the year 2008 or thereafter. Lower tax treaty rates may be granted if applicable
September 2011
Caishui [2008] No. 1 (22 February 2008) Tax Incentives for Software, Integrated Circuit, and Security Investment Funds Industries
(1)
(2) (3) (4)
Following the previous policies and circulars (e.g. Caishui [2000] No. 18, 25 etc), Circular No. 1 provides generous tax incentives to software production companies, IC production companies, as well as security investment funds. Tax preferential treatments e.g.: full deduction of qualifying training expenses for CIT purposes, Customs Duty and VAT exemption at import level granted for qualifying import equipment and A 5-year CIT tax holiday granted for newly established software enterprises, etc. Specifically, for key software enterprises under the states planning (Key Software Enterprises), an additional CIT incentive has been provided, i.e., a 10% CIT rate would be applied if a Key Enterprise has not enjoyed the CIT exemption for the current year.
September 2011
Caishui [2008] No. 1 (22 February 2008) Tax Incentives for Software, Integrated Circuit, and Security Investment Funds Industries (contd)
Reinvestment tax refund will continue to apply to reinvestment in relation to IC production and assembly companies in general and software products production companies newly set up in the Western Region. Furthermore, if tax holidays apply to these software production companies and IC production companies as mentioned in Circular No. 1, then the starting time for tax holidays remains the same as that under the old FEIT regime, i.e. the first profitmaking year instead of the first revenue-generating year as stipulated under the new CIT regime.
September 2011
Fagaigaoji [2009] No. 3357 (31 December 2009) List of Qualifying Key Software Enterprises under the States Planning of Year 2009
On 31 December 2009, four central government authorities jointly published a list, containing 186 qualified Key Software Enterprises of 2009, for such CIT preferential treatment purpose as stipulated in Caishui [2008] No. 1 above. To access the full content of Circular 3357, click the link: http://www.ndrc.gov.cn/zcfb/zcfbtz/2009tz/t20100108 _323653.htm
September 2011
Caishui [2008] No. 1 (22 February 2008) Transitional Arrangements of Preferential Tax Policies Available to Certain Industries and Enterprises under the Previous Regimes
Circular No. 1 also allows the continuation of 6 types of fixedperiod preferential tax policies (e.g. deductions or following the original tax treatments) available to certain critical industries and enterprises until their expiry, namely: re-employment, 2008 Olympic Games and 2010 World Expo social welfare enterprise reform agriculture, and state reserves etc.
September 2011
Guoshuifa [2008] No. 23 (27 February 2008) Clarifying Unclear Grandfathering Treatments under Circular No. 39
Reinvestment Tax Refund To complete all reinvestment steps and obtain Business License or the new Business License on or before the end of 2007 2007 profits are not eligible for reinvestment tax refund in any case WHT on interest, royalty etc. If exemption criteria met and entered into before 2008, the WHT exemption will continue to apply until the expiry of the original contracts Observing the original requirements for tax holidays e.g. business nature and scope, operation period for production FIEs to enjoy the 2+3 tax holiday
September 2011
Caishui [2009] No. 69 (24 April 2009) Notice on Certain issues Concerning the Implementation of CIT
Clarifies certain issues concerning the various CIT transitional treatments set out in Guofa [2007] No. 39 as well as certain preferential policies under the new CIT law and its implementation rules. Tax rate in a tax holiday - The base rate for the 50 percent reduction in a tax holiday (e.g. transitional treatment under Circular 39, western areas etc) will be based on the applicable preferential CIT rate; for all other enterprises, it will be based on the CIT rate of 25 percent. No overlapping tax incentives in both the old tax regime and the under the new CIT law. Distribution of profits formed before 2008 basically exempt from CIT, except for distribution by publicly issued and traded shares that are held less than 12 months .* *only applicable to TREs
September 2011
Caishui [2009] No. 69 (24 April 2009) Notice on Certain issues Concerning the Implementation of CIT (Contd)
Branch if established before 16 March 2007, can enjoy CIT transitional treatment separately if requirements in Circular 39 are met Small-scale enterprises with low profitability the preferential tax rate of small-scale enterprises shall not apply to the enterprises using the deemed profit method to calculate taxable income Specialised equipment under financial lease e.g. purchase cost for environmental protection, power and water conservation and safe production can be credited against tax payable for the lessee in a finance lease (if the equipment is transferred to the lessee at the end of the lease term)
September 2011
Caishui [2009] No. 69 (24 April 2009) Notice on Certain issues Concerning the Implementation of CIT (Contd)
Software or integrated circuit enterprises Circular 69 clarifies the definition of newly-established software production enterprises set out in Article 1 of Caishui [2008] No. 1. Qualified software and IC production enterprises established before the end of 2007 are entitled to transitional CIT treatments in respect of tax holidays set out in Caishui [2008] No. 1. Enterprises which already started the tax holiday before 2008 can continue to enjoy the tax holiday until its expiry. Investment in medium-or-small-sized advanced and new technology enterprises by venture capital enterprises Circular 69 gives clarification regarding the recognition criteria of medium-or-small-sized advanced and new technology enterprises and whether investment in advanced and new technology enterprises recognized before the end of 2007 qualifies for the relevant tax incentives.
September 2011
Guoshuihan [2010] No. 79 (22 February 2010) Notice on Timing and Calculation for Recognizing Certain Types of Income under the CITL and DIR
Rental income Day the rent is due as stated in the lease agreement (spread rent paid in advance evenly over the term of the lease) Income from debt restructuring Day the debt restructuring contract or agreement becomes effective Capital gains on transfer of equity interests At the time the equity transfer agreement is executed and the formalities for the change in equity ownership are completed
September 2011
Guoshuihan [2010] No. 79 (22 February 2010) Notice on Timing and Calculation for Recognizing Certain Types of Income under the CITL and DIR (contd)
Dividends, profits and other investment income Day the shareholder meeting resolves to make a distribution of dividends or profits, or convert retained earnings into equity Depreciation of fixed assets Value stated in the asset purchase agreement as the tax bases for depreciation purposes (an adjustment must be made to reflect the actual invoice amount within 12 months of putting the relevant FAs into use) Expenses incurred in generating tax-exempt income Costs and expenses incurred in connection with tax-exempt income (e.g. government bonds, dividends distributed between resident enterprises) should be deductible pursuant to articles 27 and 28 of the DIR
September 2011
Guoshuihan [2010] No. 79 (22 February 2010) Notice on Timing and Calculation for Recognizing Certain Types of Income under the CITL and DIR (contd)
Pre-operating expenses Expenses incurred in the start-up period will not be considered losses in the current period but must either be deducted in the year the manufacturing or business operations commence or be amortized as long-term expenses over a minimum three-year period (see Article 9 of Guoshuihan [2009] No. 98, 27 February 2009). Entertainment expenses of equity investment enterprises Enterprises engaged in the business of equity investment (including group headquarters and venture capital enterprises) may deduct entertainment expenses incurred on dividends, profits and capital gains received from their investee enterprises subject to limitations.
September 2011
SAT Announcement [2010] No.19 (27 October 2010) CIT treatment on capital gains and certain other income derived by enterprises
Monetary or non-monetary income derived from transfer of properties (including various types of assets, equities and debts, etc.), debt restructuring, donations and waiver of debts, shall generally be treated as one-off income subject to CIT in the year when the income is recognized. For the aforesaid income derived from 1 January 2008 to the enforcement date of Announcement 19 that has started evenly spreading over five years for CIT calculation, the remaining balance that has not yet been included as taxable income, shall all be recognized as income and subject to CIT for the current year, i.e., the year of 2010. Announcement 19 takes effect from 27 November 2010.
September 2011
DIR - Deductibility of Expenses

Major Changes Advertising expenses and business promotion expenses Old FEIT Regime
New CIT Regime Deduction cap: 15% of Sales 30% of sales revenue for certain industries, including manufacturers (not trading companies) of cosmetics, pharmaceuticals and beverages (excluding alcohol) see Caishui [2009] No. 72 (31 July 2009) which is effective from 1 January 2008 to 31 December 2010 Excess: Carried over to and deductible in future years Flexibility provided in the DIR to give leeway
No restriction
September 2011
DIR - Deductibility of Expenses

Major Changes Business entertainment expenses Sponsorship expenses Old FEIT Regime 0.5% - 0.3% on sales 1% - 0.5% on service income

New CIT Regime Deduction cap: 60% of actual expense incurred and maximum set at 0.5% of total income
No clear restriction
Non-deductible if non-advertising nature and not relevant to business operation
Donation
No limit on qualified expenses
Limited to 12% of accounting profit Also see Caishui [2009] No. 124 (8 December 2009) reiterates that a companys donations to eligible charitable social organizations (CSOs) are deductible up to 12% of its total annual accounting profits
September 2011
DIR - Deductibility of Expenses (contd)

Major Changes Commercial insurance expense Provisions Old FEIT Regime Deductible if IIT has been paid
New CIT Regime Non-deductible for staff and investors
Generally nondeductible, except for financial institutions
Generally non-deductible, subject to State Councils further rules? e.g. Caishui [2009] No. 64 (30 April 2009) Notice on CIT deduction of loan loss provisions fro financial enterprises (effective from 1 January 2008 31 December 2010) 1% x balance of loan assets at the end of the current year balance b/f
Staff education expenses
Capped at 1.5% 2.5% of total salaries and wages
Capped at 2.5%, excessive expenses can be carried forward to future years
September 2011

Major Changes Management service fees Old FEIT Regime Management fee nondeductible
New CIT Regime Management fee non-deductible How about genuine related party services for which service fee is charged at arms length? Guoshuifa [2008] No. 86, 14 August, lays down the basic principles and the mechanism for treatment of service fees paid by a Chinese subsidiary to its parent company in Mainland China for CIT purposes A service fee based on a reasonable profit similar to an arms length transaction between unrelated parties, but no mention what mark up, or level of profits should be
September 2011

Major Changes Management service fees (contd) Old FEIT Regime Management fee nondeductible
New CIT Regime Execution of service contracts between the parent and subsidiaries as supporting evidences Service sharing agreement vs. cost sharing agreement Avoid using the terms management fees or management services in the inter-comnpany service agreements because SAT interprets management fees as a pure allocation of overhead expenses without specific benefit received by the payer of the fees.
September 2011
Guoshuihan [2009] No. 98 (27 February 2009) Tax Matters Regarding the New CITL
Circular 98 covers staff welfare, education funds, wages funds, advertising and promotion, R&D expenses, and pre-start-up expenses. It became effective from 1 January 2008. Pre-start-up expenses (1) Enterprises may opt to deduct pre-start-up expenses on a one-off basis, or amortize them over a minimum of three years (under FEITL, 5 years). Once a treatment option has been selected, it may not be changed. (2) The current balance of unamortized pre-start-up expenses may be treated in accordance with the above provision. Corporate Income Tax AF4222_L2 September 2011
Caishui [2009] No. 29 (19 March 2009) Notice on CIT Deduction of Commission Expenses

Circular 29 became effective from 1 January 2008. Deduction ceiling The excess amount over the deduction ceiling cannot be deducted or carried forward;
Company Ceiling % Calculation base
Property insurance company

Life insurance company Other company
15%
10% 5% Total premium income less cash surrender value Revenue prescribed by the commission agreement
September 2011
Caishui [2009] No. 57 (16 April 2009) Notice on CIT Deduction of Asset Losses

Circular 57 became effective from 1 January 2008. Scope of asset losses Actually incurred asset losses pertaining to taxable revenue earned include: - cash loss - deposit loss - bad debt - loan loss - equity investment loss - fixed asset and inventory loss due to shortage, damage, scrap, theft, and - loss due to force majeure such as a natural disaster. Any recovery of asset losses deducted should be added back when received
September 2011
SATs Announcement [2010] No. 6 (28 July 2010) Equity Investment Losses Deductible in One Go for CIT Purposes
In calculating its taxable income for CIT purposes, an enterprise can deduct a loss incurred in equity investments in one go in the year in which the loss is incurred as confirmed by the tax authority. Enterprises can deduct in one go in 2010 equity investment losses that were incurred prior to 28 July 2010 but have not been dealt with before then. This Circular is effective from 1 January 2010.
September 2011
SAT Announcement [2011] No. 25 (31 March 2011) Announcement on Measures for CIT Deduction on Asset Losses of Enterprises
Announcement No. 25 became retrospectively effective from 1 January 2011, and also applies to losses of prior years but have not been handled for tax purposes. The approval system () introduced by Guoshuifa [2009] No. 88 is replaced with a filing system (). Two types of asset losses: (1) actual asset losses, and (2) statutory asset losses (e.g. accounts receivables outstanding for more than 3 years). In both cases, the asset losses should have been treated as such for accounting purposes before they can be deducted in calculating the taxable income of the enterprises for CIT purposes.
September 2011
SAT Announcement [2011] No. 25 (31 March 2011) Announcement on Measures for CIT Deduction on Asset Losses of Enterprises (contd)
In addition to account receivables overdue for more than 3 years, account receivables overdue more than 1 year that the amount of an individual transaction is not more than RMB50,000 / 0.01% of the companys annual revenue can be deductible as a bad debt loss provided that the company has already treated the same amount as a bad debt loss for accounting purposes. Losses on intangible assets are added into the scope of deductible asset losses with detailed descriptions of what evidence a taxpayer should provide to substantiate the deduction of such loss. Certain articles regarding asset losses incurred by financial institutions stipulated in Circular 88 are also removed from the new measures.
September 2011
Qi Bian Han [2009] No. 33 (4 September 2009) Tax Treatment of Staff-related Expenses Clarified

Circular 33 provided the guidance on staff-related expenses as follows: Petrol expenses for private cars of staff Before 2008, deductibles as salaries; from 2008, deductible as staff welfare expenses and subject to limit
* From 1 January 2008, enterprises shall deduct salaries actually released to staff.
Personal accident insurance for staff Deductible only if insurance is related to special job types or other commercial insurance specified by MOF / SAT Allowances to retirees Not deductible Severance payments Deductible if made in accordance with relevant labour regulations
September 2011
Guoshuihan [2009] No. 777 (31 December 2009) Deductibility of Interest Expenses related to Loans Borrowed by Companies from Natural Persons for CIT Purposes
Pursuant to Circular 777, interest expenses paid to natural persons shall be deductible for CIT purposes: (1) Interest expenses paid to related natural persons (e.g. shareholders) - Shall be deductible according to the relevant rules and conditions provided in Article 46 of the CITL and Caishui [2008] No. 121 (September 2008) if the statutory debt-to-equity ratio is exceed., i.e.. 2:1 or 5:1. (2) Interest expenses paid to non-related natural persons (e.g. employees) - Shall be generally deductible, to the extent that the interest expenses do not exceed the amount charged by a financial institution for similar types of loans over the same period (i.e. the financial loan rate), provided the following 2 conditions are both met: (a) The loan from the natural person is authentic, legitimate and valid. The loan shall not be associated with any illegal financing purposes or other activities violating relevant laws or regulations. (b) A loan contract has been signed between the company and natural persons.
September 2011
SAT Announcement [2011] No. 34 (9 June 2011) Expense Deduction in Quarterly CIT Filing Permitted Pending Documentary Support

Announcement No. 34 became effective from 1 July 2011. Where an enterprise has actually incurred costs and expenses but has not managed to obtain the valid documentary supports in time due to various reasons, it can deduct those costs and expenses based on its accounting record in its quarterly provisional CIT filing. No tax adjustment will be required in the quarterly filings. However, in its annual CIT filing, the enterprise will have to provide valid documentary support for the abovementioned costs and expenses. Where the valid support cannot be supplemented by the end of the annual CIT filing, there can be a risk that such costs and expenses are not deductible in calculating the taxable income for CIT purposes for the year.
September 2011
Anti-avoidance Measures
New concepts: Cost sharing arrangements Thin-cap rules (a financing issue) Controlled foreign corporation rules (a DE issue?) General anti-avoidance rules (GAAR) Emphasis on substance rather than form New Interest Levy TP Contemporaneous documentation requirements More follow-up explanatory guidelines and implementation regulations are expected.
September 2011
Cost Sharing Arrangement (CSA)

No legal basis under the current FEIT regime Very limited precedents in practice Cover both IP and service arrangements CSA in the form of APA preferred Arms length principle More follow-up guidelines are expected (e.g. OECDs)
September 2011
GAAR rules

To target arrangements without reasonable commercial purpose Defined in the DIR as where main purpose is to achieve taxation benefits such as reducing, eliminating or deferring the payment of taxes and etc. Left to interpretation of SAT and local tax bureaus and assessing practice Chance of abuse?
September 2011
Interest Levy on Special Tax Adjustments

No interest / surcharge or penalty on transfer pricing adjustments under the FEIT regime. In the new CIT regime, adjustments including TP, CFC, GAAR, Thincap, etc. are subject to Interest Levy Interest rate is: RMB loan basic rate of the year of assessment in which the tax adjustment relates (financial aspect) 5% (penalty element) Non-tax deductible Fines/surcharges ranging from below RMB 2,000 up to RMB 50,000, for failure to provide certain RPT Disclosure forms and / or TPD (see Chapter 12 of the Measures issued in early January 2009) Penalty interest of 5% may be waived for TPD Imposed on pre-2008 transactions? 10 years?
September 2011
Impact
to Foreign Investors
September 2011
Withholding Income Tax

Reduced to 10%: dividend, interest, royalty, rental, etc. (Assume under non-treaty jurisdiction.) Exemption eligible for foreign government loans to Chinese government interest to International Financial Organizations on preferential loans to be determined by State Council? Any hope on: exemption for dividend from HNTEs? any transitional concession for FIEs dividends? (pre-2008 profits) See Caishui [2008] No. 1 (22 February 2008)
September 2011
Thin-cap (Financing)
Interest on exceeding debt-equity ratio from related parties is non-deductible (Article 46 of the CITL and Article 119 of the CITLIR) Debt refers to all interest-bearing debts and equity refers to the equity investment Debt-equity ratio (Safe harbour)? Related party and unrelated party? Related party debts include back-to-back loans, loans guaranteed or where related parties are jointly liable Non-deductible interest Cross-border only? (e.g. a non-PRC holding company made an inter-co debt to an FIE in return for interest) Any leeway allowed?
September 2011
Other Issues
Reinvestment Tax Refund No longer available after 1 January 2008 Also see Circular No. 23 (Clarifying Unclear Grandfathering Treatments) Tax holidays for Technologically Advanced Enterprises Not allowed for 2008 and beyond GAAR rules Substance and form Corporate Restructuring Entire chapter removed from the final DIR Tax-free restructuring?
September 2011
Impact
to Foreign Enterprises
September 2011
Tax Residence Enterprises

If the place of effective management of a FE is situated within China, it would be taxed as a PRC tax resident Place of effective management: a place where effective overall management and control over the production and business operation, employees, accounting and properties of an enterprise, in substance, is exercised broadly worded how to interpret and who to determine? Who will be affected? e.g. RHQs, ROs, foreign funds, processing, sourcing, etc. with management activities in China Result: worldwide income if PRC resident status See Circular 82 (22 April 2009)
September 2011
Sources of Reference

PricewaterhouseCoopers, 2008, Update on China Corporate Income Tax Law, webcast seminar paper, 2 April, Hong Kong PricewaterhouseCoopers, 2008, China Regulatory Briefing: Latest Development in Cooperate Income Tax Reform, seminar paper, 9 January, Hong Kong Ernst & Young, 2008, Corporate income tax incentives for energy and water conservation equipment, environmental protection equipment and recycling businesses, 11 September, Hong Kong. Ernst & Young, 2007, Annual Year End Review and Planning for 2008, tax seminar paper (in Chinese), 13 December, Hong Kong. KPMG, 2008, R&D expenses deduction for Corporate Income Tax, Issue 53, December, Hong Kong KPMG, 2008, Corporate income tax implications of service fees charged from a holding company to its subsidiaries in China, Issue 36, October, Hong Kong KPMG, 2008, Taxes or expenses not deductible for withholding tax calculation, Issue 35, October, Hong Kong KPMG, 2008, The New Corporate Income Tax Law in China, seminar paper, January, Hong Kong Deloitte Touche Tohmatsu, 2008, Withholding Tax Implications of Investing in H-Shares, Tax Analysis, Issue P37/2008, 2 December, Hong Kong Publications in websites from Big 4 (as of January 2011)
September 2011
III. New Corporate Annual Income Tax Return and Related Party Transaction Annual Reporting Forms
September 2011
Key Features of New Annual Corporate Income Tax Return
Guishuifa [2008] No. 101, 30 October 2008 a new set of annual Corporate Income Tax return forms and supporting schedules Type A for PRC resident taxpayers As for transactions conducted with related parties, such data shall be supplied in a Related Parties Transaction Reporting Form, as an attachment to the annual CIT return The deadline of submission for 2008 CIT return and the RPT reporting form is 31 May 2009
September 2011

The New Return comprises of a lead tax return form and 11 supporting schedules:
Income Expenses Tax adjustments [including income, deduction, assets, provisions, estimated profit from provisional sales of properties, special tax adjustments (adjustments to income or expenses arising from the application of CFCs, transfer pricing and thin capitalization)]
September 2011

Losses c/f Tax incentives (tax exemption or reduction, super-deduction of R&D expenditure etc., incentives previously granted and transitioned, capital investment in qualified machinery and equipment) Foreign tax credit Gain or loss from revaluation of financial assets and liabilities and investment properties Advertising and business promotion expenses Depreciation and amortization Provisions and reserves Gain or loss from long-term investments
September 2011
CIT Annual Tax Filing Forms Special Tax Adjustments
A taxpayer can make a new voluntary special tax adjustment in Appendix 3 of the new annual CIT filing (or called post-transaction adjustment) According to the explanatory notes of Appendix 3, taxpayers can make an upward adjustment to taxable income in accordance with the provisions (or requirements) of Special Tax Adjustment circular and to bring it to an arms length basis The adjustment can only be upwards and could arise from any special tax adjustment (e.g. CFC, thin capitalization, transfer pricing or other) Taxpayers can self-initiate an upward adjustment, but the explanatory notes do not address any corresponding VAT or BT issues that might arise from such an adjustment, e.g. implicitly change the customs value of related party imports It also remains to be seen how the tax authorities will respond to downward income adjustments
September 2011
Key Features of RPT Annual Reporting Forms (RPT Disclosure Forms)

Guoshuifa [2008] No. 114, 16 December 2008 These forms are in accord with Article 43 of the CITL and provide a rough blueprint of the relevance of transfer pricing to the taxpayer Quantify the amount in RMB of RPTs of the following categories:
Sale of materials (products) Purchase of products (materials) Income from the provision of services Expenses for the receipt of services Transfer in of intangibles Transfer out of intangibles Transfer in of fixed assets Transfer out of fixed assets Interest income from lending Interest expense from borrowing Others
September 2011

Form 1: Related Party Relationships Form 2: Summary of Related Party Transactions Form 3: Purchases and Sales Form 4: Labour Services Form 5: Transfer of Intangible Assets Form 6: Transfer of Fixed Assets Form 7: Financing Form 8: Outbound Investment Form 9: Outbound Payments
September 2011
Applicable to TREs and Non-resident enterprises with establishment or place of business in China Contemporaneous transfer pricing documentation (TPD) in place? Together with the 2008 Annual CIT Return by 31 May 2009
September 2011
New Annual Corporate Income Tax Returns for Non-resident Companies

Guoshuihan [2008] No. 44, January 2008 two of the four return forms applicable to non-resident companies Guoshuihan [2008] No. 801, 22 September 2008, clarifies how a non-resident company which has a PE within China should file a CIT return. Five new sets of CIT return forms for 2008 and 2009 onwards: actual basis, deemed basis and withholding company CIT reporting form Details on the determination of tax residence and the filing method for a tax resident enterprise that is legally registered outside China but that has its effective management located in the PRC are not elaborated on in the new CIT returns. Do the new CIT returns apply to this type of tax residence?
September 2011

PricewaterhouseCoopers, 2008, Whats New in the Annual Related Party Transactions Report, Issue 18, December, Hong Kong PricewaterhouseCoopers, 2008, New Look of Annual Corporate Income Tax Return Package , Issue 16, November, and Webcast, 16 December, Hong Kong PricewaterhouseCoopers, 2011, Trick o Treat? Release of the <Administrative Measures for Overseas Registered Chinese-capital Controlled Tax Resident Enterprises (Trial)>, News Flash, Issue 22, August, Hong Kong PricewaterhouseCoopers, 2011, Go West New Round of Fiscal Incentives for Chinas Western Region, News Flash, Issue 18, August Ernst & Young, 2008, China Transfer Pricing: Related Party Transaction Annual Reporting Forms, 17 December, Hong Kong Ernst & Young, 2008, China strengthens tax administration on non-resident companies, 25 November, Hong Kong KPMG, 2008, Related-party transactions annual reporting forms finalized, Issue 51, December, Hong Kong KPMG, 2011, Further Clarification on Tax Residency Status of China-controlled Foreign Enterprises, China Alert, Issue 29, August KPMG, 2011, Corporate Income Tax Incentives for Western Regions Extended by Ten More Years, China Alert, Issue 28, August Deloitte Touche Tohmatsu, 2008, New Enterprise Income Tax Returns Requirement and Highlights, Tax Analysis, Issue P44/2008, 23 December, Hong Kong Deloitte Touche Tohmatsu, 2008, SAT Releases New Related Party Transaction Disclosure Forms, Tax Analysis, Issue P41/2008, 18 December, Hong Kong
September 2011

Lecture No. 3 Special Tax Adjustments and Anti-avoidance Measures
164
AF4222_L3 Special Tax Adjustments
September 2011
Special Tax Adjustments and Anti-avoidance Measures
165
September 2011
Implementation Measures for Special Tax Adjustments (Trial)
Draft version entitled The Regulation of Special Tax Adjustments (Trial) (13 chapters and 120 articles) for public comments on 21 March 2008 Final version of the Implementation Measures for Special Tax Adjustments (Trial) [Guoshuifa [2009] No. 2, 8 January 2009] released by SAT on 9 January 2009 How to enforce the provisions contained in Chapter 6 Special Tax Adjustments, of the CITL governing transfer pricing, advance pricing arrangement (APA), cost sharing agreement, controlled foreign corporation, thin capitalization and the general anti-avoidance rule It also imposes mandatory contemporaneous transfer pricing documentation requirements.
166
September 2011
The Measures contain 13 chapters and 118 provisions covering various aspects of Chapter 6, retrospective effect from 1 January 2008: Chapter 1: General Provisions Chapter 2: Reporting of Related Party Transactions Chapter 3: Administration of Contemporaneous Documentation Chapter 4: Transfer Pricing Methods Chapter 5: Transfer Pricing Investigations and Adjustments Chapter 6: Administration of Advance Pricing Arrangements
167
September 2011

Chapter 7: Administration of Cost Sharing Agreements Chapter 8: Administration of Controlled Foreign Corporations Chapter 9: Administration of Thin Capitalization Chapter 10: Administration of General Anti-Avoidance Chapter 11: Corresponding Adjustments and International Consultation Chapter 12: Legal Obligations Chapter 13: Supplementary Provisions
168
September 2011
Thin Capitalization

Caishui [2008] No. 121, 23 September, by SAT and MOF Safe harbour of debt-to-equity ratio (DER) For financial institutions, DER is 5:1 For other industries, DER is reduced to 2:1 According to Guoshuihan [2009] No. 72, capitalized interest expenses should be taken into consideration for the calculation of non-deductible interest under the TCR. Article 46 of the CITL disallows interest deduction for loans from related parties in arriving at taxable income if the DER is in excess of the prescribed standards Article 119 of the CITLIR lays down the definition of debt investment from related parties and equity investment (e.g. ownership of a companys net assets etc.) Related party debt investment refers to financing, directly or indirectly (e.g. back-to-back debt investments made through a third party, guarantee, having a substance of a debt etc) from its related parties that requires repayment of principal and interest or compensation in other forms.
169
September 2011
Thin Capitalization
Circular 121 allows a departure from the prescribed DER if one of the two conditions is satisfied:
-
Able to provide relevant information tax authorities in order to substantiate that the related party financing activity is at arms length in terms of the reasonableness of its capital structure and interest deduction, or The effective tax rate of a resident borrower (viz. the interest payer) is not higher than a resident related party lender (viz. the recipient of the interest) (namely a departure may be accepted if the financing is viewed as neutral or beneficial to the Chinese tax authority)
AF4222_L3 Special Tax Adjustments September 2011
170
Thin Capitalization
If a company engages in both the financial services industry and other businesses, the interest expenses paid to related parties should be apportioned using reasonable methods; otherwise, the DER standard for non financial institutions should be used in determining the portion of deductible interest expenses. Any disallowed amount cannot be deductible while such a disallowed amount remains taxable at the recipient level The non-deductible outbound interest expense paid to overseas related parties would be deemed as a dividend distribution and subject to WHT at the higher of the WHT on interest and the WHT on dividends
171
September 2011
Thin Capitalization
Sum of average of related party debt investment of each month from January to December DER of = comapny
_____________________________________
Sum of average of equity investment of each month from January to December
172
September 2011
Thin Capitalization
DER Standard Non-deductible = Interest expenses Annual interest payable to x foreign related parties (1 ___________ )
DER of a company
e.g. 100,000 x (1 2/1 divided by 3/1 for a non-financial institution) = 100,000 x (1 2/3) = 33,333 (not deductible provided that arms length is satisfied)
173
September 2011
Thin Capitalization

Actual interest payment refers to an enterprises recognized interest cost as opposed to remitted interest payment Interest expenses to include guarantee fees, collateral fees and other expenses in the same nature of interest Interest deductions disallowed due to thin capitalization or deemed as dividend are not within the scope of mutual agreement procedures for double taxation relief Related party interest that is not arms length will be subject to transfer pricing investigation and adjustment before being evaluated for thin capitalization purposes Documentation to justify the arms length principle for the intercompany borrowings appears to be a good strategy to distant from the 5% penalty tax in case of any adjustment
174
September 2011
Controlled Foreign Corporations (CFC)
175
Article 45 of the CITL provides for the inclusion into a Chinese enterprises taxable income the relevant profits of CFC of that Chinese enterprise that are established in countries with effective tax burdens substantially lower than Chinas. The Measures provide guidance for calculating the amount of the deemed dividend income and any associated credits. These CFC rules may not be a concern to most foreign-invested companies, considering that they are not inclined to use a China-based company to invest outside of China at this stage.
September 2011
The CFC test adopts the multiplication principle, that is, if an intermediate shareholder holds over 50 percent of the shares of the lower-layer entity, the shareholding percentage of the ultimate shareholders to the shares of the lower-layer entity will be calculated by multiplying by 100 percent. (It differs from RPT which adopts a look-through method by 25 percent.) The CFC test includes Chinese enterprise resident shareholders and Chinese individual resident shareholders, whereas so far there are no similar CFC rules introduced in the IIT regulations. The SAT has issued a list of non-low-tax-rate countries, that is, a white list of 12 countries, which may be updated.
176
September 2011
The deemed dividend income from a CFC attributable to its Chinese resident enterprise shareholder:
Number of Shareholding days ___________ x Shareholding percentage
Income attributed Amount of To a Chinese resident = deemed x Enterprise shareholder Dividend In the current period distribution Number of days In the CFCs tax year
177
September 2011

Exemption criteria: The CFC is established in a country with an effective tax rate that is not low, as designated by the SAT It has income derived mainly from active business operations It has annual profit less than RMB 5 million
178
Cost Sharing Agreements (CSA)

CSA for joint development of intangibles and sharing of services Follows OECDs transfer pricing guidelines The measures state that the costs borne by the participants to a CSA should be consistent with what an independent enterprise would bear for obtaining the anticipated benefits under comparable circumstances (cost-benefit matching principle) Anticipated benefits reasonable, quantifiable, based on reasonable commercial assumptions and common business practices With commercially viable purposes or economic substance Comply with the arms length principle
179

Items to be contained in a CSA: Names and details of participants Content and scope of intangible assets or services covered by the CSA specific responsibilities and tasks Terms of the agreement Calculation methods and assumptions relating to the Cost Sharing Agreements (CSA) - anticipated benefits to the participants Initial and subsequent contribution by the participants and explanation of conforming with the arms length principle Accounting methods and changes Entrance and withdrawal from the agreement Compensating payments Amendments / Termination of the agreement Use of result of the CSA by non-participants
180
September 2011

Service-based CSA limited to group procurement or group marketing strategies (Why so restrictive?) However, if an enterprise requests other types of CSA because of operational needs, the SAT will take the request into consideration. A change Buy-in and buy-out payments Compensating payments for mismatch between the shared costs and the actual benefits Costs allocated not deductible if the CSA not considered as an arms length or without reasonable commercial purpose or economic substance
181

May apply an APA to cover a CSA No royalties for intangible properties should be paid for intangible-related CSA; this emphasizes that the payment of the CSA is the cost to be shared, not the royalties Costs allocated under a CSA and deducted for CIT purposes clawed back if the operation period less than 20 years since the signing of the agreement What is the BT treatment for CSA? R&D super deduction eligible under an intangible related CSA, especially involving cross-border shared costs?
182
General Anti-avoidance Rules (GAAR)

Commence a GAAR investigation on an enterprise: Abuse of preferential tax treatments Abuse of tax treaties Abuse of corporate structure Use of tax havens for tax avoidance purposes Other arrangements that do not have a reasonable business purpose
183
September 2011

Special focus on the principle of substance over form Request for relevant information and supporting evidences in the investigation Procedures and approval for conducting a GAAR investigation and making a GAAR adjustment Disregard the tax benefits solicited from the tax avoidance arrangements Especially for those cases in tax haven countries, the tax authorities may disregard the existence of such enterprise The GAAR are new, vaguely drafted and untested * See Cir. 698 (December 2009) and Jiangdu case (June 2010) Most effective defence the proof of valid business purposes
184

The SAT (in its special seminar on 31 March 2009) emphasized that (1) transactions involved in general anti-avoidance adjustments should be re-characterized, (2) tax benefits that accrue because of tax-avoidance should be annulled, and (3) the existence of tax-avoidance entities (especially shell companies) should be denied.
185
September 2011
Guoshuifa [2009] No. 114 (27 July 2009) Detailed Measures on Further Strengthening Tax Collection and Administration

Accelerating assessment of PRC tax residency for overseas incorporated enterprises that are controlled by PRC investment. Focusing on investigating the transfer of domestic equity interests between non-resident enterprises to prevent abuse of legal forms, tax havens and tax treaties. Scrutinizing RPT in certain industries such as financing for highway construction, pharmaceuticals (particularly for valuation of intangibles), hotel chains of four-stars or above paying service fees and management fees to foreign parents) Closely monitoring enterprises with limited functions and risks (i.e. enterprises that only perform manufacturing, distribution or contract R&D activities) that are set up by multinational groups, with a view to preventing the shifting of foreign operating losses to domestic enterprises.
186
September 2011
Chongqing Case
In 2008, the Chongqing tax bureau imposed taxes on gains a Singaporean seller derived from the indirect transfer of a Chinese resident company by selling a Singapore intermediary holding company. (Note: This ruling was not based on the new CITL, and did not focus on GAARs of the new CITL because the transaction took place before 2008. Is there any legal basis to form the decision to tax the gains?) Although there was little information about the case, tax practitioners were speculating about whether the Chinese tax authority would formally adopt this position in similar transactions. At that time of attack in 2008, the application of GAARs in the CITL is not yet known. But the issuance of Circular 698 in December 2009 laid such speculation to rest.
187
September 2011
Chongqing Case
Taxpayer: Gain on transfer of shares in a non-resident company not subject to income tax in China, a genuine and legal transaction Tax authority: Gain sourced from China, no documentary evidence to prove B Cos management was located outside China, the transaction in substance was to transfer interest in a Chinese company
188
Chongqing Case
A Co (Singapore) 100% B Co SPV (Singapore) 31.6% overseas A Co (Transferor)
100%
B Co
31.6%
China
C Co (JV) D Co C Co D Co (Transferee)
September 2011
189
Offshore Special Purpose Vehicles (Offshore SPVs)

Used as intermediate holding company of MNCs and investment funds for income tax, operational or other reasons. From income tax perspective, the Offshore SPV could enjoy the applicable tax treaty benefits such as reduced WHT rate on dividend, interest and royalty payment or capital gain tax exemption on transfer of shares. Another reason is to facilitate the future exit strategy through transfer of shares in the Offshore SPV without triggering any taxes in the country where the investment is located. In most cases, the transfer of shares in the Offshore SPV will not trigger any taxes in such offshore country.
190
Guoshuihan [2009] No. 698 (10 December 2009) Equity Transfer by Non-China Tax Residents
Circular 698 effective retrospectively to 1 January 2008 is to counter and counteract avoidance of China tax gains derived from indirect transfer of Chinese companies equity via disposing the equity of the Special Purpose Vehicle (SPV) offshore in China. In Chongqing case, the Chinese local tax bureau disregarded that SPV on the ground that the SPV had no substance and the purpose of interposing and disposing such SPV was solely for China tax avoidance. Though the case ended up with WHT being collected over the equity transfer gains, no strong legal basis is available.
191
Guoshuihan [2009] No. 698 (10 December 2009) Equity Transfer by Non-China Tax Residents (contd)
Highlights of Circular 698
192
Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company (namely the SPV), and the latter is located in a country (jurisdiction) where the effective tax burden is less than 12.5% or where the offshore income of her residents is not taxable, the foreign investors shall provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the share transfer. The requisite documents and information may include the equity transfer contract/agreement, documents showing the relationship, operation of the SPV being transferred, written explanation of the reasonable commercial purpose of the foreign investor in setting up the SPV being transferred and other information as requested etc.
Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through the abuse of form of organization, etc and there are no reasonable commercial purposes such that the CIT liability is avoided, the tax authorities shall have the power to recharacterize the nature of the equity transfer in accordance with the substance-over-form principle and deny the existence of the offshore holding company that is used for tax planning purposes. Once the SPV is disregarded, the transfer should be effectively treated as a non-TRE transferring the Chinese investee companys equity, and thus the transfer gain is of China source which should be subject to China WHT of 10% (depending on DTA if applicable)..
193
September 2011
Circular 698 stipulates a very tight timetable to fulfil the withholding and compliance requirements as it requires a foreign company to pay the taxes due within seven days from the equity transfer day, or receipt of the total transfer consideration if the withholding agent fails to file and remit the CIT liabilities. Taxing right is back to China and double taxation among the jurisdictions the non-TRE, the SPV and the transferee. Income derived from equity transfers as mentioned in the circular refers to income derived by non-resident enterprises from direct or indirect transfers of equity interests in Chinese resident enterprises, excluding shares in Chinese resident enterprises that are bought and sold openly on stock exchanges.
194
Overseas Investors
Transfer of shares
New Investors
Indirect offshore disposal
Holding Company (i.e. Offshore SPV)

Overseas
PRC Resident Company
PRC
195
September 2011
How to Navigate Indirect Disposals under Circular 698
Guoshuihan [2009] No. 698 (10 December 2009) deals with indirect offshore share disposals undertaken by investors. Such offshore disposals of PRC companies may be required to be disclosed to the PRC in-charge tax authorities (reporting of offshore disposals), and may potentially be subject to PRC taxation where they are considered to be motivated by tax-avoidance purposes (substantiation of reasonable business purposes).
196
What Investors Are Affected?

Sellers who have previously undertaken an offshore indirect transfer of offshore holding companies after 1 January 2008 Investors who currently hold PRC investments through offshore holding companies Investors intending to acquire / establish PRC companies in future Investors in pre-IPO offshore structures
197
September 2011
Implications to Reportable Transactions
PRC tax authorities can, upon SATs approval, apply the PRC general anti-avoidance provisions to recharacterize offshore indirect disposition as an direct disposition of China companies where it is concluded that the structure has

No reasonable business purpose Abusive use of organizational form The result of deriving a tax benefit as its primary objective
Effectively ignore the existence of offshore holding companies Therefore, seller deemed to have derived a PRC sourced capital gain and subject to PRC taxation
198
Factors Triggering for Looking Through an Offshore Disposal
Will SAT deny the existence of offshore holding company (e.g. BVI or Hong Kong SPV) in the following holding structure?
No reasonable business purposes No other business or management activities No employees with nominee directors Thinly-capitalized All services are outsourced to third party service providers
Caymans SPV
BVI SPV
HK SPV
PRC Company
199
September 2011
Factors Triggering for Looking Through an Offshore Disposal
Will the following holding structure make any difference?
Caymans SPV
Not subject to tax in Cayman Islands
BVI SPV
HK SPV
PRC Company
Business activities (e.g. management functions exercised) in HK Directors located and board meetings held in HK Directors exercised control and supervision over the investment in the PRC Services are outsourced to related companies in HK Appropriately capitalized
200
September 2011
How to Substantiate Business Purposes?

-
Possible business reasons for SPV structures Investment funds source financing from investors from different countries. SPV groups these investors for specific investment targets. This is popular for financial investors (compared to industrial companies). SPV (single or multiple) structures to facilitate: introduction of new partners - pooling investor interests together through a common investor vehicle different levels of debt/equity financing/bankruptcy remoteness etc thus easy access of fundings and less complicated administrative procedure asset segregation / greater legal protection - getting ready for an initial public offering Funds have substantial operations but may not reflect in a particular SPV
201
September 2011
What Are the Dos under Circular 698?

Investors should thus consider:
As Circular 698 draws from GAAR and seeks to challenge Offshore Disposals effected pursuant to an abuse of organizational form, holding companies within the investment structure that are artificial and which do not have substance are particularly at risk of being challenged, e.g. SPVs established in tax haven jurisdictions would appear to be the primary targets of such enforcement actions thus a more defensible investment holding structure (even in tax treaty jurisdictions) Provide reasonable business purposes for establishment of the intermediate investment holding structure and the circumstances of the sales. (Also see the substance factors in Circular 601 Substance-over-form.)
202
Uncertainties of Circular 698
How to determine capital gain where PRC tax authorities apply a look through approach?
- What is the cost base for capital gains tax purposes?
Are there fines / penalties for failing to report to the tax authorities?
-
Will tax authorities apply the Tax Collection and Administration Law of the PRC? Are PRC subsidiaries subject to penalties and tax liabilities of the foreign investor seller?
203
What Do These New Requirements Mean for Foreign Investors?

Increased monitoring on cross-border transactions by PRC tax authorities Greater compliance burden on reporting or disclosures Need to focus on and document business substance and reasonable business purposes when setting up and implementing investment holding structures and on investment exit Need to assess potential exposures and consider how the investment structure can be strengthened to mitigate potential challenges Significant uncertainties on how the rules (in particular Circular 698) would be interpreted and enforced in the context of GAAR (see Chongqing case was before 1 Jan 2008)
204
September 2011
Defendable Factors for Indirect Transfer

Merit for defending GAAR (1) Reasonable commercial purposes of the offshore company (2) Substance of the offshore company e.g. its competent management team which may serve the business of the group (3) Other message delivered from the meeting e.g. the management function at SPV (e.g. owned by the offshore company) level, management controls and costs
205
September 2011
Indirect Transfers under Attack
Chinese tax authorities are taking an active approach rather than merely relying on nonTRE investors to voluntary report the case Not reporting does not mean no GAAR Invoke GAAR at the SAT level
206
September 2011
Jiangdu Case
Overseas Investor
Transfer of shares
US Investor
Indirect offshore disposal
Hong Kong Holding Company

Overseas 49% Chinese partner EJV (Jiangdu city)
PRC
207
September 2011
Jiangdu Case
The China Taxation News, on 6 June 2010 reported the collection of withholding tax of RMB173 million by the Jiangsu tax authority on a capital gain arising from an indirect transfer of a 49% equity interest in Chinese company (actually a JV) in Jiangdu (administratively part of Yangzhou), Jiangsu Province. This is the first publicly reported case since the SAT announced Circular 698 involving the look through of certain intermediary entities considered as being established for tax avoidance purposes and lacked business substance and commercial activities.
208
Jiangdu Case (contd)
A company established in an offshore jurisdiction by a US investment group (overseas investor), a private equity fund, holds 49% of the equity of a Chinese company in Yangzhou, a city in Jiangsu province, via its wholly-owned subsidiary in Hong Kong. Both the HK subsidiary and the offshore intermediate company have no operation/economic substance, i.e., no office, staff, assets and liabilities other than the investment in the Chinese company. Actually at the beginning of January 2009, the local state tax bureau of Jiangdu city (Jiangdu STB) became aware of the intended disposal of the Hong Kong subsidiary by the overseas investor and thus a team of expertises was set up to monitor the proposed transaction.
209
September 2011
On 14 January 2010, the Jiangdu STB, from the buyers website, learnt an announcement that the overseas investor ie., the US Group disposed of the PRC equity through an indirect transfer by the offshore intermediate company of 100% of the shares of the HK subsidiary to a US listed group (US investor) at a capital gain of USD254 million (approximately RMB1,730 million). Although the disposal was between two non-resident companies and involved a non-resident company, the Chinese tax authorities imposed tax of RMB173 million on the gain realized by the sellers on the disposal (tax return filed on 29 April 2010 and tax duly paid on 18 May 2010).
210
September 2011
In assessing the transfer to tax under Circular 698, the tax authority determined that the HK subsidiary did not have any economic substance, as it had no employees, assets (other than the JV interest), liabilities or operations other than the investment in the JV. After reviewing the transaction, the tax authorities recharacterized the transaction under the GAAR in order to assess the gain on disposal to tax in China. The tax authorities disregarded the existence of the HK subsidiary and treated the profits on sale as being sourced in China and imposed withholding tax on the gain. The sellers argument that the transaction took place outside China was apparently not accepted.
211
September 2011
Lesson Learnt from Jiangdu Case (Indirect Share Transfers)
In December 2009, the SAT issued circular 698 that set off alarms throughout the foreign investment community in China. Circular 698 established procedures for the reporting and potential taxation of so-called indirect transfers of shareholdings in Chinese companies. An indirect transfer occurs when a foreign investor transfers the shares of an intermediate holding company located outside China that directly or indirectly holds a subsidiary in China. Under certain circumstances, most importantly where the foreign investor is unable to show a reasonable commercial purpose for the holding structure or for selling the holding company instead of selling the Chinese subsidiary directly, China asserts the right to levy income tax on the capital gain that the seller derives or is deemed to have derived from the indirect transfer.
212
September 2011
Lesson Learnt from Jiangdu Case (contd)
While the widely reported circular 698 case in Jiangsu is the poster child of tax planning subject to the attack of circular 698, it is expected much of the controversy surrounding circular 698 will come from the fact that the broad language of the circular leaves a great deal of room for interpretation. For example, whether the PRC tax authorities will allow access to a relevant treaty once an offshore transaction is recharacterised into an onshore transaction; whether the buyer of the offshore holding company can obtain a step-up basis in the Chinese subsidiary after the re-characterisation; and when an offshore transaction is recharacterised as a direct transfer of the Chinese subsidiary, whether the foreign investor can claim tax-free treatment for the deemed direct transfer under the relevant tax-free reorganisation rules.
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September 2011
Although there are many grey areas under circular 698 as discussed above, the issue that gives rise to most concerns might be the interpretation of reasonable commercial purpose. While Article 6 of circular 698 permits the tax authorities to disregard the existence of the intermediate holding company and to recharacterise the transfer of its shares as a direct transfer of the shares of the underlying Chinese company where the foreign investor has avoided taxation in China through the abuse of organisational form and without a reasonable commercial purpose, it does not define the meaning of these three factors.
214
September 2011
Under generally accepted international tax principles, reasonable commercial purpose and economic substance are two distinct concepts. Yet, it has been observed a tendency in practice for these two concepts to be conflated, with the emphasis on economic substance as being determinative of reasonable commercial purpose. For example, it may be the case that an offshore holding company that does not have any economic substance may have been established for tax-efficient financing or cash pooling purposes, or for other non-PRC tax planning purposes (some jurisdictions have relatively more sophisticated corporate governance required for the parties). Without any guidance from the SAT, much of this is just speculation and would result in endless disputes between the taxpayers and the local tax bureaus.
215
September 2011
If China were to reach up five or six tiers to a transaction that arguably has a reasonable commercial purposes as part of an internal restructuring to achieve non-Chinese tax benefits and efficient financing flows; might a taxpayer have no choice but to look at dispute resolution with an end game of competent authority where the numbers involved are large?
Source
Baker & McKenzie, Tax Disputes Gradually Becoming a Reality in China, Client Alert, April 2011, pp.5-6.
216
September 2011
Henan Case
217
In August 2010, the local tax authorities in Henan Province initiated an investigation against a USbased investment bank. The investigation also involves capital gains tax relating to transfers of shares in non-resident companies that in turn held, directly or indirectly, shares of a Chinese publicly listed company. Compared with the Jiangdu case, the factual background and holding structure of the Henan case is far more complicated. Moreover, a greater number of parties are involved at different layers of the holding structure, and the potential tax exposure may be even higher than in the Jiangdu case. AF4222_L3 Special Tax Adjustments September 2011
Henan Case (contd)
The indirect transfer of equity of the Chinese company was achieved by a series of offshore restructuring and transfers, some of which occurred before 1 January 2008, i.e., before the new Corporate Income Tax Law and its antiavoidance rules took effect [Circular 698 also took effect retrospectively on 1 January 2008]. Therefore the timing of the transfers also adds to the uncertainty about the outcome of this investigation. The Henan case is still under investigation, and the tax authorities have not issued any decision.
218
Recent Developments for Circular 698 and Interpretations / Clarifications
The SAT released the Bulletin Concerning Certain Issues Related to Taxation of Non-resident Enterprises (NREs) (SAT Bulletin [2011] No. 24, Bulletin 24)1 on 28 March 2011 to clarify Circular 698 (i.e., Guoshuihan [2009] No. 698, the well-known notice regarding taxation of indirect equity transfers of Chinese subsidiaries by NREs) and certain other tax issues related to NREs. Although Bulletin 24 only became effective on 1 April 2011, it is set to have retroactive effect to determine the tax treatment of any transaction that occurred after 1 January 2008 and before 1 April 2011 unless the tax authorities have already ruled on the transaction. Another retroactive rule being issued well over two years from its effective date. The full text of Bulletin 24 is available at: http://www.gzds.gov.cn/xwzx/zxfg/201104/t20110414_808178.htm (in Chinese).
219
September 2011
Recent Developments for Circular 698 and Interpretations / Clarifications (contd)
If an NRE directly transfers the shares of a Chinese enterprise and receives payment in installments, the NRE must recognize the entire amount of the capital gain when the relevant contract becomes effective and the share transfer registration procedures have been completed.
220
September 2011
The rules on the direct transfer of a Chinese enterprise do not apply to shares bought and sold in a public securities market. Bulletin 24 provides that in order to qualify as shares of a Chinese enterprise bought and sold in a public securities market, the subject, quantity and price of the transaction must be determined based on the normal trading rules of the public securities market instead of by private agreement between the buyer and the seller.
221
Bulletin 24 also defines foreign investors (actual controlling party) for indirect transfers of Chinese subsidiaries under the Articles 5, 6, and 8 of Ciruclar 698 to include all the investors that indirectly transfer the shares of the Chinese enterprise.
222
September 2011
Actual tax burden under Article 5 of Circular 698 refers to the actual tax burden of the gains from share transfer, and not being subject to enterprise income tax under Article 5 means that the gains from share transfer are not subject to enterprise income tax.
223
September 2011
Under Circular 698, reporting obligations will arise if either of the following conditions is met: The actual tax burden in the jurisdiction of the target company (i.e., the intermediate holding entity to be transferred) is lower than 12.5%; or The jurisdiction of the target company does not tax its residents on foreignsourced income. Bulletin 24 has put a new spin on these conditions by further defining the terms actual tax burden and does not tax. Now, after Bulletin 24, the conditions triggering a reporting obligation under Circular 698 should be interpreted to be: The actual tax burden on capital gains in the jurisdiction of the target company (i.e., the intermediate holding entity to be transferred) is lower than 12.5%; or The jurisdiction of the target company does not tax its residents on foreignsourced capital gains.
224
When two or more foreign investors indirectly transfer shares of a Chinese enterprise at the same time, they can entrust one of the foreign investors to report the transfer to the competent tax authorities where the transferred Chinese enterprise is located.
225
September 2011
If an offshore transaction indirectly transfers the shares of two or more Chinese enterprises that are located in different provinces (or municipalities), the foreign investor may choose to report the transfer to one of the competent tax authorities (thus Bulletin 24 will reduce compliance burdens for foreign sellers by permitting a foreign seller to make a consolidated reporting in one location). However, if the transaction is taxable, then separate tax payments should be made to the respective local tax authorities.
Source Baker & McKenzie, Recent Developments for Notice 698,China Tax Monthly, April 2011, pp.1-3.
226
September 2011
Shantou Case
An interesting Circular 698 case was recently released (Shantou case) that shows the tax authorities willingness to launch a Circular 698 investigation based on unofficial information The Shantou Municipal State Tax Bureau (SMSTB) used publicly available information from the Internet describing an offshore transaction involving a Shantou operating company in November 2010 and launched an investigation. The investigation revealed that a BVI company (BVI Seller) sold a wholly owned BVI subsidiary (BVI 1), which through a number of other holding companies owned a Shantou company (Shantou Co), to another BVI company (BVI Buyer), namely BV1 Seller BVI 1 BVI 2 HK Co. Shantou Co. BVI Seller made the transfer of shares in BVI 1 to BVI Buyer (which is owned by a Hong Kong listing company. All companies are within the same group.
227
September 2011
Shantou Case (contd)
The SMSTB concluded that the existence and use of all of BVI 1, BVI 2 and HK Co lacked a reasonable commercial purpose and the offshore transfer of BVI 1 should be deemed as a direct transfer of Shantou Co. Therefore, the offshore transfer should be subject to PRC capital gains tax. The result was that BVI Seller paid a capital gain tax of RMB 7.2 million (approximately USD 1.1 million) to the SMSTB at the end of March 2011.
228
September 2011
According to the news report in the China Taxation News (Reported on China Taxation News on 11 May 2011 (http://www.ctaxnews.net.cn/html/201105/11/nbs.D340100zgswb_01.htm), the SMSTB relied on the following key factors for imposing tax on the offshore transfer: (1) neither BVI nor Hong Kong taxes its residents on foreign-sourced income; (2) BVI 1, BVI 2 and HK Co are all special purpose vehicles (SPVs) that do not have any other business or investments except the investment in Shantou Co; and (3) BVI 1 and BVI 2 were both newly established in July 2009 and could not provide any evidence to show a reasonable commercial purpose.
229
This case is particularly interesting because the foreign seller was four tiers above the Chinese subsidiary and yet was still caught by the PRC tax authorities. The SMSTB obtained the initial information on the offshore transfer from the Internet. It is another good example of the PRC tax authorities launching investigations on offshore transactions involving Chinese subsidiaries based on information collected from other channels even though the non-resident sellers have not voluntarily reported the offshore transactions under Circular 698.
230
September 2011
Substantively, however, the Shantou case adds little to the understanding of Circular 698 because the facts of the case were indisputable that all the intermediate holding companies were SPVs with presumably little reasonable commercial purpose outside of avoiding PRC tax. Therefore, this case provides little insight into the more difficult questions raised by Circular 698, such as what constitutes a reasonable commercial purpose and what is the relationship between reasonable commercial purpose and economic substance. Also, as the Shantou case was decided before Bulletin 24 was issued (28 March 2011), it is of no help in interpreting Bulletin 24s effect on the reporting obligations under Circular 698 that have been repeatedly addressed. Source Baker & McKenzie, Recent Developments for Notice 698,China Tax Monthly, April 2011, pp.3-5.
231
Individual Income Tax: Capital Gain from Indirect Share Transfer
In June, the first case in which a local tax bureau imposed individual income tax (IIT) on capital gains derived by a Hong Kong individual from the indirect share transfer of a Chinese entity became publicly available. A local tax bureau in Shenzhen successfully attacked an indirect share transfer of a Chinese entity carried out by a Hong Kong individual transferor and collected IIT in an amount of RMB 13.68 million. The Hong Kong individual had transferred his shares in a Hong Kong company (HK Holdco), which in turn was the sole shareholder of a Shenzhen logistics company (WFOE), to a Singapore company in return for more than RMB 200 million. The tax bureau found the following facts:
232
September 2011
Individual Income Tax: Capital Gain from Indirect Share Transfer (contd)
the HK Holdco was a shell company that did not have any business operations, and its actual business activities were mainly carried out by the WFOE; the registered capital of the HK Holdco was only HK$10,000; the only asset of the HK Holdco was the shares of the WFOE; the WFOE had been incorporated in 2000 and had acquired logistics facilities (apparently including real property); the value of the WFOEs assets had appreciated substantially because of the growth in the real estate market; and the price for the HK Holdco shares was based on the appraised value of the WFOEs assets.
233
September 2011
The case report did not explain the legal basis for the decision to levy tax. The factors listed above cited by the tax bureau the report suggest that they applied the general anti-avoidance principles (GAAR). However, the IIT laws and regulations in China do not contain the GAAR; it is found only in the enterprise income tax law and regulations. Moreover, the Chinese regulation that gives the tax authorities the power to tax indirect share transfers, Circular 698,3 is part of the enterprise income tax framework.
234
September 2011
An alternative explanation for the decision in the case is that the tax bureau relied on the double tax arrangement between mainland China and Hong Kong (the DTA). Pursuant to Article 13(4) of the DTA, gains derived from the transfer of shares in a company whose assets, directly or indirectly, mainly comprise immovable property situated in China may be taxed in China. The term mainly is defined as no less than 50%. Therefore, if at least 50% of the value of the HK Holdco arose from the WFOEs real property, the DTA would permit the tax authorities in China to levy tax. At this stage, insufficient information is available to confirm this explanation. Furthermore, even if the DTA would permit taxation, there is still a question as to whether domestic law in China empowers the tax authorities to levy tax on an individual in this situation. Source Baker & McKenzie, Individual Income Tax: Capital Gain from Indirect Share Transfer, China Tax Monthly, June 2011, pp.4-5.
235
Administrative Systems for Special Tax Adjustment
On 23 February 2010, the SAT released Goushuihan [2010] No. 84 entitled Notice of Briefing on Anti-tax Avoidance Work in 2009. The targets of the 2010 anti-tax avoidance work was to establish a work system for special tax adjustment. It intended to enhance the coordination and implementation of special tax adjustments including the administration of Advance Pricing Arrangement, Mutual Agreement procedure (MA), as well as a joint review procedure for significant special tax adjustment investigation. Final design of the Systems was subject to the SATs decision.
236
Administrative Systems for Special Tax Adjustment (contd)

Reinforcement of the leadership of the SAT and nationwide consistency Information-sharing and inter-departmental cooperation Information collection in special tax adjustment investigation Follow-through administration of special tax adjustments Negotiation and implementation of APA Development of professional special tax adjustment teams
Source Ernst & Young, China Transfer Pricing Headlines New Development of Administrative Systems for Special Tax Adjustment, Tax Alert, 22 March 2011
237
September 2011
(1)
(2)
(3)
On 25 March 2011, the SAT released Guoshuihan [2011] No. 167 which reports the 2010 anti-tax avoidance work conducted by the SAT and the 2011 work plan. Circular 167 lists out the details of enforcement of anti-tax avoidance work in 2010 from three aspects, i.e., administration, service and investigation, with the following key points: There were 324 taxpayers transfer prices or tax planning models were adjusted during the TP administration in 2010, and tax liabilities of RMB7.168 billion were raised accordingly. Tax liabilities of RMB796 million were raised through the services of both advanced pricing arrangement (APA) and mutual agreed procedure (MAP). By deepening the TP investigation by focusing on large-scale MNEs, there were tax liabilities of RMB2.308 billion raised from the TP investigation.
238
September 2011
(1)
(2)
(3) (4)
(5) (6)
In Circular 167, the SAT also lists out the details of work plans for year 2011: Establish anti-tax avoidance work system from the aspects of administration, service and investigation Trial run of expert committee for each anti-tax avoidance case Expand anti-tax avoidance scope Promote the application of quantitative analysis method and establish a team of economic analyst Understand the pattern of tax avoidance in specific industries Regulate the management of funds for anti-tax avoidance
239
September 2011
(1) (2) (3)
(4)
(5)
(6)
Moreover, Circular 167 specifically calls for expanding the anti-tax avoidance work in he following areas: Domestic enterprises with outbound investments Processing trade and tertiary-industries such as banking and trading Related party transactions on share transfer, intangible asset transfer as well as financing, etc. Enterprises in southeastern coastal areas as well as that in central and southern areas TP administration strengthening and formulations of new regulations regarding the general anti-tax avoidance rules and rules in respect of cost sharing, controlled foreign companies and thin capitalization Tax planning through offshore costs sharing, financing structuring, holding structure and use of tax heaven, etc.
Note: Circular 167 can be accessed at http://blog.sina.com.cn/s/blog_62a6573d0100stav.html
240
September 2011
(1)
(2)
(3)
(4)
On 16 August 2011, the Jiangsu State Administration of Taxation provided some insights into the future path of anti-avoidance in Jiangsu province: Strengthen academic training in transfer pricing and enhance cross-regional communication Strengthen industry-wide joint investigation efforts and expand investigation (e.g. only focus on key enterprises and conduct comprehensive investigations of the industries such as liquid crystal display (LCD), battery and communications industries, focus on transfer pricing issues of large enterprises with large domestic related party transactions, domestic enterprises with outbound investments, and enterprises involved in equity transfers among related parties, focus on the split of profit along the supply chain, etc) Review transfer pricing documentation and perform special investigations on functions and risks Willing to accept administrative appeals
241

PricewaterhouseCoopers, 2009, Unveiling of Long-awaited Special Tax Adjustments Implementation Measures, Issue 1, January, Hong Kong PricewaterhouseCoopers, 2008, Thin Capitalization Ratios, Issue 10, October, Hong Kong Ernst & Young, 2009, China Transfer Pricing: Guoshuifa [2009] No. 2: Implementation Measures for special tax adjustments (the Final Measures), 9 January, Hong Kong Ernst & Young, 2008, China Upfolds thin capitalization ratios, 24 October, Hong Kong Ernst & Young, China Transfer Pricing Headlines New Development of Administrative Systems for Special Tax Adjustment, Tax Alert, 22 March 2011 Ernst & Young, The 2010 Anti-tax Avoidance Work Report, China Tax & Investment Express, Issue 15, 15 June 2011 KPMG, 2009, Effect of the Administrative Regulations on Special Tax Adjustments on Transfer Pricing in China, Issue 1, January, Hong Kong Deloitte Touche Tohmatsu, 2008, Thin Capitalization Threshold Announced, Tax Analysis, Issue P30/2008, 15 October, Hong Kong Tsoi, A. and Poon, K. (2010), China homes in on offshore equity transaction, A Plus, May, pp. 38-40. Bowdern, D. et. al. (2010), Circular 698 shows its teeth, A Plus, September, pp. 42-44. Baker & McKenzie, 2010, China Tax Monthly, October. Baker & McKenzie, Tax Disputes Gradually Becoming a Reality in China, Client Alert, April 2011, pp.5-6. Baker & McKenzie, Recent Developments for Notice 698,China Tax Monthly, April 2011, pp.1-5. Baker & McKenzie, Individual Income Tax: Capital Gain from Indirect Share Transfer, China Tax Monthly, June 2011, pp.4-5. Publications in websites from Big 4 and other professional firms (as of September 2011)
242
September 2011
Lecture No. 4 Tax Incentives for HNTEs and ATSEs
Outline
Preferential tax treatment for High/New Technology Enterprises (HNTEs) Preferential tax treatment for Software Production Enterprises (SPEs) and Integrated Circuit Enterprises (ICEs) Preferential tax incentives for Advanced Technology Service Enterprises (ATSEs) Tax Planning Ideas
I. II.
III. IV.
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AF4222_L4 Tax Incentives for HNTEs and ATSEs
September 2011
I. Preferential tax treatment for

High/New Technology Enterprises (HNTEs)
24 5
September 2011
High/New Technology Enterprises (HNTEs)
New CIT Law and Detailed Implementation Rule of CIT Law specific articles regarding the tax benefits for HNTE effective from 1 January 2008 Guofa [2007] No. 40 (26 December) transitional arrangement on preferential tax treatment for HNTE Guokefahuo [2008] No. 172 (14 April 2008) administrative measures on HNTE recognition and Catalogue of Key HighNew Technological Territories Supported by the State Guokefahuo [2008] No. 362 (8 July 2008) guidelines on HNTE recognition and management http://www.most.gov.cn/tztg/200807/t20080711_63012.htm
Guoshuihan [2009] No. 203 (22 April 2009) Notice of the Relevant Issues Concerning the Preferential CIT Policies on HNTEs
24 6
September 2011
Key Preferential Tax Treatments (see Lecture No. 2)

Forms of Incentives (3) Reduced tax rate Industrial sector / activities High/New Tech Enterprises (HNTEs)
Detailed treatment and criteria in the DIR 15% Applicable to the whole companys income Criteria for qualification include: - Ownership of core proprietary intellectual property rights - Products/services fit into specified scope - Ratio of R&D expenditure against total income - Ratio of high/tech income against total income - Ratio of no. of technical staff against total no. of staff Rules for assessment to be released jointly by Ministry of Science and Technology, MOF and SAT later
24 7
September 2011
Criteria for HNTEs under CIT DIR

Holding an independent ownership of core proprietary IP rights; The products or services fall within the specific Scope of State-encouraged High-new Technologies; The ratio of research and development expenditures to the enterprises total income shall not be less than the ratio stipulated; The ratio of income from high-new technology products or services to total income shall not be less than the ratio stipulated; The percentage of employees working in the science and technology field against the total number of staff shall not be less than the ratio stipulated; and Other rules for assessment or conditions stipulated by the verification and administrative measures over high-new technology enterprises jointly by Ministry of Science and Technology (MOST), Ministry of Finance (MOF) and SAT.
24 8
September 2011
Grandfathering Treatments Geography-based Tax Incentives under the CITL
24 9
Guofa [2007] No. 40 Notice on the Implementation Rules of the Grandfathering Relief in respect of High and New Technology Enterprises in Special Economic Zones and Shanghai Pudong New Area (26 December 2007) by the State Council According to Article 57 of the CIT Law, High/new Tech Enterprises newly established on or after 1 January 2008 in six zones (5 SEZs and Pudong New Area) can enjoy a 2+3 tax holidays with the following: Half reduction period: 25%/2 12.5% (not 7.5%) From the 1st business income generating year Only applicable to profits generated in these areas (separate accounts for income and expenses from businesses inside and outside the zone)
AF4222_L4 Tax Incentives for HNTEs and ATSEs September 2011
Summary - Tax Benefits for HNTE under New CIT Regime

Preferential CIT rate 15% on an entire entity basis (Article 28 of CITL) starting from the tax year where the HNTE status is obtained New HNTE located in SEZs (i.e., Shenzhen, Zhuhai, Shantou, Xiamen and Hainan) and the Shanghai Pudong New Area established on or after 1 January 2008, will enjoy a tax holiday of 2-year exemption and 3-year half deduction (Article 57) starting from the first year the HNTE derives its operation income Deduction of taxable income of venture capital that makes investment in unlisted small and medium sized HNTEs (Article 31) 70% of investment creditable against its taxable income, with indefinite carryforward. According to Caishui [2009] No. 69 (24 April 2009), it gives clarification regarding the recognition criteria of medium-or-small-sized advanced and new technology enterprises and whether investment in advanced and new technology enterprises recognized before the end of 2007 qualifies for the relevant tax incentives.
25 0
September 2011
Other Technology-related Tax Incentives
25 1
Income from qualified technology transfer CIT income exempt / reduced for TRE transferors only R&D expenses super deduction (Article 95, DIR), and - cost sharing arrangement Depreciation methods of fixed assets - depreciation over shorter period - adopt of accelerated depreciation methods
What is It?
The new assessment rules appear to be more stringent than the previous rules based on the following prevailing regulations: Administrative Measures for Assessment of HNTE (Measures) - Guokefahuo [2008] No. 172 Catalogue of High/New Tech Domains Specifically Supported by the State (Catalogue) Working Guidelines for the Administration of the Assessment of HNTE (Working Guidelines) Guokefahuo [2008] No. 362 Effective date from 1 January 2008
25 2
Who to Apply?
Requirements on the Applicants Identity
Legal identity Resident enterprises registered in China (excluding Taiwan, Hong Kong and Macau) (No foreign companies such as ROs, R&D centres or divisions) Enterprises established for more than one year (in the mainland China) No geographical restriction (Enterprises in all locations are able to apply for HNTE status)
September 2011
Years of establishment Geographical scope
25 3
How to Qualify?
Main Theme of HNTEs (Article 2 of the Measures) HNTEs . continuously conduct research and development and transform the technological achievements, form their own proprietary intellectual property rights and carry on business activities within the scope of the (Catalogue) based on these attributes.
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September 2011
Six Criteria for HNTE Status under Circular 172 (The Measures) and Circular 362 (The Working Guidelines)
(1) (2) (3) (4) (5)
(6)
Intellectual Property (IP) ownership Products / Services Staffing R&D spending Qualified revenue Other requirements
25 5
September 2011
Criterion 1. Ownership of Core Proprietary IP Rights

Obtained through: (1) Self-R&D, transfer / purchase, assignment, donation, M&A etc. in the last 3 years (must be registered in China); or (2) Exclusive license for at least or more than 5 years - Exclusively on worldwide basis (not just Mainland China)*
* This requirement may turn out to be difficult for a foreign investment company whose overseas parent company wishes to retain IP rights. No other party including the technology supplier shall be permitted to use the licensed technology. Ownership of IP right by a PRC enterprise is usually not an option for foreign investors.
The validity of HNTE status should fall within the valid period of the exclusive license AND the IP rights of core technology should be associated with the main operation and for its main products or services
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September 2011
HNTE Related Intellectual Property (IP) Rights

Invention patent (relating to a product or process, valid for 20 years) Utility model patent (relating to the shape and/or structure of a product, valid for 10 years) Design patent (excluding simple change of product pattern or design; relating to the shape, pattern and/or colour of the product, valid for 20 years) Software copyright (* Software is not patentable in China.) Trade secrets IP Rights in IC design New plant varieties (cultivated artificially or developed from discovered wild plants, possess novelty or distinctiveness, consistency and stability) Know how and other non-registerable IP may not be recognized as core IP rights
25 7
September 2011
Criterion 2. Products / Services Fall into the 8 Encouraged Domains

1) 2) 3)
4)
5) 6) 7) 8)
Electronic information technology Biological and new pharmaceutical technology Aviation and aerospace technology New material technology High technology service industry New energy and energy conservation technology Resources and environmental technology High and new technology for traditional industries innovation
Note: Please refer to the Catalogue for the details of 218 items at http://www.chinatax.gov.cn/n480462/n480513/n480902/n7827192.files/n7827185.doc
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September 2011
Criterion 3. Headcount of Scientific Technology Staff and R&D Staff

No. of scientific technology personnel / Total headcount > 30% and No. of R&D personnel / Total headcount > or = 10% The personnel must: 1) Be with college degree (associate degree)* and above, 2) Engage in the respective disciplines (engaged in scientific technological activities, R&D projects etc.), 3) Be full time or part-time with more than 183 days on duty.
-
In China, an associate degree refers to a 3-year post-secondary course leading to a certificate, and not a bachelor degree.
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September 2011
Criterion 4. Qualified R&D Expenditures Reaching the Prescribed Percentage of Total Revenue for the Past Three Years (or Actual Operating Period)
-
Percentage
Revenue (in RMB) Revenue < 50M 50M < Revenue < 200M 200M < Revenue % > or = 6% > or = 4% > or = 3%
R&D expense incurred within China / total R&D expenditure > 60% 80% of outsourcing R&D accountable as qualified R&D expenditure Other relevant expense / total R&D expenditure < 10% Detailed R&D expense accounts required
26 0
September 2011
Qualified R&D Expenses under the Working Guidelines

Payroll expenses of employees engaged in R&D activities Direct costs Depreciation expenses and amortization of long term expenses Design expenditure Equipment and installation expenses Amortization of intangible assets Out-sourced R&D projects expenditure relevant to the companys business (N.B. The R&D results should be owned by the company and only 80% of such expenses can be included) Other expenses (capped at 10% of the total R&D expenses)
26 1
Criterion 5. Income from High/New Tech Product/Service > or = 60% of Total Annual Income
High/New Tech product/service should fall into the encouraged domains Income from High/New Tech product/service includes the technology related income from Technology transfer; Technology contracting; Technical services; Testing or sample products; and Performing the R&D activities for third parties.
26 2
September 2011
Criterion 6. Scoring More Than 70 in a 100-point Score System Based on the Following Parameters as Evaluated under Guokefahuo [2008] No. 362
Weighted Factors Core Proprietary IP Rights Transformation Capability from Technology to Practice (i.e. for converting R&D outcome) Quality of R&D organization and management Growing Potentials (for capital and sales) In total
Full Value 30 points 30 points
20 Points 20 Points 100 Points

September 2011
26 3
Criteria 6. Six-Level Grading System for Each Parameter

Level A: 80% - 100% Level B: 60% - 79% Level C: 40% - 59% Level D: 20% - 39% Level E: 1% - 19% Level F: 0
The total score of the enterprise is the summation of the scores in each parameter. The score-card system is not an overall assessment for the first five criteria, but an additional requirement with the aim to guide enterprises to develop their own new/high technology.
26 4
September 2011
HNTE Application Procedures

1. 2. 3.
4. 5. 6. 7.
Self-assessment Online registration (HNTE website at http://www.innocom.gov.cn) Physical submission of documents (Business license, tax certificate, IP certificates, exclusive IP licensing agreements, 3-year audited financial statements, R&D expenses and activities statements certified by qualified intermediary agencies) Assessment by recognized institutions (within 60 days) Public opinion solicitation (listed on-line for 15 working days) Issuance of HNTE certificate (if no objection)* Application for 15% CIT rate (valid through three years; reassessment for beyond three years )
* Any company whose HNTE certificate is cancelled for various reasons is banned from applying for a new HNTE certificate for a period of five years.
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September 2011
Assessment Institutions
National level:

Ministry of Science and Technology (MOST) Ministry of Finance (MOF) State Administration of Taxation (SAT)
Provincial or equivalent levels: their subordinate divisions Assessment should be carried out at provincial or equivalent levels No delegation to lower-level assessment institutions Also responsible for the supervision and inspection of HNTEs
26 6
What are the Challenges?

26 7
Core proprietary IP right (due to global IP management strategy, especially for MNCs) Headcount of scientific technology / R&D personnel (due to the corporate / operational structure) Qualified R&D expenditures (due to mega-size sales revenue) R&D outcome may not be self-owned (in case of contract R&D) Look back requirement (3 years prior to 2008) Score-card system is most difficult as it is a live examination
What are Your Actions?

Inform HQ/Parent companies/IP right centres about this new HNTE doctrine and get direction and assistance Form a local taskforce of departments of Tax/Accounting/Finance/IP Rights/HR/R&D/Legal/government Affairs/External advisors to deal with different aspect Carry-out self-assessment in accordance with detailed Criteria in the Working Guidelines Follow up closely with local-level Assessment Institutions/local governments for their latest positions, policies and procedures Stay tune on new policies/clarifications, if any
26 8
September 2011
Existing HNTEs under the Old CIT Regime
For companies located inside or outside High-Tech Industrial Development Zones approved by the State Council (including the Beijing New Technology Development Zone) and qualified as HNTEs under the old CIT regime, their HNTE statuses are still valid until expiry (see Guofa [2007] No. 39). Not automatically entitled to new preferential tax treatments prescribed under the new CIT regime unless they are reaccredited with the new HNTE statuses. Existing HNTEs can apply for the new HNTE status before the expiry of the old status or can wait until the expiry. They can apply for the new HNTE status in order to enjoy the lower CIT rate of 15% as early as possible.
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Guoshuihan [2009] No. 203 (22 April 2009) Notice of the Relevant Issues Concerning the Preferential CIT Policies on HNTEs
Transitional tax treatments on HNTEs (1) If an enterprise was recognized as an HNTE and was entitled to the preferential tax incentives pursuant to the old FEIT/EIT regulations, the tax incentives shall be grandfathered until their expiry date, provided that the enterprise is recognized as an HNTE under the new CITL. (2) If an enterprise established between 1 January 2006 and 16 March 2007* was recognized as an HTNE under the old FEIT/EIT regulations, and if the enterprise was in a cumulative loss position as at the end of 2007, the enterprise shall be allowed to enjoy the tax incentives entitled under the old regulations from 1 January 2008, provided that the enterprise is recognized as an HNTE under the new CITL. * Not established between 16 March 2007 and 1 January 2008
27 0
Guoshuihan [2009] No. 203 (22 April 2009) Notice of the Relevant Issues Concerning the Preferential CIT Policies on HNTEs (Contd)
Administrative measures for HNTEs (1) An HNTE shall be allowed to enjoy the preferential CIT treatments starting from the year that the HNTE status is recognized. (2) Eligible enterprises shall proactively apply for the tax incentives with the tax bureau in charge by providing the HNTE certificates and other required documents. (3) An HNTE shall submit the required documents to the responsible tax bureau for record keeping purposes before the annual CIT filing deadline each year. (4) Where the conditions for qualifying as an HNTE have been changed, the enterprise shall report to its responsible tax bureau (within 15 days upon changes). If the enterprise no longer qualifies as an HNTE, it shall pay tax according to the relevant laws and regulations.
27 1
September 2011
PRC Local Practices

-
Relaxation of qualifying criteria to attract investment in local jurisdictions For example: Acquisition of IPs which are not relevant nor useful to the enterprises main operation Some local rules provide second review of the HNTE application and granted the HNTE status in the second review to disqualified enterprises (e.g. Shanghai) Intermediary professional firms that issue false audit reports
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PRC Local Practices (Contd)

Central government review of HNTE status for certain jurisdictions Initially, five jurisdictions: Beijing, Shanghai, Hainan SEZ, Guangdong and Liaoning As a result of the review process, certain enterprises may see their HNTE status revoked Intermediary professional firms that issue false audit reports may also be punished (i.e. R&D expenditures) They may propose an on-going annual review process to review HNTE status to be expanded to other jurisdictions
27 3
HNTE Statistics

HNTEs (31 December 2007) (restricted to Hi and New Technological Zones): 56,047 HNTEs (31 December 2008) (national-wide): around 51,000 (including 15,541 through the new recognition guidelines and the remaining from those still qualified under the old rules) In Beijing, HNTEs: around 3800 (as of August 2009) (rank 1st) (Source: http://www.chinatax.gov.cn report on 28 August 2009) According to the website www.stcsm.gov.cn of Science and Technology Commission of Shanghai Municipality as of 30 July 2009, 1,812 enterprises in Shanghai have secured HNTE status in 2008, of that, 408 FIEs are certified, accounting for 22.7%.
27 4
September 2011
Disqualification of HNTEs in Beijing
On 30 July 2010, the HNTE Recognition and Administrative Office issued a notice regarding the disqualification of the HNTE status of 26 companies in Beijing. The notice lists the names of the disqualified HNTEs and their HNTE certificate numbers. According to the notice, the disqualified HNTEs failed to meet the requirement stipulated in the Administrative Measures on HNTE Recognition and were discovered during the specific finance inspections conducted by the MOF in the year 2009.
27 5
September 2011
HNTE Qualification Could be Revoked if

Have provided false information in the process of the HNTE application; Have committed tax evasion or tax fraud; Have major accidents occurred related to work safety or work quality; and Have been penalized by competent authorities for violating the laws and regulations concerning environmental protection.
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* The application of the HNTE status of the same entity cannot be accepted by the relevant authorities within five years.
Applicable Tax Rate and Foreign Tax Credits for Overseas-sourced Income of HNTEs
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On 31 May 2011, the MOF and the SAT jointly issued Caishui [2011] No. 47 clarifying the CIT rate applicable to foreign-sourced income derived by HNTEs. The salient points specified by Circular 47 are summarized below: (1) For recognized HNTEs, a preferential CIT rate of 15% could be applicable to their foreign-sourced income and be used to calculate the total tax payable on total income when calculating the limitation of foreign tax credit (FCT). (2) Other than the preferential CIT rate stated above, HNTEs should follow the treatments set out in Caishui [2009] No. 125 and the SAT Announcement [2010] No. 1 that provide procedural guidelines on FCTs related to foreign-sourced income. Circular 47 took effect on 1 January 2010.
Applicable Tax Rate and Foreign Tax Credits for Overseas-sourced Income of HNTEs (contd)
In general, foreign-sourced income derived by China enterprises cannot enjoy CIT preferential treatment. The rules in Announcement 1 that provided further detailed guidance on FCT for foreign-sourced income indicate that the applicable tax rate in calculating the FCT limit shall be the standard CIT rate, i.e.. 25% even though domestic income is eligible for tax benefit. Meanwhile, it also opens a door for relevant authorities to formulate rules of applying for the preferential tax rate applicable to domestic income to foreign-sourced income of China enterprises. Circular 47 can be accessed at: http://www.cd12366.gov.cn/art/2011/6/7/art_6481_282.html
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September 2011
Applicable Tax Rate and Foreign Tax Credits for Overseas-sourced Income of HNTEs (contd)
[Example] A qualified HNTE derives China-sourced income of RMB100 million and foreign-sourced income of RMB2 million, on which the HNTE has paid income tax RMB0.4 million overseas. From 1 January 2010 (based on Circular 47), Total tax payable on total China and foreign sourced income (100 + 2) x 15% = 15.3 Limitation of FCT 15.3 x [2/(2 + 100)] = 0.3 < 0.4 CIT payable (100 + 2) x 15% - 0.3 = 15 Source Ernst & Young, Applicable tax rate and foreign tax credits for overseas-sourced income of HNTEs, China Tax & Investment Express, Issue No. 2011017, 4 July 2011
27 9
September 2011
II. Preferential tax treatment for

Software Production Enterprises (SPEs) and Integrated Circuit Enterprises (ICEs)
28 0
September 2011
Software Production Enterprises (SPEs)

28 1
Preferential treatment under Caishui [2008] No. 1 (22 February) The SPE recognition criteria under the new CIT law remains the same as specified in Circular Xin Bu Lian Chan [2000] No. 968 Full deduction of qualifying training expenses for CIT purposes Customs Duty and VAT exemption at import level granted for qualifying import equipment A 5-year CIT tax holiday - 2-year exemption and 3-year half reduction for newly established SPEs from first profitable year (Note: Companies that have enjoyed a 2+3 holiday before are not eligible for the tax holiday under this circular.) CIT rate of 10% for Key nationally designated SPEs if tax exemption is not utilized Reinvestment tax refund will continue to apply to reinvestment in relation to IC production and assembly companies in general and software products production companies newly set up in the Western Region.
Fagaigaoji [2009] No. 3357 (31 December 2009) List of Qualifying Key Software Enterprises under the States Planning of Year 2009
On 31 December 2009, four central government authorities jointly published a list, containing 186 qualified Key Software Enterprises of 2009, for such CIT preferential treatment purpose as stipulated in Caishui [2008] No. 1 above. To access the full content of Circular 3357, click the link: http://www.ndrc.gov.cn/zcfb/zcfbtz/2009tz/t20100108 _323653.htm
28 2
Qualifying Key Software Enterprises Update
28 3
On 21 February 2011, the NDRC, the Ministry of Industry and Information Technology, the MOC and the SAT jointly announced a list included in Fagaigaoji [2011] No. 342, containing 240 qualified key software enterprises under the states plan of year 2010 (Key Software Enterprises), allowing them to enjoy the relevant CIT benefits. Circular 342 reiterates that qualified key Software Enterprises are allowed to be eligible for a reduced CIT rate of 10% in case they fail to enjoy a lower tax rate than 10% for the current tax year. http://www.sdpc.gov.cn/zcfb/zcfbtz/2011tz/t20110223_396384. htm
Integrated Circuit Enterprises (ICEs)

Preferential treatment under Caishui [2008] No. 1 (22 February) Same tax holidays as SPEs Preferential tax rate of 15% under certain conditions 5-year exemption and 5-year half reduction under certain conditions 2-year exemption and 3-year half reduction starting from its production period under certain conditions Companies that enjoyed a 2+3 holiday before are not eligible for the tax holiday discussed above Investors in IC production companies may enjoy a 40% CIT refund on reinvestment for the years from 2008 to 2010
28 4
September 2011
Caishui [2009] No. 69 (24 April 2009) Notice on Certain issues Concerning the Implementation of CIT
Software or integrated circuit enterprises Circular 69 clarifies the definition of newly-established software production enterprises set out in Article 1 of Caishui [2008] No. 1. Qualified software and IC production enterprises established before the end of 2007 are entitled to transitional CIT treatments in respect of tax holidays set out in Caishui [2008] No. 1. Enterprises which already started the tax holiday before 2008 can continue to enjoy the tax holiday until its expiry.
28 5
September 2011
More Tax Incentives to Software & IC Industries
According to Guofa [2000] No. 18 and Caishui 25 [2000] No. 25 for promoting the software and IC industries, for the 10 years up to the end of 2010, software products developed and sold by a general VAT payer are subject to the stipulated VAT rate of 17%, and an immediate levy, immediate refund policy was implemented whereby the portion of effective VAT burden in excess of 3% of the sales revenue would be immediately refunded to the VAT payer. To the extent that the VAT refund is used by the enterprise for research and development of software products and to increase production, it would not be treated as taxable income of the enterprise and thus not be subject to CIT. As the above-mentioned VAT refund policy expired at the end of 2010, many enterprises in the software industry were eagerly awaiting announcement on whether such policy would be extended beyond 2010.
28 6
September 2011
More Tax Incentives to Software & IC Industries (contd)
On 28 January 2011, the State Council issued Guofa [2011] No. 4, officially confirming the extension of this VAT refund policy and providing various incentives for the software and IC industries as follows. Circular 4 took effect from the date of issue.
Confirmed Existing Tax Incentives New Tax Incentives to be Introduced
Immediate Levy, Immediate Refund VAT policy for software enterprises 2+3 CIT holiday and 5+5 CT holidays for certain IC manufacturing enterprises meeting the prescribed criteria 2+3 CIT holiday for newly established software and IC design enterprises
BT exemption for qualified software/IC related services (e.g. development, design, consultancy, etc.) Reduced CIT rate for Key IC Enterprises under the States plan Policy to solve the cash-flow issue of large amount of input VAT for significant IC projects, which could not be credited timely CIT incentives for qualified enterprises engaging in IC packaging, testing, manufacturing of the key IC materials, manufacturing of specialized IC equipment
Source: PricewaterhouseCoopers, News Flash, Issue 4, March 2011
287
III. Preferential tax incentives for Advanced Technology Service Enterprises (ATSEs)
28 8
September 2011
Caishui [2009] No. 63 (24 April 2009) Tax Policies Concerning Advanced Technology Service Enterprises (ATSEs)
Background
The State Council, in Guobanhan [2009] No. 9 (15 January 2009) entitled Responses to issues Relating to Promoting the Development of the Service Outsourcing Industry, has approved 20 cities (e.g. Beijing, Tianjin, Shanghai, Chongqing, Dailian, Shenzhen, Guangzhou, Suzhou etc.) to be pilot service outsourcing cities, where a series of tax breaks, financial subsidies and other support will be granted to boost the growth of service outsourcing. MOF and MOC Cai Qi [2009] No. 44 Notice for the Management of Supporting Funds to International Service Outsourcing Business To implement the incentive programmes proposed on 15 January 2009 by the State Council, the MOF, the National Development and Reform Commission (NDRC), the SAT, the Ministry of Science and Technology (MOST) and the MOC have jointly formulated tax incentives for ATSEs and clarified the eligible service scope and recognition criteria under Caishui [2009] No. 63.
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September 2011
20 Pilot Service Cities under Guobanhan [2009] No. 9 (15 January 2009)
The 20 cities are: Beijing, Tianjin, Shanghai, Chongqing, Dailan, Shenzhen, Guangzhou, Wuhan, Harbin, Chengdu, Nanjing, Xian, Jinan, Hangzhou, Hefei, Nanchang, Changsha, Daqing, Suzhou and Wuxi.
Note: Xiamen was added by State Council in February 2010. So, there are now 21 model cities.
29 0
September 2011
Caishui [2009] No. 63 (24 April 2009) Tax Policies Concerning Advanced Technology Service Enterprises (ATSEs) (Contd)
Tax incentives
Qualified ATSEs established in the 20 pilot service outsourcing cities can enjoy the following tax incentives, which are valid during the period from 1 January 2009 until 31 December 2013.

Preferential CIT rate of 15% Pre-CIT deduction of actually-incurred staff education charges, up to a limit of 8% of the total payroll (normally 2.5%) Business tax exemption for offshore outsourcing service income
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September 2011
Business Tax Exemption for ATSEs

An enterprise may be entitled to a BT exemption provided that the enterprise satisfies all of the following three conditions:
(1)
The income must be earned by the enterprise for technology assignment, technology transfer, technology development or the provision of related technology consulting services; The relevant technology contract must be verified by the local technology organization where the technology licensee is located; and The verified technology contract must be submitted to the PRC tax authorities for record.
(1)
(1)
29 2
Caishui [2010] No. 64, 28 July 2010
According to Caishui [2010] No. 64, 28 July 2010, regarding the threshold lowered for business tax exemption on service outsourcing, it has expanded the scope of enterprises qualified for the above business tax exemption to cover all the enterprises registered in the 21 model cities (namely 20 model cities set out in Circular 63 plus Xiamen as added by State Council in February 2010) that are engaged in offshore service outsourcing provided to overseas entities. However, the service scope must be ITO, BPO or KPO as laid down in Circular 63 (see below). There are no certification requirements under Circular 64. That means an ATSE status is now not a pre-requisite for business tax exemption for these enterprises. The reduced preferential enterprise income tax rate of 15 percent might not be applicable to them if they have not obtained the ATSE status.
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September 2011
Eligible service scope
ATSEs in the following three categories of services (which replacing the five categories of businesses under the Suzhou Industrial Park pilot program*) can enjoy the aforesaid tax incentives: Information Technology Outsourcing (ITO) (e.g. software R&D services, software technical services of consulting, maintenance, training, testing, etc) Business Process Outsourcing (BPO) (e.g. design of operational flows, business internal control, business operations management and supply chain management, etc.) Knowledge Process Outsourcing (KPO) (e.g. R&D on IP rights, R&D and testing on medicine and biotechnology, R&D on product technology, industry design, analytics and data mining, etc.)
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September 2011
Eligible service scope (contd)
According to Caishui [2006] No. 147 On Supporting Policies of the Pilot Scheme to Encourage Development of High-Tech Service Enterprises in the Suzhou Industrial Park, the qualified high-tech services included (1) software research and development services, (2) product technology R&D and industrial design services, (3) information technology R&D services, (4) information technology outsourcing services and (5) technical process outsourcing services.
As mentioned aforesaid, these five categories have been consolidated into the three key categories of service under Circular 63, namely ITO,BPO and KPO.
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Eligible service scope (contd)
Circular 63 includes an appendix which details the scope of activities for each category, ITO, BPO and KPO in more details. e.g. Relevant services include IT and software-related services, data processing and management, R&D, business process design, etc. e.g. The scope of activities has been expanded compared to the pilot program; for example, ITO includes circuit design, and animation, online game R&D and educational courseware are newly added under KPO.
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September 2011
Recognition measures for ATSEs

Engage in one type or more of the advanced technology services prescribed above, i.e., ITO, BPO or KPO. Register and operate in a pilot service outsourcing city of the 20 cities. (Note: In addition to the 20 model cities set out in Circular 63, State Council added Xiamen as the 21st model city in February 2010.) Bear a legal person qualification (with sound corporate records) without any violation in import and export, finance and taxation, foreign exchange and customs administration in the past two years and enjoy a stable business growth. Adopt advanced technology or process a strong R&D capability. More than 50% (instead of 70% in the former Suzhou Industrial Park pilot program) of employees hold a college degree or above in accounting.
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September 2011
Recognition measures (contd)
Income from advanced technology services accounts for more than 70% of the total income of that year. (Note: According to Guobanhan [2010] No. 69, 7 April 2010, regarding the encouragement of the development of service outsourcing industry (Circular 69), the rate of technologically advanced service turnover is reduced from 70 percent to 50 percent.) Posses relevant international qualification certificates (including development capability and capability maturity model, capability maturity model integration (CMMI), IT service management, information security management, security environment for service providers, ISO qualify assurance certification, human resource management certification, etc.)
29 8
September 2011
Recognition measures (contd)
Have concluded service contracts with overseas customers and such offshore income shall not be lower than 50% (instead of 70% in the former Suzhou Industrial Park pilot program) of annual income. (Note: According to Circular 69, the recognition criteria of these international qualifications are also removed.)
Although HNTEs as defined under the CITL also are entitled to a reduced rate of 15%, the above qualification thresholds for ATSEs are comparatively lower in terms of the requirements in intellectual property, investments in R&D, etc.
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September 2011
Application Procedures
Approved authority A team jointly formed by the local counterparts of MOF, NDRC, SAT, MOST and MOC Application process The local team (district / municipal level) will be responsible for the initial review The provincial level team will be responsible for the final review The provincial counterparts of MOF, NDRC, SAT and MOST and MOC will issue local implementing rules for the recognition of ATSEs status. For example, Jiangsu province has issued the implementing rules. Shanghai just released the application procedures in August 2009 (See later: Hukehe [2009] No. 31). Beijing would issue the implementing rules on its own.
30 0
September 2011
Guokehuozi [2009] No. 152 (26 June 2009) Guidance on Recognition and Administration of Advanced Technology Service Enterprises
30 1
To facilitate local governmental authorities at the provincial level to implement the policy as laid down under Circular 63, the MOST published detailed guidance, Circular 152. Circular 152 standardizes the key elements for the ATSE approval procedures, including application document requirements, application procedures, reviews, and verification administrations for ATSE recognition. Circular 152 permits local authorities to stipulate additional procedural requirements in line with local circumstances. It also calls for its local branches at provisional level to cooperate with other provisional authorities in ATSE recognition matters. Thus, Circular 152 may help minimize the differences among local practices and ensure fairness in ATSE recognition nationwide. Indeed Circular 69 (April 2010) as aforesaid also specifies steps of simplifying the application and inspection procedures to expedite the recognition for an ATSE.
Caishui [2010] No. 65, 5 November 2010
On 5 November 2010, the MOF, the State Administration of Taxation, the Ministry of Commerce, the Ministry of Science and Technology and the National Development and Reform Commission jointly issued Caishui [2010] No. 65 (Circular 65), which replaces the previous tax policy for TASEs, i.e., Caishui [2009] No. 63. (24 April 2009). The full text of Notice 65 is available at http://szs.mof.gov.cn/zhengwuxinxi/zhengcefabu/201011/t2010 1119_350332.html (in Chinese).
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September 2011
Caishui [2010] No. 65, 5 November 2010 (contd)
The major differences between Circular 63 and Circular 65 is:
Circular 63
Circular 63 covered 20 trial cities.
Circular 65
Circular 65 covers 21 trial cities (see following slide for details).
Comments
Circular 65 covers the same 20 cities under Circular 63 and adds a new city, Xiamen.
The effective date of the tax incentives under Circular 63 was from 1 January 2009 to 1 July 2010. Besides granting a reduced Enterprise Income Tax rate of 15% to TASEs, Circular 63 also provided a Business Tax exemption on offshore service outsourcing business of TASEs.
The effective date of the tax incentives under Circular 65 is valid from 1 July 2010 to 31 December 2013. Circular 65 is focused on Enterprise Income Tax policy and does not cover Business Tax. Caishui [2010] No. 64 (28 July 2010) has already provided an expanded Business Tax exemption on offshore service outsourcing for all enterprises in the 21 trial cities. See previous slide for details of Caishui [2010] No. 64.
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September 2011

Circular 63 To qualify as a TASE under the certification requirements of Circular 63, the annual revenue from technologically advanced services must account for more than 70% of the total annual revenue of the enterprise. Circular 65 The percentage requirement of technologically advanced service revenue is lowered from 70% to 50%. Comments These changes were first provided in Guobanhan [2010] No. 69 (15 January 2009).
An enterprise must obtain relevant international qualifications in order to qualify as a TASE. The status of TASEs was certified by provincial-level authorities.
The international qualification requirement is removed/abolished.
The recognition procedures have been simplified. The status of ATSEs is now certified by municipal-level (or city-level) authorities.
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Sources: Baker & McKenzie (2010), China Tax Monthly (November), p.4-5. KPMG (2010), China Alert (December), Issue 20, p.1.
September 2011
The key changes provided in Circular 65 are a slightly broader geographic scope of application and a lower threshold for certification. As explained before, these changes were first provided in Guobanhan [2010] No. 69, which was issued on 7 April 2010, and are restated in Circular 65 as a set of consolidated policies for ATSEs.
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September 2011
The 21 cities covered by Circular 65 are Beijing, Tianjin, Shanghai, Chongqing, Dalian, Shenzhen, Guangzhou, Wuhan, Harbin, Chengdu, Nanjing, Xian, Jinan, Hangzhou, Hefei, Nanchang, Changsha, Daqing, Suzhou, Wuxi, and Xiamen. See Guobanhan [2009] No. 9 (15 January 2009) and Caishui [2010] No. 64 (28 July 2010). (Please refer previous slides.)
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September 2011
Local Experience: Shanghai Pudong New Area (SPNA) a Pilot Area for ATSEs
Around April/May 2009, the State Council issued Guofa [2009] No. 19: Opinions on Boosting Development of Modern Service and Advanced Manufacture Industry and Establishing International Financial and Shipping Centre in Shanghai, which proposes that the SPNA will be the pilot area for encouraging the development of ATSEs.
30 7
SPNA will support the development of technologically advanced services such as software R&D and service outsourcing, and the outsourcing of technology services procedures.
Shanghai Pudong New Area (SPNA) a Pilot Area for ATSEs (Contd)
1)
2)
3)
4)
The following tax and financial incentives will be available: From 1 January 2009 to 31 December 2013, the CIT rate on all technologically advanced service enterprises that meet requirements will be reduced to 15%; Education expenses of personnel of technologically advanced service enterprises that do not exceed 8% of gross payroll will be tax deductible for CIT purposes; No business tax will be imposed on the offshore outsourcing service income of technologically advanced service enterprises; and Government funds will be set up for ventures to inject capital into advanced manufacturing and advanced technology services.
30 8
Shanghai issues application procedures for service outsourcing enterprises (i.e. ATSEs)
30 9
To provide more local guidelines on application procedures for ATTSEE, six government authorities in Shanghai have jointly announced application procedures for recognition as ATSE registered and operating in Shanghai See Hukehe [2009] No. 31 (21 August 2009) Provisional Administrative Measures Governing Recognition of Advanced Technology Service Enterprises in Shanghai. These local regulations in Shanghai largely mirror the national regulations See Caishui [2009] No. 63 (24 April 2009).
Shanghai issues application procedures for service outsourcing enterprises (i.e. ATSEs) (Contd)
Application procedures include:
1) 2)
3)
4)
5)
To apply, an enterprise must be registered and operating in Shanghai. The application process consists of five phases: enterprises selfassessment; on-line registration; verification and recognition; public announcement; and record filing. There are two levels of review: a preliminary review by district-level authorities, and a review by the Shanghai municipal ATSEs recognition office. Successful applicants will be listed on a public website, and their ATSE Certificate shall be issued if no objections are received within 10 working days. Upon receiving this certificate, an ATSE can then apply for applicable tax incentives.
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September 2011
Local Experience: ATSEs in Shenzhen
On 26 August 2009, the Shenzhen Bureau of Science Technology and Information issued Shenzhen [2009] No. 247 Circular on Recognition of Advanced Technology Service Enterprises in Shenzhen which provides the same tax and financial incentives for ATSEs, namely (a) a reduction of enterprise income tax rate to 15 percent; (b) enterprise income tax deduction of staff education and training expenses, capped at 8 percent of gross payroll and (c) business tax exemption on offshore outsourcing service income. The qualifying criteria for ATSEs in Shenzhen are similar to those set out under the national regulations see Circular 63.
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IV. Tax Planning Ideas
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September 2011
Possible Tax Planning Ideas
HNTE vs. SPE vs. ICE vs. ATSE

IP ownership Industry HNTE Catalogue (8 domains) Capabilities of the company satisfying the criteria Location for preferential tax treatment (5 + 1) 21 cities for ATSEs BT exemption Overall group structuring and development plan
Consideration on location of IP ownership

Ownership: domestic vs. overseas Registration: domestic vs. overseas Patent vs. non-patent
31 3
September 2011
Possible Tax Planning Ideas
Group structuring arrangement

Maintaining the high-new technology status Setting up new company with IP ownership Export of advanced technology service Special Economic Zones/ Shanghai Pudong New Area vs. other locations Any preference among the 21 cities?
Location of HNTE
Location of ATSE
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September 2011
Actions Points

All the existing HNTE should apply for the HNTE status under the new regulations and guidelines Assess the possibility for qualifying the HNTE/SPE/ICE/ATSE Assess the overall group situation and development plan Determine the type of status to be applied for Understand the local requirement and application timeline and procedures Proceed with the application urgently Update record for any change of status
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September 2011

Baker & McKenzie, 2009, HNTE Incentives in China: Tax, Transfer Pricing, and Intellectual Property Protection, tax seminar paper, 2 September, Hong Kong Baker & McKenzie, 2010, China Tax Monthly (November), p.4-5. Chan, S. and Cheung, D., 2010, Tax Incentives for advanced technology service enterprises in China, Tax Planning International Review, 37(9), September, pp.4-7. Ernst & Young, 2008, New China Tax Regime How to handle the impact, tax seminar paper, 18 July, Hong Kong Ernst & Young, Applicable tax rate and foreign tax credits for overseas-sourced income of HNTEs, China Tax & Investment Express, Issue No. 2011017, 4 July 2011 PEO, 2008, Latest Development of High New Technology Enterprise Rules in China, seminar paper, 28 August, Hong Kong PricewaterhouseCoopers, News Flash, Issue 4, March 2011 TIHK at. el., 2008, Mainland and Hong Kong Taxation Forum, conference paper, 30 July, Hong Kong Publications in websites from Big 4 and professional firms (as of September 2011)
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September 2011
Lecture No. 5 Individual Income Tax
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AF4222_L5 IIT Sept 2011 Sept 2010
Major Contents

Scope of Charge and Domicile Treatment of Wages and Salaries Annual Bonus, Stock Options Other Incomes (non-wages and salaries) Exemptions, tax credit Tax administration and IIT Filing
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AF4222_L5 IIT
Historical Background
Prior to 1994 Tax Reform

Foreigners Individual Income Tax Law Chinese nationals Individual Income Regulatory Tax Law; Income Tax Law of Individual Industrial and Commercial Business Unit
In 1994, consolidated into the new Individual Income Tax Law ( ), applying to both foreigners and local Chinese nationals
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Governing Laws and Regulations
Individual Income Tax Law ( ) adopted by the 5th NPC on 30.9.1980 and revised on 31.10.1993 by the 8th NPC to take effect from 1.1.1994* Detailed Implementing Rules ( ) promulgated by the State Council in 1980 and amended on 28.1.1994
* Further amended on 30.8.1999 to exclude exemption of saving deposit interest from banks; recently revised for monthly deduction from RMB800 to 1,600 on 1.1.2006, and from RMB1,600 to 2,000 on 1.3.2008
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Scope of Charge

Wages and salaries Compensation for independent personal services Income from leasing of property Income from transfer of property Interest and dividends Royalties Income from authorship Incidental income Production or business income derived from private industrial or commercial enterprise Income from sub-contracting or leasing operations Other income specified by the MOF
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Taxpayers
PRC-domiciled individuals

Charged on world-wide income Include all permanent Chinese citizens and persons who habitually reside in China because of household registration, family, or economic ties Individuals who lives aboard by reasons of education, employment, etc. and must return to China thereafter is regarded as resident or domiciled in China Tax position depends on the period of stay in China
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Non-PRC-domiciled individuals
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Non-PRC-domiciled individuals
Non-residents who stay in China for less than one year
Charged on income sourced in China only Can be exempted if conditions satisfied Charged on world-wide income, but upon approval, nonChina-sourced income is only taxable if borne or paid by a China establishment Charged on world-wide income
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Residents for at least 1 year but less than 5 years
Residents for more than 5 years
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One-year Residence Test
Individuals resided in China for 365 days in a calendar year are deemed to have lived in China for a full year. Temporary absences from China for not more than 30 days per single trip, or 90 days in aggregate in a calendar year are not deducted in calculating the days of residence.
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Non-PRC-domiciled Individuals Who Stay Less Than 1 Year (Non-resident Taxpayers)

Subject to tax on income derived within China Wages and salaries derived by an expatriate during the period he actually worked in China, regardless of whether paid by employers in or outside China, are income sourced in China Time apportionment formula (Guoshuifa [1994] No. 148, Article 6): IIT on total employment No. of work days in China income for the month, X paid in or outside China No. of days in the month
(1)
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Non-PRC-domiciled Individuals Who Stay Less Than 1 Year (contd)
In counting the number of work days in China, the day of entry and the day of departure are counted as half day respectively (Guoshuifa [2004] No. 97)
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Exceptions: If an individual stays in China for less than 90 days (or 183 days for resident of a tax treaty country), China-sourced income is not taxable if not paid or borne by a China establishment (i.e. IIT fully exempted if income is paid by a foreign employer) In counting the number of days for the 90-day rule or 183-day rule, both the day of entry and day of departure are counted as one day respectively. See Guishuifa [2004] No. 97. Pursuant to Mainland-HK DTA (DIPN 44 (revised) para 113), The days of physical presence method is adopted, i.e. the day of arrival or departure and each day in the period during which he stays in the Other Side will be counted as one day respectively. Directors fees received from an enterprise in China is fully taxable Senior personnel of an enterprise in China is liable to pay tax on all income paid by that enterprise
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If the number of work days in China not more than 90 days or 183 days, but China-sourced income is borne or paid by a China establishment, then:
IIT on total income for the month
Salary paid in China ______________
No. of work days in China _________________

Total days in the month
(2)
Total salary for the month
See Guoshuifa [1994] No. 148 Article 2 and Guoshuifa [2004] No. 97.
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Salary deemed to be paid or borne by a China establishment include the situation where employer company was taxed on deemed profit basis or not subject to enterprise income tax because of no business income, e.g. representatives of representative offices, employees of FEs carrying projects or consultancy services in China which constitute a permanent establishment ()
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Non-PRC-domiciled Individuals Staying for a Full Year to 5 Years (Nonresident Taxpayers)
Subject to tax on world-wide income, but subject to approval by the tax authority, may be taxed on the portion of income derived from China only. Foreign sourced income not taxable unless paid/borne by a China establishment. See Guoshuifa [1994] No. 148 Article 4. Time apportionment formula (Guoshuifa [1995] No. 125 Article 2): Salaries paid No. of work days IIT on total outside China outside China income for the X ( 1 X month No. of days in the Total salaries month
)(3)
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Non-PRC-domiciled Individuals Staying for More Than 5 Years
Starting in the 6th year of residence in China, time basis treatment is not allowed and IIT liability is computed on worldwide income An individual is considered as resident in China continuously for 5 years if he has been present in China consecutively for a full year in each of the past 5 years If in the 6th year, residence is less than a full year but more than 90/183 days, subject to IIT on China-sourced income only residence is less than 90/183 days and income is not paid/borne by a China entity, IIT exempted
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Non-PRC-domiciled Individuals Staying for More Than 5 Years (contd)
An individual can break his 5-year residence if he resides in China for less than 90 days (or 183 days) in any year from the 6th year onwards 5-year residence rule starts from 1.1.1994, i.e. tax liability on world-wide income may arise from 1999 onwards
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Summarized Position of Expatriates IIT Liability on Wages and Salaries Income

Length of
Services rendered in China
Income paid/borne by establishmen t in China Income paid by overseas entity & not borne by establishment in China Non-taxable
Services rendered outside China

Income paid by Income paid by establishment in overseas entity China
residency
< 90/183 days 90/183 days<x<1 year 1<x<5year
Taxable(2)
Non-taxable
Non-taxable
Taxable(1)
Taxable(1)
Non-taxable
DIDO Circular 148
Non-taxable
DIDO Circular 148
Taxable(3)
Taxable(3)
Taxable(3)
Non-taxable
DIDO, Cir. 125
>5 years
Sept 2010
Taxable
Taxable
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Taxable
Taxable
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Senior Management Personnel
A non-resident who holds the position of director or senior manager in a Chinese enterprise is subject to IIT on all income derived from the Chinese enterprise (Guoshuifa [1994] No. 148 Article 5) Senior management personnel includes general managers, deputy general managers, chiefs of departments, directors, and other similar managerial positions Income paid or borne by China enterprises is taxable irrespective of whether the relevant services are performed in or outside China Income paid and borne by foreign employers will be exempted if period of stay is not more than 90/183 days (See Circular 97) Time apportionment formula (applicable if < 5 years):
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IIT on total income for the X ( 1 month
Salaries paid outside China
No. of work days outside China
X
Total salaries
No. of days in the month
) (3)
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Directors fee
Director of a FIE with dual capacity of director and senior manager subject to IIT separately: directors fee under income from personal service (tax rates from 20% to 40%) salary income under wages and salaries (tax rates from 5% to 45%) If paid in form of directors fee or dividend only, should report to tax authority income attributable to daily management, or income may be deemed by reference to the salary level of similar managerial position and industry
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Taxable Remuneration
1 Base wage and salary 2 Hardship allowance, foreign service premium, cost of living allowance, etc. 3 Bonus 4 Per diem allowances 5 Tax reimbursement 6 Housing allowance in excess of actual rental 7 Other kind of income
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Non-taxable Fringe Benefits for expatriates

Housing, meal and laundry received in a non-cash form or on a reimbursement basis Reimbursement of relocation expenses upon commencement or cessation of China assignment (expatriate) Travel allowance for expatriate Home leave allowance (for employee only and up to 2 times per annum) Language training in China Education for children (paid to PRC institutions only)
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Exemption of local staff employment benefits
Caishui (2006) 10:
statutory contribution to basic pension insurance premiums, basic medical insurance premiums and unemployment insurance premiums made by employers are exempt from IIT; contribution of such kinds made by employees are tax deductible ; Contribution by ER in excess on statutory limits are taxable to IIT Housing allowance, medical aid, or pension contributions paid to local employees in cash are taxable Housing fund contributed by ER and EE is not taxable if <= 12% of average salary of an EE in the year before. However, the average monthly salary cannot exceed three times of the average monthly salary of an employee of the city in the year before exempts birth allowances and birth medical expenses
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Calculation of IIT Liability for Wages and Salaries

Basis period - monthly Progressive tax rate from 3% to 45% Formula for non-tax borne case
IIT payable = (Taxable Income - Allowable Deduction ) x Applicable Tax Rates - Quick Deduction
Formula for tax-borne case

1 Grossed-up Taxable Income
= Take-home Income - Allowable Deduction - Quick Deduction 1 - Tax Rate
2 IIT Payable
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= [Grossed-up Taxable Income x Tax Rate - Quick Deduction

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Monthly standard deduction local employee RMB800* [1,600]** [2,000]# expatriate RMB4,000 [4,800]** [5,200]#[4,800]## * Some cities allow a higher deduction for local employees e.g. additional deduction allowance of RMB1,700 and RMB1,260 in Shenzhen and Guangzhou respectively. See next slide for recent changes on the allowable deduction
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Sept 2010

** On 23 August 2005, the draft amendment which included lifting the tax collection starting line from RMB800 to RMB1,500 (subsequently amended to RMB1,600) and forcibly asking high-income groups to file tax returns and pay taxes themselves was submitted to the Standing Committee of the NPC for deliberation. The new amendments have been implemented on 1 January 2006 as it was then approved in October 2005. ** Non-domiciles are allowed an additional deduction of RMB3,200. Hence, the new level of personal expense deduction for non-domiciles is raised to RMB4,800. # On 29 December 2007 (Saturday), in the 31st session of the 10th NPC Standing Committee approved to raise the IIT threshold from RMB1,600 a month to RMB2,000 and the amendment will go into effect on 1 March 2008. Correspondingly, RMB5,200 applies to non-domiciles. ##However, by Notice of the State Council on the Revision of the Implementation Rules of the PRC IIT Law, signed on 18 February 2008, Article 29, effective from 1 March 2008, allowable bonus deduction for expatriate decreased by RMB400 to RMB2,800. Therefore, total deduction reverted to RMB4,800 AF4222_L5 IIT Sept 2010
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Monthly standard deduction (effective 1 September 2011) Local: RMB3,500 Expatriate: RMB 4,800
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Allowable Deduction for Wages and Salaries (contd)
Statutory contributions to basic pension insurance premium, medical insurance premium, unemployment insurance premium and housing reserve fund* by both employers and employees are deductible against taxable income (with effect from 1 January 2006) * According to Caishui [2006] No. 10 (27 June 2006), contribution to the housing fund by both employer and employee are non-taxable and deductible respectively. The condition is that the contributions do not exceed 12% of the individuals monthly average salary for the previous year. Monthly average salary cannot exceed three times the monthly average wage prevailing in the local city (e.g. Shanghai, RMB2,235) Donation to educational and other welfare undertakings up to 30% of taxable income
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Applicable Tax Rates and Quick Deduction

Taxable Income (RMB) 0 - 500 501 - 2,000 2,001 - 5,000 5,001 - 20,000 20,001 - 40,000 40,001 - 60,000 60,001 - 80,000 80,001 - 100,000 Above - 100,000 Tax Rate 5% 10% 15% 20% 25% 30% 35% 40% 45%
Quick Deduction
0 25 125 375 1,375 3,375 6,375 10,375 15,375
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Grossed-up Taxable Income (RMB) 0 - 475 476 - 1,825 1,826 - 4,375 4,376 - 16,375 16,376 - 31,375 31,376 - 45,375 45,376 - 58,375 58,376 - 70,375 Above - 70,375
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Tax-borne case
Applicable Tax Rates and Quick Deduction (effective 1 Sept 2011)

Taxable Income (RMB) 0 - 1,500 1,501 - 4,500 4,501 - 9,000 9,001 - 35,000 35,001 - 55,000 55,001 - 80,000 Above - 80,000 Tax Rate 3% 10% 20% 25% 30% 35% 45%
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Illustrative Example
An employee of a Hong Kong company took up the position of MIS Manager in the Chinas subsidiary. For August 2011, he was paid monthly salary of HK$20,000 and RMB10,000 from the China and Hong Kong company respectively. He spent two-third of his time in China. Exchange rate: HK$1=RMB1.07
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Illustrative Example - Solution
IIT payable before apportionment:

(Monthly total salaries Allowable deduction) x Applicable tax rate Quick deduction = (RMB31,400 RMB4,800) x 25% - RMB1,375 = RMB5,275
IIT liability for each month

RMB5,275 x 20/30 (*precise days to be applied) = RMB3,516
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Being absence from China for more than 90 days a year, he will not be regarded as resided in China for a full year
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Bonus (Prior to 1/1/2005)
Prior to 1/1/2005, the bonus payment is generally taxed, in the month of receipt, as a separate income item that is not added to other monthly salary income. The progressive tax rate scale is applied and no standard deduction may be allowed to offset against the bonus
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Annual Bonus (effective 1 Jan 2005)

With effect from 1 January 2005, Guoshuifa [2005] No. 9 [2005] 9, a new tax calculation is applied Annual bonus is a payment determined with reference to the financial performance of an entity and its employees performance on a collectively basis, including year-end salary increase and annual salary tied to performance and other parameters
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Annual Bonus
The tax calculation method: 1. Treat the annual bonus (A) as taxable item separate from the monthly salary or wage received during the month 2. Divide the whole annual bonus received during the month by 12 months (i.e. A/12) in order to determine the applicable tax rate (B) and the related quick deduction (C) 3. Tax payable = annual bonus x applicable tax rate quick deduction 4. A taxpayer can declare a bonus as separate income item only once a year. Other special payments, even of bonus nature, to be added to other monthly compensation and taxed at the marginal rates AF4222_L5 IIT
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Annual Bonus (contd)
Example [Annual Bonus of RMB50,000] Compare the tax effects before and after the implementation of Guoshuifa [2005] No. 9
Before 1.1.2005
On or after 1.1.2005
Tax base Tax rate Quick deduction factor IIT payable
50,000 30% 3,375 11,625

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50,000 15% 125 7,375
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Example of annual bonus
Mr B is a Chinese taxpayer and his salary of RMB25,000. He receives an annual bonus in January 2005 in the amount of RMB90,000, and also a performance bonus of RMB20,000 in April 2005. His tax liability associated with the bonus payment would be calculated as follows: Tax liability on annual bonus = RMB90,000 x 20% - 375 = RMB17,625 Where tax rate at 20% and quick deduction of 375 are determined by checking against the tax rate table for RMB7,500 (ie RMB 90,000/12) Tax liability on performance bonus and monthly salary in April 2005 = (RMB20,000 + RMB25,000 RMB800) x 30% - 3,375 = RMB9,885
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Stock Option

Benefits derived from stock options are subject to IIT Guoshuifa (1998) 9, Caishui (2005) 35 and Guoshuihan (2006) 902 address the treatment of stock options Stock options may be structured in the following examples: An enterprise may grant options to its employees to sell stocks to its employees at a pro forma price upon completion of a vesting period or satisfaction or other conditions; Employees may be awarded stocks or other marketable securities in an unrelated company (including an overseas company) at a discounted price; and/or An employees investment in stocks or other securities may be partially financed by his/her employer
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Stock Option

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Circular 35 No tax liability at granting the option At exercising, taxable income = (market price per share exercise price per share) x number of shares If the employee transfers the stock option before exercising, the net income from the transfer should be treated as salary and compensation for IIT purpose
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Stock Option allocation of onshore and offshore income
Circular 190 Income, earned by expatriates that includes both China and overseas assignments, the income should be allocated to the number of months the expatriate worked onshore and offshore respectively Circular 902 The number of onshore and offshore working months taken into consideration shall end at the vest date
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Stock Option (effective 1/7/2005) calculation of taxes on exercising stock option
Circular (2005) 35* (only for employing entity which is a listed company according to circular 461) Salary income sourced from China relating to stock options should be calculated separately from the monthly salary as follows: IIT payable = (taxable stock option income / stipulated number of months x applicable tax rate quick deduction ) stipulated number of months
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Circular 902* (only for employing entity which is a listed company according to circular 461) For multiple instances of taxable income from stock options in one calendar year, the tax payable for each stock option income should be calculated on the basis of prior stock option income in the same calendar year as follows: IIT payable = (sum of taxable stock option income in one calendar year / stipulated number of months x applicable tax rate quick deduction ) / stipulated number of months sum of taxes paid
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Circular 461
Preferential IIT treatment for stock options under Circular 35 and 902 only applies to employing entity which (i) is within two-tier from the listed company (removed with effect from 1 May 2011 by Public Notice 27 (issued by SAT) and (ii) is owned by the listed company for not less than 30%
Stipulated number of months refers to the number of months the staff worked in China to which the stock option is attributable and is capped at 12 Applicable tax rate and quick deduction shall be determined based on the salary income relating to stock option divided by the stipulated number of months
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Stock option example
Expatriate M was granted stock options of 10,000 shares at the price of USD24 per share on 1/9/2003. The vesting period is two years. M worked in China from 1 January 2003 to 31 October 2003. M exercised all the stock options on 1/9/2005 after he left China. The market share price on the exercise day is USD42 per share. The monthly salary of M was RMB15,000 from Jan to Dec 2005. Exchange rate was USD1 = RMB8
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Income sourced from China =(USD42 USD24) x 10,000 shares x RMB8 x 10 months onshore (ie 1 Jan 2003 to 31 Oct 2003) / 32 working months before vest (ie 1 Jan 2003 to 1 Sep 2005) =RMB450,000 Taxable income spread over 10 months = RMB450,000 / 10 months = RMB45,000 per month
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Monthly taxable IIT on stock option = RMB45,000 x 30%* RMB3,375* = RMB 10,125; based on total taxable income of RMB60,000 (ie RMB15,000 + RMB45,000) Total IIT liability relating to stock option = RMB101,250 (RMB10,125 x 10 months)
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Stock Option subsequent transfer of stock

Gain derived from transfer of stocks are treated as income on assignment of property and shall be subject to IIT However, income from transfer of stocks on the Chinese stock market is temporarily exempt from IIT. For Chinese taxpayers, income from the transfer of stock in overseas market shall be subject to IIT as assignment of property For foreign taxpayers, the gain on selling overseas shares is exempted from IIT unless the taxpayers have resided in China for 5 full years and are taxed on worldwide income Dividend income received on shares acquired through the stock option plan, is subject to IIT as interest and dividends
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Stock option compliance
The employer company and the taxpayer have the obligation to file information, documents etc relating to the tax authorities Penalty be imposed on non-compliance
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Calculation of IIT for Other Income
Production and business income of industrial and commercial household (including sole proprietor and partnership) Deduction for costs and expenses, and losses incurred Progressive rate from 5% to 35% Annual taxable income Not exceeding RMB5,000 RMB5,001 to RMB10,000 RMB10,001 to RMB30,000 RMB30,001 to RMB50,000 Over RMB50,000 Tax rate 5% 10% 20% 30% 35% Quick Deduction 0 250 1,250 4,250 6,750
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Calculation of IIT for Other Income (contd)
Production and business income of industrial and commercial household (including sole proprietor and partnership) (contd) - Namely, (Annual income Cost, expenses and losses) x Applicable tax rate Quick deduction
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-
For sole proprietor and partnership enterprises, With effect from 1.1.2000, ceased to be chargeable to domestic EIT but the individual partner or proprietor subject to IIT If the deemed taxable income method is adopted, deemed profit rates from 5% to 40% for different trade and industries are specified If the actual income method is followed, various items like salary and household expenses of investors, excessive advertising and entertainment expenses, provisions, etc. are specifically listed as non-deductible.
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Income from independent personal services (including director fees) Fixed deduction of RMB800 [RMB1,600 w.e.f. 1 January 2006,: RMB2,000 w.e.f. 1 March 2008], or 20% of income, whichever is higher Flat rate at 20% (if income is below RMB20,000) Additional tax on abnormally high payments: 50% of tax normally payable on amount between RMB20,000 and RMB50,000 (i.e. effective rate 30%) 100% of tax normally payable on amount over RMB50,000 (i.e. effective rate 40%)
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Income from independent personal services (including director fees) (contd) - Namely, - Each time income below RMB4,000: (Income 800 or 1,600, or 2,000) x 20% - Each time income above RMB4,000: Income x (1 20%) x 20% - Quick deduction
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Income from independent personal services (including director fees) (contd) Progressive rate from 20% to 40%
Taxable Income RMB 0 20,000 20,001 50,000 Above 50,000 Tax Rates % 20 30 40 Quick Deduction 0 2,000 7,000
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Income from authorship, royalties and leasing property

Fixed deduction of RMB800, 1600 or 2,000 or 20% of income, whichever is higher (depending on whether each time income is below or above RMB 4,000) Flat rate at 20% *Authors are entitled to a further 30% deduction in tax payable
Interest income, dividends (from investments) and bonus, and incidental income (e.g. awards and winnings from lotteries)

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No allowable deduction or allowance Flat rate at 20% Interest on bank saving deposit is taxable from 1.11.1999, except specific educational saving deposit. However, the IIT rate on interest from deposit savings was reduced to 5% with effect from 15 August 2007 (see Decree No. 52 of the State Council); exempt with effect from 9 October 2008 (see Caishui [2008] No. 132, 9 October 2008) Taxable income on dividends received by individual investors from domestic listed enterprises is reduced by 50% (Caishui [2005] No. 102, w.e.f. 13 June 2005) Interest income from securities accounts of individual investors temporarily scrapped from 9 October 2008 (see Caishui [2008] No. 140, 26 October 2008) AF4222_L5 IIT
Income from contracting or leasing the operations of enterprises Deduction of necessary expenses (fixed at RMB800, 1600, or 2000 per month) (Annual income Necessary expenses) x Applicable tax rate Quick deduction Charged at progressive rate from 5% to 35% [Please see the same table as shown under Production and Business Income from Private Enterprises (including sole proprietor and partnership enterprises.)]
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Income from sale and transfer of movable or immovable property including real estate Deduction of the original cost of property and reasonable expenses Flat rate at 20% (Income Original cost Reasonable expenses) x 20% Exempt income from transfer of the only living quarters which has been personally used by the family for more than 5 years Exempt income from transfer of listed shares by individual Earnings from auctions of private property e.g. paintings, jewelry, postal collections, coins etc., with effect from 1 May 2007, are taxed at 20%. (2% will be levied on properties certified by cultural heritage authorities as cultural relics being brought back into China from overseas.) See Guoshuifa [2007] No. 38.
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Exemptions from IIT

Award for scientific, educational, technological, cultural and environmental achievements Interest on national debt obligations and other financial bonds issued by the State Indemnities from insurance Allowance and subsidies paid in accordance with State regulations Welfare benefits, disabled persons and survivors pension, and relief payments Settling-in payment, severance payment, retirement pay, wages and subsidies for retired personnel
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Exemptions from IIT (contd)

Military severance pay and demobilization pay Rewards for assisting investigation of crimes 2% statutory service fee received by individual for acting as tax withholding agent Dividend and bonus on B shares or overseas shares issued by enterprises in China received by foreigners (see Guoshuifa [1993] No. 45) Income of diplomatic agents and consular officials
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Tax Credit

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Foreign tax paid can be set off against IIT liability as a tax credit Deduction restricted to the amount of IIT payable calculated according to the IIT Law on income derived from sources outside China, any excess can be carried forward over 5 years Deduction on a country/region by country/region basis
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Tax Administration
Tax registration - expatriates
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Employee of FIEs and resident representative of ROs must register with the local tax authority where he normally works or resides upon entry into China Other individual should register at such times as he becomes liable (i.e. an expatriate should register within 7 days after the month in which the period of stay exceeds 90/193 days in a calendar year)
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Tax Administration (contd)
Tax filing and payment - expatriates
Tax return should be filed and tax paid monthly within the first 7 days of the month following that in which income was earned The income-paying unit (employer) shall be the withholding agent Income from overseas may be reported on annual basis and taxes paid within 30 days after the end of calendar year
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Appendix 1
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Arrangement between the Mainland of China and HKSAR for the Avoidance of Double Taxation on Income (DIPN 44)
A Hong Kong resident will be exempted from IIT on wages and salaries derived from the Mainland if: he stays not more than 183 days in any 12-month period commencing or ending in the taxable year concerned; remuneration is paid by an employer who is not resident of the Mainland; and remuneration is not borne by a PE of the employer in the Mainland
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Arrangement between the Mainland of China and HKSAR for the Avoidance of Double Taxation on Income
183 days exemption not apply to:

chief representative employees of a Hong Kong company providing consultancy services, etc. in the Mainland where the services of that company constitute a PE in the Mainland
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Arrangement between the Mainland of China and HKSAR for the Avoidance of Double Taxation on Income (contd)
For a Hong Kong resident providing independent services in the Mainland, IIT will be exempted if he:
stays in the Mainland for not more than 183 days; and does not has a fixed base regularly available to him in the Mainland. See Article 3 of the Arrangement.
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A Guide for HK Residents working across the Mainland Border (Dec. 2003)
If the above exemption conditions not met, the employment income derived by a Hong Kong resident in respect of employment exercised in the Mainland is subject to IIT as: 1. If he is employed to render services only in the Mainland and no services are rendered in Hong Kong, the whole of his income should be subject to IIT in the Mainland
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2. If he is employed to render services both in the Mainland and in Hong Kong and the aggregated periods of stays in the Mainland exceed 183 days The total income received from the Mainland entity and the overseas employer (including HK employer) will be chargeable to IIT. Tax will be calculated on the total income and then apportioned on time basis (see the summary of expatriates summary position)
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3. If he is employed to render services both in the Mainland and in Hong Kong and the aggregated periods of stays in the Mainland do not exceed 183 days Income paid or borne by the Mainland entity will be chargeable to IIT. Tax will be calculated on the chargeable income and then apportioned on time basis. Income paid by an overseas employer (including a Hong Kong employer) is not chargeable (see expatriates summary position)
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The two-tier test in counting days The first tier: - Hong Kong resident is physically present in the Mainland will be included and part of a day is counted as one day (the N day rule) - Visits Shenzhen in the morning and returns to HK in the afternoon counted as one day for the purpose of 183 day rule
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The second tier - In determining the tax liabilities in the Mainland the N-1 day rule applies (When NOT travel between the Mainland and HK during a particular day) - Either the day of arrival or day of departure is counted as one day - Example e.g. Arrives in Shenzhen on 1 April and returns to HK on 3 April two days - For travel between the Mainland and HK during a particular day, e.g. arrives in Shenzhen in the morning to work and returns to HK in the afternoon to continue work in HK office half-days service. [However, if he only provides services either in the Mainland or Hong Kong on that day, he would be counted as having been present for one day in the Mainland or Hong Kong, as the case may be. See DIPN No. 44 (Revised) (Aug 2008) paragraphs 109-114.]
AF4222_L5 IIT
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The Two-Tier Test in China
Guishuifa [2004] No. 97 (23 July 2004) Notice on Issues in Implementation of IIT Regulations and Tax Treaty for Non-residents in the PRC With effect on 1 July 2004 In counting the number of days present in the PRC, both the day of departure (exit) and date of arrival (entry) are considered full days present in the PRC (equivalent to N day rule)
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AF4222_L5 IIT
The Two-Tier Test in China (contd)
However, the counting of days is different when calculating the IIT liability for a taxpayer that is taxed based on the time apportionment method. In such cases, both the entry day and the exit day are counted only as half days (equivalent to N-1 day rule) If entry and exit on the same day, it will be counted as one day, whereas for purposes of computing tax liability, the day will be counted as a half day.
AF4222_L5 IIT
38 9
Senior Management Executives / Directors under Circular 97
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If < 90 (or 183) days in a tax year, the senior management executive is exempt from IIT if his salary is not paid or borne by a PRC employer. If borne, all income borne by the Chinese employer is taxable, then tax is computed without regard to the N or N-1 day rules (this is different from non-senior employees) If > 90 (or 183 days) days but < 1 year and if not borne by a PRC employer, then tax is computed on DIDO rule (see the summary position) If 1 5 years, his entire salary income is subject to tax (but income paid by a non-PRC employer for services rendered outside China is exempt), see summary position Chinese Green Card Holders IIT Implications
AF4222_L5 IIT
Appendix
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AF4222_L5 IIT
Annual IIT Filing on Self Assessment Basis
Guishuifa [2006] No. 162 issued by the SAT on 6 November 2006 Notice Regarding Trial Measures for Individual Income Tax Annual Filing on Self Assessment Basis (namely Provisional Regulations Relating to the Annual Individual Income Tax Return Requirements for Resident and Nonresident Taxpayers) Additional to the existing monthly filing obligation via withholding agents Notice 162 now imposes a legal obligation on certain individual taxpayers to submit an annual IIT return to the tax authorities, even if taxes have been duly withheld and paid on a monthly basis such that there is no additional tax liability accrued on the annual return
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AF4222_L5 IIT
Annual IIT Filing on Self Assessment Basis (contd)

From 1 January 2006 Individuals of China domicile and resident individuals (who are not of China domicile, but has resided in China for one year during any one calendar year) with annual income exceeding RMB 120,000 must file an annual IIT return Annual income includes all categories of taxable income
AF4222_L5 IIT
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From 1 January 2007 Who must file:

Individuals receiving wages from two or more employers in China Individuals receiving income from sources outside China Individuals receiving taxable income on which tax is not withheld at source
The form, together with a copy of the individual valid personal identification document, may be filed either via electronic submission, by mail, or in person at the local tax bureau by the end of March of the following year, e.g. for 2006, due by 31 March 2007 Penalty for non-compliance a fine of up to RMB 10,000
AF4222_L5 IIT
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Guishuihan [2006] No. 1200 by SAT (in December 2006) To clarify issues relating to the calculation of annual income for taxpayers whose annual income exceeds RMB 120,000 as required under the Notice No. 162. The major clarifications for calculating or reporting the annual income (not IIT) are:
Taxes paid for personal services income, royalty income or rental income not deductible Income from transfer of property (if on deemed basis) shall be taxed at the deemed tax rates of 5%, 10% and 15% rather than the actual tax rates of 1%, 2% and 3% respectively Actual interest income from bank accounts and bonds Income from an unincorporated business, or partnership business (if on deemed basis) deemed tax rate to calculate the taxable income Net gains from share transfers as income in the tax return (if negative, report zero income)
Annual return, if submitted by agent or other person, must be supported by a signed authorization agreement or contract; otherwise it is not accepted
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AF4222_L5 IIT

This is the first time that the SAT has required high-income earners to report their earnings. Penalty for failing to report income by the deadline of 31 March: RMB 2,000 10,000 while for those false reporters, fines can be up to RMB 50,000. Penalties for evading taxes can equal five times the amount of unpaid tax and a jail term. As of 2 April 2007 (the deadline for filing the personal income tax returns), SAT had received 1.6 million declarations from the high-income earners. It is estimated that there are around 6-7 million individual with annual income exceeding RMB 120,000. According to Beijing Local Taxation Bureau, on 1 April 2007 it received 255,000 declarations out of the expected 350,000. Enquiries can be made on 12366 for advice.
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AF4222_L5 IIT

From 1 January 2008 Individuals with annual income of more than RMB120,000 last year to continue to fill the forms and pay IIT by themselves Trying to strengthen monitoring of taxpayers that fall into this category and those who fail to report as required would be fined Self-reporting period: 1 January 31 March 2008 They are also required to list their gains from stocks and property transactions No plan to levy tax on gains from the stock market, and the requirement is just meant to help collect information and data for Chinas macro-control policies Registration work is going smoothly According to SAT, Chinas IIT revenue rose to RMB318.50 billion in 2007, up 73.3 billion yuan or 29.9% over 2006. [Chinas total tax revenue surpassed RMB4.9 trillion in 2007, up 30% year on year.] IIT is growing faster than other taxes.
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AF4222_L5 IIT
Strengthening collection and administration of individual income tax on employment income

Guo Shui Han [2009] No. 259 (Circular 259) Local tax bureaus would select at least 10% of the taxpayers in their charge to analyse the amount of individual income tax withheld by employers against salary expense details provided. Tax audit focus areas: Correct classification of salary expenses Correct treatment of benefits-in-kind Correct amount of remuneration reported
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AF4222_L5 IIT
SAT to establish a National Natural Persons Database (NNPD)
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SAT issued an urgent notice in June 2009 requiring all eligible local tax authorities to report detailed IIT information to the SAT, so that to establish a nationwide IIT information network system, eventually to a NNPD Data requested: Basic information of the IIT taxpayer Income information Tax payment information Basic information of the withholding agent Remuneration payment information Tax withholding information, etc
AF4222_L5 IIT
SAT to establish to a National Natural Persons Database (NNPD)

NNPD is the 3rd phase of the Golden Tax Project With NNPD, SAT can have a fuller picture and greater control over detailed IIT information of all regions, reinforce the administration on tax sources, and gradually develop knowledge of and control over multiple sources of personal income With NNPD, SAT can exchange information with other government departments, the departments together to fight tax evasion, smuggling, foreign exchange evasion and cheating on export tax rebates
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AF4222_L5 IIT
SAT to establish to a National Natural Persons Database (NNPD)
With NNPD, SAT can obtain mass information for analysis, enabling comparisons of personal income sources, average income levels, and regional diversities and variances. Hence to facilitate future IIT reform, particularly consolidated IIT system (combining 11 types personal income) NNPD reinforce administration of IIT on wages and salaries through:

Monitoring individuals who have wages and salaries from more than one place Comparing the IIT withholding information and IIT self-reporting information Analysing the average remuneration levels of all sorts of business and types of jobs.
AF4222_L5 IIT
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Tax Certification System
From January 2008, tax authorities will implement the full tax certification for each IIT taxpayers of each tax withholding employer/unit for all its employees and full amount. The implementation plan is:
by end of 2007, for units with total IIT exceeding RMB 800,000 by end of 2008, for units exceeding RMB 300,000 by end of 2009, all units
AF4222_L5 IIT
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Lecture No. 6 Business Tax & Value Added Tax (Part A)
Part A Business Tax
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AF4222_L6_BT&VAT_Oct 2011
Provisional Regulations and Detailed Implementation Rules of Business Tax (Amended)

The BT PR was amended on 10 November 2008 (Order of the State Council No. 540) The amended BT DIR was then released on 15 December 2008 in order to ensure a smooth implementation of the amended BT PR (Order of the MOF No. 52) The amended BT PR and DIR will be effective 1 January 2009
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Scope of Charge taxable activities (1)

Provision of taxable labour services, assignment of intangible assets and sale of immovable property within PRC DIR, Art 4:

Units or individuals that provide or receive services are within PRC Units or individuals that receive the intangible assets being transferred (not including land use rights) are within PRC Land in respect of which land use right are transferred or leased is within PRC Immovable assets that are sold or leased are within PRC
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Scope of Charge taxable activities (2)
Contribution of intangible assets or immovable properties made for the purposes of obtaining shares of an enterprises and participating in the risks and rewards of the investee enterprise are not subject to business tax. The corresponding transfer of share rights is also not subject to business tax (Circular 191)
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Taxable Labour Services (DIR, Art 2)

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Transportation Construction Finance (e.g. loan interest) and insurance Post and telecommunication Cultural activities and sport Entertainment Other service areas (such as agency, hotel restaurant and catering services, tourist services, storage, rental and leasing services, advertising and other services Sale of self-constructed and self-used house by an individual will be exempt from business tax
Non-taxable labour services

Processing, repair, installation services are not subject to BT, but subject to VAT Employment services provided by staff to employers are non-taxable to BT Exempt services (see below) Business Tax threshold. Individuals taxpayers are subject to business tax only if their business income exceeds the tax threshold Revenue from disposal of hazardous wastes, medical wastes and radioactive wastes
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Deemed taxable activities (DIR, Art 5)

Transfers immovable property or land use rights as gifts Sell any self-constructed buildings Any other circumstances specified by Ministry of Finance and the State Administration of Taxation
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Services performed outside PRC
Old BT rules: provision of labour services inside China refer to labour services which are rendered inside the territory of mainland China New BT rules: provision of labour services inside China includes those labour services provided or received by units or individuals inside China.
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Services performed outside PRC (contd)
Circular 111 states that the following services provided wholly outside China by a foreign entity or individual to a Chinese entity or individual be exempted from BT:

Cultural and sports industry (except broadcasting) Entertainment industry Lodging, hairdressing, laundering and dyeing, mounting, transcribing, engraving, copying and packing services
Circular 111 also grants temporary BT exemption to Chinese entities or individuals providing services outside China in the construction industry and the cultural and sports industry (except broadcasting) It is unclear whether offshore services, such as consulting, designing, agency etc will be exempted.
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Specific Exempt Activities under BT PR & BT DIR (1)
Educational and nursing services rendered by nurseries, kindergartens, homes for the aged and welfare associations for the disabled, matchmaking agencies and funeral services Services rendered by the disabled Medical services rendered by hospitals, clinics or other medical institution Education services from schools and other educational institutions Entrance fee for cultural activities held by memorial centre, museum, art centre, cultural centre, gallery, library, etc
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413
Specific Exempt Activities under BT PR & BT DIR (2)

Entrance fee for religious activities Agricultural services
Cultural activities. Admission fees received for cultural activities conducted by memorial hall, museums, cultural centres, etc Insurance products provided by domestic insurance institutions to cover export goods
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414
Additional Exemption granted by State Council

Technology transfers (see below) Insurance premium (see below) Transfer of land-use rights to farmers for farming Transfer of copyright by individuals
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Additional Exemption granted by State Council technology transfers (1)

Receipts on technology transfers by research and development units are exempt from BT Technology transfers refer to the transfer of the overall rights or the user rights of patented or non-patented technology for valuable consideration Effective 19/5/2004, BT exemption on technology is not subject to approval by the competent tax authority, instead it is required to file and make record to the tax authority only. Therefore, domestic entities and individuals need not present any BT certification document to the bank for making outward payment of royalties.
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Technology Transfer (2)
Income earned by units or individuals for technology transfer, technology development or the provision of related technology consulting services is exempt from BT (Caishui (1999) No. 273) Technology transfers is the paid transfer to other users of a proprietary or usage right relating to a patent or know-how by the transferor Technology development is the research and development of new technology, new products, new skills or new materials and related systems Technology consulting is the provision of feasibility studies, technology projections, special technology research and analysis and evaluation reports for a high technology projects Technical consulting and service provision relating to technology transfer and technology development refer to the technical consulting and service provision activities conducted under the technology transfer or development contract by the transferor or consignor in order for the transferee or consignee to make use of and fully understand the transferred technology
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The following types of income relating to technology transfer and development shall be exempt from BT For the transfer of technology achievements by providing blue prints, drawings and documents, the BT-exempted income shall be the total income plus any extra charges paid by the transferee For the transfer of technology achievements by providing samples, test machines and equipment, the BT-exempted income shall EXCLUDE the purchase price of commodities. Such samples, test machines and equipment shall be subject to VAT The income earned for the provision of microbe specimens and new biological or botanical strains while furnishing biological technology shall be exempt from BT. The batch sale of microbe specimens should be subject to VAT
Technology development and technology transfers eligible for a business tax exemption as specified in Caishuizi [1999] No. 273 refer to technology development and technology transfers to natural science. (Caishui [2005] No. 39) Effective19 May 2004, no tax exemption certificate is required when purchasing foreign currency from a local bank or uses its own foreign currency to settle a royalty payment overseas. (Guoshuifa [2005] No. 28 of 7 March 2005)
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Additional Exemption granted by State Council insurance premiums
Insurance premiums received by insurance companies for life insurance policies with terms of one year or more, on which the premium is refundable upon expiration of terms are exempt from business tax
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Other BT Exempted Income (1)
Membership fees received by foreign chambers of commerce in Beijing are exempt from business tax. (Guoshuihan [2005] No. 370 QFII ()s security transactions in China (Cai Shui [2005] No. 155) Employment of disabled persons. Entities that recruit disabled persons will be entitled to a BT deduction of 6 times the minimum wages approved by the provincial government and the tax deduction cannot exceed RMB35,000 per year per person. Such deduction only available for income from provisions of services (excluding advertising) that amounts to 50% of the total income (Circular 92)
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Money lending within a company group. A group finance company is exempt from BT on the interest income received from the subsidiaries, provided that the collection of such interest is for the purpose of repaying the financial institutions from which the group finance company borrows money. (Circular 13 by SAT on 10 Feb 2002) Income from offshore outsourcing services for recognized advanced technology services enterprises is exempted from BT. (Circular 63)
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Transfer of shares, Caishui (2002) 191 Income derived by an individual from sale of an ordinary residential unit which has been held for five years or more, Caishui (2011) 12 The gain from buying and selling of securities conducted in China by the domestic companies entrusted by Qualified Foreign Institutional Investors (QFIIs), Caishui (2005) 155 Individuals are temporarily exempted from BT for:

Income derived from transactions involving foreign exchange, securities, financial futures, other financial products; and The transfer of immovable property and land use right as a result of divorce, inheritance, or as a gift to family members
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Effective from 1 Jan 2010, the international traffic services provided by Chinese units or individuals, Caishui (2010) 8 From 1 Jan 2009 to 31 Dec 2013, interest income generated from small-scale loans granted by financial institutions to peasants, Caishui (2010) 4 From 1 July 2010 to 31 Dec 2013, enterprises registered in 21 specified cities such as Beijing, Shanghai, etc are exempted from BT for income arising from offshore outsourcing services, Caishui (2010) 64. Effective from 1 Jan 2011, the income gained by energy conservation service companies from energy management projects is temporarily exempted if relevant conditions are satisfied.
Determination of Taxable Amount
Taxable amount
= Full Consideration + Other charges
Other Charges ()

Handling fee Fund raising charge () Fee received on behalf () Disbursements () Others
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425
Determination of Taxable Amount Special Cases
Tour services
The balance of total price less costs for hotel rental, meal, transportation, ticket fares and other payments received on behalf of other institution (BT PR, Art 5(2))
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426
Construction services (NOT including decoration services)
Taxable turnover includes the price of raw materials, equipment, other materials and energy used in the project
The price of equipment provided by the project employer should be excluded. (BT DIR Art 16)
Excluding sub-contracting fee for principal subcontractor (BT PR Art 5(3))
Self-construction: units/individuals selling newly constructed buildings are assessed on a deemed amount of business turnover
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427
Immovable property & land use right:
taxable turnover is the balance of total revenue received less the original purchase price of the property/right Selling immovable assets or land use rights obtained from debt clearing, taxable turnover is the balance of total revenue less the equivalent debt amount (Caishui (2003) 16)
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428
Transportation. For taxpayers who subcontracts their transportation work to

others, taxable amount is the balance of the total price and other charges less the transport payment made to other units or individuals (BT PR Art 5(1))
Purchase equipment on behalf of customer. The purchase price may be deducted if the following conditions are met
The contract must have been signed for the procurement or manufacturing of equipment or materials and all the equipment and materials must have been used for the proposed project All original invoices must have been issued in the name of the customer and the customs duties paid by the customer directly The equipment or materials procured or manufactured must be owned by the customer and should be forwarded and retained by the customer, and used according to the project
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429
Transfer of real estate - from 1 Jan 2010 (Circular 157):

(1)
Individuals that sell standard real estate (thereby excluding luxury properties) which has been owned for 5 or more years are exempt from BT.
(2)
Individuals sell standard real estate which has been owned less than 5 years or sells non-standard real estate which has been owned by the individuals for five or more years, BT be charged on the difference between gross proceeds of sale and the original purchase price of such property Individuals sell non-standard real estate which has been owned for less than 5 years, BT be charged on the gross sale proceeds
(3)
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430
Sales of foreign exchange, securities and commodities

excluding cost of purchase (BT PR Art 5(45) NO BT for trading of goods futures (BT DIR Art 18) Taxable turnover consists of various charges collected from audience including box-office receipts, on-stage fees, song dedication fees, etc
Entertainment
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Decoration service under actual-cost method (ACM). ACM refers to the situation where all the major materials and equipment are provided by the client, taxpayer only charges labour fee, management fee and auxiliary materials fee. The taxable turnover shall be the total amount of labour fee, management fee and auxiliary materials fee and will NOT include cost of materials and equipment purchased by the client itself.
431
Return of income. If the turnover is reduced as a result of any return of income, appropriate BT shall be refunded (BT DIR Art 14) Discount. Where a taxpayer specifies the price and discount involved on the same invoices, the discounted price shall be turnover; where a separate invoice is issued for the discount, such discount shall not be deducted from the turnover (BT DIR Art 15)
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432
Determination of Taxable Amount Deeming Provision

Taxable amount unreasonably understated Comparison to market rate of similar services / property, recent average prices Formula
Deemed taxable amount = Operating costs or project cost x (1 + deemed profit ratio) (1 - applicable business tax rate)
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433
Business Tax Rate

Transportation Construction, installation, repairs, decoration and others 3% Post & telecommunication Cultural activities & sport Entertainment 5%-20%
Professional services Restaurant & hotel Advertising Leasing (except on movable property) Warehousing Transfer of intangibles - land use right - trademark - unpatented technology - royalty - copyright Transfer of immovable properties (see Cir. 75 5.5%)
5%
Banking & other financial institutions 5%
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434
(reduced from 8% to 7% in 2001, 6% in 2002 and 5% in 2003 and onwards)
Business Tax Levied on Toll Fees
Caishui [2005] No. 77 on 11 May 2005, specifies that as from 1 June 2005, the expressway toll fees charged by expressway enterprises are subject to business tax at 3% (namely the rate for transportation services)
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Calculation of WHT Payable
Guoshuifa [2009] No. 3, January 2009 Detailed Requirements for the Withholding Agents in relation to the WHT withholding obligations. Under the former FEIT regime, when computing WHT on royalties, BT was allowed to be deducted from the gross amount. Circular 3 reiterates that such deduction is no longer allowed in computing WHT on passive income. Furthermore, it is clarified that, where the Withholding Agent and the non-TRE agree that the WHT liabilities should be borne by the Withholding Agent, the taxable income should be grossed-up before arriving at the WHT liabilities. This will increase the cost of the payer (i.e. Withholding Agent), not only by the WHT itself, but also by the tax on-tax element.
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Timing of Liability and Filing

Time of liability arising On receipt of revenue / income On issue of demand note / income Guoshuihan (1998) No.757 (1998) 757 (9 December 1998) Rent, royalty, interest, etc. withholding liability arise when expenses are accrued or listed
Time of filing Within 15 days after the end of each month
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437
Location for Reporting

Provision of services
location of providing services location where the property is situated location of the transferor for foreign enterprise transferee to act as withholding agent
Transfer of immovable property
Transfer of intangible asset

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438
Reporting Obligations

PRC entities Non-PRC entities - through withholding agent

Subcontractors of construction and installation project - Main contractor Re-insurance premium - Insurer Transfer of immovable property or intangible asset Transferee
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439
Mixed Sales v. Concurrent Sale

Sales of machinery and equipment and installation Decoration/construction with supply of raw materials One single invoice/contract, one mixed sale. Otherwise concurrent sale For mixed sale of wholesale/trading business VAT For mixed sale of service provision BT, for tangible asset part VAT For minimizing BT Higher portion to VAT? Why? Concurrent sale with two contracts? Justified?
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440
Engineering contracts - mixed Sales v. Concurrent Sale ? (1)
For engineering contracts provided by foreign enterprises, Guoshuifa [1995] No. 197 (26 October 1995) is still applicable. It specifically deals with a contract of the provision of machine and equipment with labour services of installation, assembly, technical training, guidance, supervision and etc.
AF4222_L6_BT&VAT_Oct 2010 2011
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441
If the contract does not stipulate the turnover or it is not reasonable, the tax authorities, taken into account the actual circumstances, may ascertain the income from such labour services (not lower than 5% of the total contract price) and calculate the BT and enterprise income tax accordingly.
AF4222_L6_BT&VAT_Oct 2010 2011
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If the foreign enterprise is subject to a deemed profit rate for assessing its enterprise income tax, the cost of machine and equipment can be deducted from the total contract price and the deemed rate (not less than 10%) shall be applied to the net balance for enterprise income tax purpose.
AF4222_L6_BT&VAT_Oct 2010 2011
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When considering Guoshuifa [1995] No. 197, it does not mean that the contract is a kind of mixed sales, but rather an engineering contract involving the provision of equipment and labour services from a foreign service provider to a domestic entity in China. In the meantime Article 3(13) of Caishui [2003] No. 16 (13 January 2003) also specifically allows the deduction of equipment cost for tele-communication services.
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AF4222_L6_BT&VAT_Oct 2010 2011
In practice, it is rather difficult if not impossible to determine the real business scope for a foreign enterprise doing business in China. The actual implementation has to make the necessary separation of total contract price between the cost of machine and the installation services. This is to play safe and to enable (1) simpler procedures for importation and forex payment, and (2) the remittance of service fee, a common way is to have an umbrella contract, namely a sale of equipment contract and a service contract.
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AF4222_L6_BT&VAT_Oct 2010 2011
Appendix
1 Development of rules on real estate transactions
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Taxable Real Estate Activities
On 19 October 2008, the State Council made a resolution to support the purchase of real estate by individuals by reducing Deed Tax and exempting Stamp Duty and Land Value Appreciation Tax from certain transactions from 1 November 2008. To further encourage the development of the real estate market, the State Council issued circulars on 17 December and 20 December 2008 clarifying the tax incentives for Business Tax on the transfer of ordinary and non-ordinary residential housing (Caishui [2008] No. 174, 29 December 2008). Guobanfa [2008] No. 131 (20 December 2008) Several Measures to Promote Healthy Development in Chinas Real Estate Market, issued by the General Office of the State Council. The provisional BT incentives will apply until 31 December 2009..
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Taxable Real Estate Activities (contd)

Transfer of ordinary residential housing by individuals Sales within 2 (formerly 5) years If the sale is within 2 years of purchase of ordinary standard flats, BT of 5.5% shall be imposed on the net sale amount basis (i.e. after deducting the purchase cost) instead of a full gross amount. Sales beyond 2 years If the purchase of the ordinary standard flats by individuals is 2 years or more, BT is exempt on sale.
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Taxable Real Estate Activities (contd)

Transfer of non-ordinary residential housing by individuals Sales within 2 years If the sale is within 2 years of purchase of non-ordinary standard flats, BT of 5.5% shall be imposed on the gross sale amount basis Sales beyond 2 years If the purchase of the non-ordinary standard flats by individuals is 2 years or more, BT is imposed on the net basis.
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Appendix 2 Cost Sharing Arrangement
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Use Technology Cost Sharing to Repatriate Cash
Upon Chinas accession to WTO, it is now possible to charge manufacturing royalties in excess of 5 per cent and it is also easier to obtain a BT exemption on technology related royalties. SAT recently endorsed an international R&D cost sharing arrangement (CSA) for a particular taxpayer. SAT is willing to countenance a CSA and to possibly afford an outbound CSA payment an exemption from both withholding tax (FEIT) and BT, namely under this ruling, BT can be waived. Moreover, the payment can be possibly deductible for enterprise income tax purposes if it is of recurring nature. In the meantime, State Administration of Foreign Exchange (SAFE) has issued a notice allowing for remittance to overseas affiliates in respect of the shared portion of R&D expenses.
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451
Requirements of a Cost Sharing Arrangement (CSA)

China entity should receive specified IP (intellectual property) ownership rights and benefits; China entity should not pay royalties; and Evidence and other administrative requirements regarding Cost Sharing pool and allocations to China entity must be provided. The downside is that the future income from the IP in China will be liable to FEIT and that the protection of the IP is relatively risky in China.
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452
CSA under the new Corporate Income Tax Law (1 January 2008)

The New CIT allows the participants to share the joint costs incurred for the research and development of intangibles and provision/receipt of services. The proposed new Detailed Implementation Regulations (DIR) would require: In the CSA agreement, spell out the sharing ration and amounts of the joint costs, matching to the respective ownership, right to use and right to benefits. The Applicant for CSA is required to submit other relevant TP information to the Chinese tax authorities for review after the conclusion of the agreement. The shared costs may only be deductible if the required information is duly prepared and submitted, the CSA is in line with arms length principles, and the CSA is supported by a reasonable commercial purpose or possesses economic substance. The DIR suggests to the applicants to use of Advance Pricing Agreement (APA) for their CSA applications.
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Tax Treatment of Services Fees Paid by Subsidiaries to Parent Company

Guoshuifa [2008] No. 86 (14 August 2008) Tax Regulations for Service Charges from a Chinese Parent Company to Subsidiaries Circular 86 requires: that the parent to charge the subsidiaries a service fee based on a reasonable profit similar to an arms length transaction between unrelated parties, and the execution of service contracts between the parent and the subsidiaries ready to be submitted to the tax authorities as supporting evidence Circular 86 does not mention what the mark up should be (e.g. According to Guoshuifa [2002] No. 128, a deemed profit margin of 5% could be applied to determine the total service charges.)
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Tax Treatment of Services Fees Paid by Subsidiaries to Parent Company (contd)
The parent company should pay BT for the abovementioned service fees, and the subsidiary can deduct the same amounts as costs for CIT purpose The parent company may enter into a master service sharing agreement with all relevant subsidiaries The taxation treatment of service sharing agreement may differ from the CSA laid down in the new CITL it may mean that the requirement for a profit mark up is expected for the service sharing agreement while the requirement for a profit mark up may not apply to the CSA Unclear if Circular 86 can apply to justify deductibility of service fees paid to an overseas parent company or related parties if a Chinese subsidiary can fulfill all the above basic principles
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Appendix 3 comparison of old and new BT rules
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Key Changes of Assessing Practice and Tax Filing under the Amended Provisional Regulations on BT
BTable turnover on a net basis only for certain eligible businesses if the prescribed requirements can be met, e.g a contractor can deduct payments to sub-contractors in calculating its BTable turnover. However, on-lending business has been removed from the list of eligible businesses thus increasing the BT burden of the financial sector, but it would provide an equal footing for foreign currency on-lending and also Renminbi on-lending businesses and eliminating the previous imbalance Insurance products by insurance company in China for the purpose of insuring export goods exempt from BT BT return filing location is the location of where the taxpayer is located or lives instead of the location of where the services are rendered (except for construction business)
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Key Changes of Assessing Practice and Tax Filing under the Amended Provisional Regulations on BT (contd)
Withholding agents for foreign enterprises without PE in China include business agent, the purchaser of taxable services, intangible properties or immovable properties A new quarterly filing period introduced (under the former PR, the longest payment period was one month) All tax return filing and payment within 15 days after the end of each filing period (monthly or quarterly) instead of 10 days under the former PR
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Two Major Changes in Amended BT DIR

New definition of provision of labour services within China Clarification of mixed sales and concurrently engaged in VATable and BTable businesses
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Revised Implementation Rules for the Provisional Regulations, effective 1/1/09 (Decree No. 52) Scope of Charge
New Regime
Either the service provider or recipient is located in China Trading of foreign currency, marketable securities by any taxpayer Deemed sales apply to either a company or an individual transferring immovable property or land use rights to other companies or individuals without any consideration
Old Regime
services rendered in China
Trading of foreign currency, marketable securities by financial institutions ONLY Deemed sales previously applied to a company transferring immovable property to other parties without any consideration
46 0
New Definition of Provision of Labour Services within China

Amend the definition of provision of labour services within China to the place where the service recipient or service provider is located In other words, where either the service recipient or service provider is located in China, then the BT will be imposed on the service income, regardless of where is the service is rendered onshore or offshore (this is totally different because where the service is rendered is the key scope under the former BT DIR) The grey area is whether labour services which are rendered onshore are excluded from BT if both the service provider and the service recipient are ex-China. Is it a planning tip? This unexpected change commencing on 1 January 2009 to defeat any export of labour services in principle services can be treated as export Significant impact to foreign-service providers rendering services inside and outside China, to Chinese service-recipients or non-Chinese service recipients
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Clarification of Mixed Sales and Concurrently Engaged in VATable and BTable Businesses

Concept of Principal Business remains to determine whether a taxpayer is subject to VAT or BT Depend on the onus of separately accounting for the taxable turnover for VAT and BT Give the in-charge local tax bureau the authority to deem the amount of turnover subject to BT if the taxpayer fails to segregate the turnover for the two businesses (instead of the old practice to bring the whole turnover to VAT) The concept of mixed sales is similar to that of the amended VAT DIR
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Grandfathering policies of former cross-year contracts (Circular 112)
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The old BT regulations regarding the recognition of domestic taxable services shall continue to apply to former cross-year contracts until 31 December 2009 (taxable if services were rendered in China, BUT not if either service recipient or provider is located in China) The old BT regulations shall continue to apply in determining the taxable income of construction, tourism, forex sub-lending and other taxable services Tax rates, starting times of tax liabilities, location of BY payments, tax withholding agents, RMB conversion rates, tax preferences and other tax-related issues concerning the former cross-year contracts shall be subject to the new BT regulations Tax paid, over paid, withheld or over-withheld before the promulgation of Circular 112 may be deducted or refunded from subsequent tax payable
Part B Value-added Tax
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Provisional Regulations and Detailed Implementation Rules of Value Added Tax (Amended)

The VAT PR was amended on 10 November 2008 (Order of the State Council No. 538) The amended VAT DIR was then released on 15 December 2008 in order to ensure a smooth implementation of the amended VAT PR (Order of the MOF No. 50) The amended VAT PR and DIR will be effective 1 January 2009
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Taxation Scope (VAT DIR Art 2)
Goods

Import and sales within China Types

Tangibles Electricity, heat, gas Real estates, intangibles
VAT VAT BT
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466
Taxation Scope (cont'd)
Services (within China)

Processing of goods Repairs Others
VAT VAT BT
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467
Processing
The business of contracting to process goods, where the contractor supplies the raw materials or major materials and the subcontractor manufactures the goods in accordance with the requirements of the contractor and receives a processing fee
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Repair and replacement
The business of contracting to carry out repairs of damaged or malfunctioning goods, and to restore the goods to their original condition and function
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Additional activities within scope of VAT

Sale of futures (including commodity futures and precious metal futures) Sale of gold and silver by banks Production and issue of stamp products for stamp collection and for sale by units and individuals other than State Post Bureau Sale of article for pawn and sale of consignment goods on behalf of consignor Financial leasing approved by PRC authorities other than the Peoples Bank of China (PBOC) is chargeable to VAT if ownership of the leased product is transferred to the lessee. However, financial leasing operations approved by the PBOC are subject to BT instead of VAT irrespective of whether the ownership of the leased products has been transferred to the lessee
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VAT taxpayers (1)

All units engaged in the sale or importation of goods or the provision of VATable labour services are VAT taxpayer Individuals engaged in the sale or importation of goods, or the provision of VATable labour services are VAT taxpayers if their sale values exceed the VAT threshold (VAT DIR Art 9; VAT PR Art 17) as follows:

For sale of goods range from RMB2,000 RMB5,000 sales value per month For VATable labour services - range from RMB1,500 RMB3,000 sales value per month For tax paid on transaction basis range from RMB150 RMB200 sales value per month The regional tax authorities under the SAT determine the applicable threshold within the above ranges
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VAT taxpayers (2)
All foreign-invested enterprises and foreign enterprises engaged in the sale or importation of goods or provision of VATable labour services are VAT taxpayers (Decree No 18 of the Chairman of the PRC) Contracted enterprises. For enterprises lease or contract out management services, the lessees or the subcontractor are the VAT taxpayers Withholding agent. For overseas units that do not have any business establishment in China, but that sell goods or provide VATable labour services in China, their agents are required to act as VAT withholding agents. If no agents, the purchasers of the goods and services will be the withholding agents
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Types of taxpayers (1)
General Taxpayer are enterprises or units whose annual VATable sales exceeds the threshold stipulated for small-scale taxpayer and that have sound accounting and auditing systems. A small-scale taxpayer may apply for approval as a general taxpayer if it maintains an sound accounting and auditing system The following taxpayers are not considered to be general taxpayer:

Enterprises do no have sound accounting and auditing system Individuals; and Enterprise selling tax-exempt items
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473
AF4222_L6_BT&VAT_Oct 2010 2011
Small-scale taxpayer - whose annual VATable sale value falls below certain prescribed thresholds or who have unsound accounting and auditing systems. Production / Processing service : VATable sales value <= RMB500,000 Wholesale / Retail: VATable sales value <= RMB500,000 Others: VATable sales value <=RMB800,000
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474
AF4222_L6_BT&VAT_Oct 2010 2011
Newly established trading enterprises have three options to apply for the general taxpayer (GT) status:

As a medium to large scale trading enterprise; As a trading enterprise with estimated annual sales revenue of RMB800,000; and As a trading enterprise with actual annual sales revenue of RMB800,000
Medium to large scale trading enterprise refers to a trading enterprise with:

A fixed place of business; Inventory More than RMB5M of registered capital; and More than 50 employees
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475
AF4222_L6_BT&VAT_Oct 2010 2011
Trading enterprises whose estimated annual sales revenue reaches the required threshold can apply for GT status if ALL of the following conditions are also met:

Have considerable scale of business operation Have a fixed place of business Have appropriate operational and management personnel Have signed purchase/sale contracts or have written evidence of intent; and Have valid purchase/sale channels for its goods (certification issued by suppliers)
In practice, local tax authorities often reject applications based on estimated sales revenue. Usually it needs to apply based on actual sale revenue.
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476
AF4222_L6_BT&VAT_Oct 2010 2011
Administration

Registration. ALL general taxpayer are required to register with the tax authority Documentation (notice of intention to register, business license, related contracts, bank account, etc) must be submitted to support the application Application form will be issued by the tax authority after it has reviewed and satisfied with the application preliminarily The tax authority will then examined the application form submitted. If conditions are met, the general taxpayer status will be granted ONLY enterprises recognized and approved as general taxpayers are entitled to use VAT invoices for crediting input tax against output tax
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VAT Rates (1)
Based on nature of commodities the tax rates are

General - 17% Special - 13% (include: Food and edible plant oil, Utilities, gas and coal, Books, newspapers and magazines, Animal feed, fertilizer, agro-chemicals and agricultural machinery, Oil liquefied gas derived from processing and compressing gas in association with oil production (Guoshuifa [2005] No.83, 18 May 2005), Diethyl Ether (DME) (Caishui [2008] No. 72, effective 1 July 2008))
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478
AF4222_L6_BT&VAT_Oct 2010 2011
VAT Rates (2)
Small-scale taxpayer: No input VAT credit and Tax rate:3%
Export zero-rated (not exempt)
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479
VAT Credit Mechanism

Input VAT

VAT paid on purchases Import VAT payable Where = Composite value x VAT rate
Composite value = CIF price + Customs duty + Consumption tax Output VAT
VAT collected on sales of taxable goods and services Output VAT = Sales amount x VAT rate
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480
VAT Credit Mechanism (cont'd)
VAT payable = Output VAT - Input VAT If negative, it means refund What factors Leading to negative?
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481
VAT Credit Mechanism (cont'd)

A numeric illustration
Value RMB Taxable sales Taxable purchase Other costs Profit VAT payable 2,500 1,000 1,000 500 VAT @17% RMB 425 (170) ----255
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482
Goods exempt from VAT
Certain goods are exempt from VAT, such as certain agricultural products sold by agricultural producers and imported instruments and equipment used directly in scientific research, experiments or education
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Deemed Sales as anti-avoidance

Consignment goods transferred to consignees Consignment sales by consignees Inter-branch supply of goods (Not the same County / City) Use of goods in non-taxable items Use of goods in investment Use of goods for distribution to investors / shareholders Use of goods for self consumption or group welfare Gifts
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484
Creditable Input VAT
VAT shown on the invoices obtained from the seller or VAT shown on the tax receipts issued by the customs For VAT exempted agricultural products Deemed creditable amount 13% of purchase amount Deemed creditable amount 7% of transportation expenses, must be applied w/in 90 days from date of invoice { [2003] 120 (18/10/2003)} Apportionment for creditable / non-creditable input VAT by reference to the amount of tax exempted sales and activities
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485
Non-creditable Input VAT

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VAT payment not supported by prescribed VAT invoices Effective from 1 Jan 2009, input VAT on purchase of fixed assets is generally available. Also various VAT exemptions (e.g. importation or domestic purchase of equipment by encouraged projects) are abolished. Prior to 2009, input VAT on purchase of fixed assets could not be credited against output VAT. And, import or domestic purchase of certain fixed assets could be exempted from VAT (as well as customs duty). Input tax on goods or VATable labour services used for collective welfare or personal consumption VAT on purchases used in tax-exempt activities VAT on loss of purchased goods, e.g. natural disasters, theft and disposal due to mismanagement, other abnormal obsolescence, etc. Input VAT related to export calculated in accordance with the prescribed formulae
486
Determination of Taxable Amount

Full consideration + other charges () Other charges:
Handling fee Subsidy Fund () Profit share, fund raising charge () Reward () Contract forfeiture charge / interest for late settlement (/)
Packaging charge Packaging material rental Reserve () Transportation / loading fee Receipt collected on behalf Payment made on behalf Others
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487
Determination of Taxable Amount (cont'd)
Specifically excluding:
Output VAT collected Consumption tax collected on goods subject to processing Transportation charges paid on behalf and

invoices addressed to the buyer of goods; and invoices to pass on to the buyer
For different categories of products subject to different VAT rates

separate ledger / record to maintain possible risk - fully liable to the highest VAT rate
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488
Determination of Taxable Amount (cont'd)

Based on invoices Combined sale price ()
By formula
Sale price = VAT inclusive sale value / (1 + Applicable VAT rate)
Deeming provisions
Deemed composite taxable value = Cost x (1 + deemed profit ratio)
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489
Determination of Taxable Amount (cont'd) Mixed Sales
Enterprises engaged in production, wholesale, retail VAT, e.g. TV factory sells TV sets with installation services Other enterprises BT, e.g. a decorator provide decoration services with supply of raw materials Production. Etc? 50% as the threshold of dividing line
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490
VAT Treatment of Futures
The SAT issued a Notice (Guoshuihan [2005] No. 1060] on 9 November 2005, clarifying for the VAT treatment of futures dealing. According to the Notice, general VAT payers may issue VAT invoices according to the amount and transaction price of goods indicated on a standard godown warrant () when selling goods on the future exchange, regardless of whether any premium has been paid or discount received. This Notice takes effect 1 December 2005.
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Timing of Liability
General principles For sales of goods and services
Receipt of proceeds or obtaining demand notes for payment

Customs declaration
For import
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492
Timing of Liability (cont'd)

Cash sales Credit sales or payment by installments Consignor to consignee Payment in advance and deemed sales By letter of credit
Receipt of proceeds Due date per contract Receipt of sale documents from consignee Delivery of goods On delivery of goods and completion of bank settlement procedure
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493
Timing of Filing
Within 15 days after the end of each month
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494
Location of Filing
General principles Entity with only one fixed establishment Entity with various fixed establishments all over China

consolidated filing possible inter-branch transfer where trade takes place local customs
Entity without any fixed establishment
Import
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495
Major Targets for VAT Assessment

Major taxpayers Major enterprises in special industries Taxpayers with unusual fluctuations in their tax burden rates Taxpayers reporting low credit ratings for tax administration purposes Taxpayers with a history of tax non-compliance Taxpayers reporting substantial output VAT but little input VAT
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Major Targets for VAT Assessment (Contd)
Taxpayers with unusual VAT reporting patterns claiming input VAT based on one of the following:
-
Import VAT payment receipts issued by Customs Freight invoices Purchase invoices for scrap material Purchase invoices for agricultural produce
Retailers of refined oil products

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VAT Assessment: Methods and Industry Benchmarks

-
Guoshuifhan [2005] No. 1205 by SAT: Benchmarking against various VAT-related indicators for the relevant industry Determining the value of raw materials consumed or purchased Determining the value of utilities consumed by the taxpayer Analyzing the number of man-hours/time cost incurred by the taxpayer Assessing the production capacity of the taxpayer
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Appendix 1 VAT Reform
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VAT Reform in Northeast Region
On 14 September 2004, SAT and MF jointly issued Provisions on Expanding the Qualifications of Fixed Asset Input VAT Deductions in the Northeast Region (Caishui [2004] No. 156) (repealed already). Circular 156 provides more detailed rules on implementing a new VAT system in the Northeast part of China. The Northeast region includes the three provinces of Heilongjiang, Jilin, and Liaoning, and the port city of Dalian ( ). To help to contribute to an increase in the overall productivity and effectiveness of the business operation in the Northeastern industrial bases.
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The six covered industry sectors in the region are allowed to deduct VAT paid on purchases of qualified fixed assets:
(1) (2) (3) (4) (5) (6)
Equipment manufacturing, Petrochemical industry, Metallurgy, Shipbuilding, Auto manufacturing, and Processing of farm products.
Subject to proper approval from the MOF and SAT, two industrial sectors, namely (7) military and defence system production and (8) high and new technology products manufacturing are included.
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The current VAT system of China denies a deduction for input VAT paid on purchases of fixed assets, which results in such VAT being borne during the production stages. Circular 156 transforms Chinas present production-type VAT to consumption-type VAT, like the system adopted in Europe. For example, VAT is borne principally by consumers while intermediary manufacturers and suppliers collect and pay only a slice of the VAT to be borne by consumers this is achieved by allowing those intermediaries to deduct the VAT that they paid on their purchases, including fixed assets.
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Circular 156 applies to general VAT payers operating primarily in the covered industries in the Northeast region. The phrase primarily means that 50% of the taxpayers annual revenue should be generated from business operations in the covered industries. As a trial measure, with effect from 1.7.2004, the following types of input VAT paid on the acquisition of qualified fixed assets can be deducted: e.g. purchase, self-construction, financing leasing, transportation costs of those qualified fixed assets.
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When an FIE acquires domestically production equipment within the limit of its total investment, the FIE may be eligible for a rebate of the input VAT that it may have paid when purchasing the relevant equipment see Guoshuifa [1999] No. 171 (20 September 1999). However, if the FIE is also a qualified taxpayer eligible for the benefits conferred by Circular 156, it can no longer apply for the aforesaid VAT rebate. Furthermore, the input VAT deduction in 2004 is capped by the year-toyear increase in VAT payable (VAT payable increase) during the same period. If the qualified input VAT deduction in 2004 is more than the VAT payable increase from 2003 to 2004, the excess amount is recorded as fixed asset input VAT to be deducted and carried over to future periods by the taxpayer without any limit on the length of carryover period.
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For implementation needs, SAT and MOF issued two more circulars, namely Caishui [2004] No. 168 and Guoshuihan [2004] No. 1111 (30 September 2004). Circular 168: - confirms the full implementation on 1 January 2005 in the region, - under the transitional arrangement from 1 July - 31 December 2004, refund of input VAT incurred on purchasing of fixed assets by enterprises engaged in designated industrial sectors - the refundable input VAT = input VAT after offsetting any outstanding VAT liabilities (given there is a cap on the incremental VAT amount against that of the corresponding period of 2003) - the refundable input VAT to be credited in two batches (before 31 October 2004 and 31 December 2004) - any un-refunded VAT input amount can be carried over to the next year Circular 1111: - sets out a restriction on usage of fixed assets that are under this consumptiontype VAT treatment, e.g. can be only used in the three north-eastern provinces.
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VAT refund for purchase of domestically made equipment within investment amount available under Guoshuifa [1999] No. 171 (20 September 1999) is not applicable for fixed assets qualifying for this new policy. Actually, in Caishui [2006] No. 61, it clearly excludes FIEs eligible for VAT credit policy for fixed assets currently applicable in certain industries in the three north eastern provinces.
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SAT issued Guoshuihan [2005] No. 823 on 22 August 2005 clarifying that the EIT incentives for revitalizing northeastern industrial bases apply only to eligible enterprises in the areas of three provinces and one municipality in the northeastern area. It is indirectly to indicate that specific region requirement is essential for this VAT incentive as stipulated in Circular 156. Enterprises outside these specified areas, including subsidiaries or branches of groups established in the northeastern area, are not eligible to enjoy the incentives. According to a report on 21 December 2005, the VAT reform in this region has proved very successful.
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The MOF and SAT recently announced, via Caishui [2006] No. 156 (17 November 2006), that taxpayers in Northeast China that are entitled to a VAT input refund on fixed assets may obtain a refund of input VAT incurred between 1 December 2005 and 30 November 2006 based on the total amount of VAT incurred and paid in 2006. The input VAT on fixed assets incurred after 1 December 2006 continues to be subject to the original rules, whereby the refund ceiling is calculated according to the incremental VAT compared with the previous year.
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VAT Reform in Central Region
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As of January 2007, former SAT Commissioner Xie Xuren said that the experiment started in the Northeast in 2004 with reforming VAT on equipment has renovated enterprises with reduced prices of equipment. The reform will be spread to central cities (actually according to Wang Li, SAT Deputy Commissioner, it has been spread since July 2006 to central part of China). However, it is still cautious in spreading it to more areas in fear of a major dent in tax revenues. It could further stoke enterprises red-hot enthusiasm for investment.
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Caishui [2007] No. 75 Provisional Measures for Expanding the Scope and Input VAT Claim in the Central Region (11 May 2007) (repealed already) to expand the trial run of this important part of VAT reform from the North-east Region to the Central Region. Starting from 1 July 2007, general VAT taxpayers engaged in the specified 8 industries as their main business (i.e. over 50% of annual turnover) within the 26 specified industrial cities of 6 provinces (i.e. Shanxi, Anhui, Jiangxi, Henan, Hubei and Hunan) will be allowed to claim credit of input VAT incurred on fixed assets subject to certain limit.
51 1
The 8 industries are: equipment manufacturing, petrochemical, metallurgical, automobile manufacturing, agricultural products processing, electrical power, excavating and high/new tech. Applicable industries include two new industries, namely excavating and electrical power under Circular 75. (The two industries specified for the Northeast Region, i.e. shipbuilding and military equipment and materials, have been taken away.) In addition, Circular 75 requires that for the Central Region, taxpayers have to be located within the specified 26 cities in order to qualify for the new AF4222_L6_BT&VAT_Oct 2011 system
VAT Reform in Eastern Inner Mongolia and Sichuan (Earthquake affected areas)
Caishui [2008] No. 94 and Caishui [2008] No. 108 (repealed already), effective 1 July 2008, to further expand the trial run for VAT reform on allowing the input VAT credit based on the consumption-typed VAT policy To allow input VAT credit for fixed assets to certain industries Eligible industries in Eastern Inner Mongolia: similar to North-east Region with slight difference on high-new technology industry Eligible industries in Sichuan: almost all industries, except cokeprocessing, aluminum extrusion, small-scale steel production, small-scale fire-powered electricity generation
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Credit restriction

Eastern Inner Mongolia: same as North-east Region, i.e. year-on-year increase in VAT payable Sichuan: not specified Eastern Inner Mongolia: quarterly basis with yearend reconciliation Sichuan: not specified
Application for VAT refund

51 3
According to Guoshuihan [2004] No. 1111, it could be inferred that the headquarters located in the Northeast Region cannot credit input VAT incurred on fixed assets purchased for the use by branches located outside the Northeast Region. However, this restriction is not imposed in the Central Region, Eastern Inner Mongolia or the earthquake stricken areas (Sichuan). Additional clarification on headquarters location
Eastern Inner Mongolia: headquarters must be located in applicable areas Sichuan: if headquarters are not located in applicable areas, but fixed assets are purchased by headquarters and used by branches located in applicable areas, the headquarters can credit input VAT on these fixed assets
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VAT for software industries
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VAT Rates for Software industries (1)
Under the VAT refund incentive policy since 2002, sales of self-developed and self-produced software products by qualified IC manufacturers VAT at 3% - Immediate VAT Refund If sales of hardware and software are not separately accounted for No refund (all will be treated as hardware subject to VAT) (based on Caishuizi [1999] No. 273) Non self-developed software No refund According to Circular 273, the refund is equal to the portion of the actual VAT liability in excess of 6% of the sale of software products (reduced to 3% as from 24 June 2000 to the end of 2010) provided the taxpayer pays VAT at a rate of 17%. However, this incentive policy has been terminated on 1 April 2005. (For those with proper qualification before 14 July 2004, the incentive policy was still valid during the transitional period up to 31 March 2005.)
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Caishui [2006] No. 174 provided that the VAT refund also should apply to self-developed software products that are embedded in computer networks, computer hardware, machines and equipment as an indivisible component, and the cost of the sale can be calculated separately. Under Circular 174, however, the VAT refund for the embedded software products sales was calculated according to the percentage of costs on the total costs of sales, not according to the respective sales. As a result, the calculation was inconsistent with the VAT refund calculation basis stipulated in Caishuizi [1999] No. 273. Thus, using the cost of sales suggested in Circular 174 as the basis for calculating the VAT refund for embedded software products would not be beneficial to software developers and would not further the goal of encouraging the software industry. This is because in the software industry the development costs for software are generally low and the profit margin relatively high.
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Caishui [2008] No. 92 further clarifies the policy and calculation formula for a VAT refund for the sale of embedded software. Circular 92 repeals Caishui [2006] No. 174 accordingly. Circular 92 provides a more favourable basis for calculation as follows: Sales of embedded software = Total sales of embedded software, computer hardware and equipment [costs of hardware and equipment x (1 + percentage of mark up on costs)] The mark up percentage may not be less than 10%. VAT refund = Sales of embedded software x (17% - 3%) Circular 92 is effective retrospective from 28 November 2005.
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Determination of Taxable Amount Software BT vs. VAT

Sale of software without transfer any ownership of the patented or non patented technology is subject to VAT Sale of software together with ownership of the patented or non patented technology is subject to BT (namely software + intellectual property subject to BT) Sale of self developed software, effective tax rate is 3%, (after tax refund) (Note: Abolished on 1 April 2005) Sale of self developed IC (integrated circuit) products, effective tax rate is 6% (after tax refund)
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519
Appendix 3 Some special VAT exemptions
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Specific Exempted Income

Caishui [2009] No. 31 (27 March 2009) Notice regarding tax issues for supporting the development of cultural enterprises (jointly issued by MOF, SAT and GAC). Revenues from movie distribution, sales of movie copies, copyrights transfer, etc. of qualifying movie production companies / enterprises, from 1 January 2009 to 31 December 2013, are exempt from Value-added Tax. Exports of books and audio-visual products, etc. from 1 January 2009 to 31 December 2013, have the Value-added Tax refunds on export.
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Specific Exemption
Caiguanshui [2009] No. 22 (1 April 2009) Notice regarding import tax policy on 2009-2011 encouraged generalized science career development State Council approved that from 1 January 2009 to 31 December 2011, any purchase of self-used films etc for broadcasting from abroad, if opened to public in science museum, observatory, earthquake station and other generalized science bases, is exempt from: (1) customs duty (2) import VAT
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Lecture No. 7 Value Added Tax (Part B)
Main topics

VAT Export Refund Revised implementation rules for VAT effective from 1/1/2009 Consumption tax
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AF4222_L7_VAT(B)_October 2011
VAT Export Refund
Background

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PRC grant preferential VAT treatment to taxpayer who exports The preferential treatment include export tax refund and export tax exemption Export goods attract zero rate of VAT. Taxpayers exporting goods can apply for a tax refund on those goods exported for which tax has been paid previously, ie tax refund on export
Background (2)
Depending on the structure of the exporting enterprises and the types of goods dealt with, export goods fall into the following categories for VAT exemption/refund purposes:

Goods eligible for tax exemption and tax refund in export Goods eligible for tax exemption on export but not a tax refund because tax has not been imposed on the goods, and Goods which are eligible for neither tax exemption nor tax refund on export because their export is restricted or banned
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Goods eligible for refund/exemption (1)
Self-produced goods exported by domestic production enterprises with export licences or consignment through foreign trading enterprises; Purchased goods exported by foreign trading enterprises with export license or goods consigned to other foreign trading enterprises for export; Self-produced goods produced by production enterprises consigned to foreign trading enterprises for exports; Self-produced goods either exported by foreign-invested enterprises after 31 Dec 1993 or consigned to foreign trading enterprises for exports
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Goods eligible for refund/exemption (2)
Goods exported by the following specific enterprises (not limited to enterprises having an export license)
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Goods exported by overseas contract construction enterprises to undertake contracted construction in overseas locations; Goods exported by overseas contract repairs and replacement services enterprises to undertake contract repairs and replacement services in overseas locations; Goods sold by ocean liner supplier or ocean transportation suppliers to foreign ocean liners or Chinese ocean liners, from which foreign currency is received; Mechanic and electronic products or construction materials sold by domestic enterprises who win sales through international bidding and with loan provided by international financial organisations or foreign governments; Goods purchased with the border and transported out of the border as foreign investments
Goods eligible for refund/exemption (4) mechanism in general
Where goods are eligible for tax refund/exemption, taxes actually incurred before export are refunded according to the stipulated rate of refund A tax refund/exemption will not be given to enterprises which export tax-exempt goods or goods which are restricted or banned from export Goods consigned to foreign trading enterprises by non-production enterprises for export are excluded from refund/exemption category
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Tax exemption without tax refund
Self-produced goods either exported by foreign-invested enterprises established before 31 Dec 1993 or consigned to foreign trading enterprises for export; Self-produced goods either exported by small-scale taxpayers who are also production enterprises or consigned to foreign trading enterprises for export; Tax will be exempted but not refunded for goods purchased by foreign trading enterprises from small-scale taxpayers for export, with certain exception
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Tax exemption where no refund necessary
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Goods processed with imported materials for export. No tax has been levied on the materials imported and hence, upon export, the processed goods will not get a tax refund Contraceptives, ancient and antique books. No tax has been levied on their domestic sales, therefore no tax will be refunded upon their export Cigarettes exported. Enterprises engaged in exporting cigarettes with cigarette export license will not be subject to VAT and consumption tax and will not get a tax refund Military supplies or goods exported by military system enterprises produced by the military supply factory or allocated by the military supply department for export
No exemption, no refund
Export of restricted/banned goods are treated a domestic sales as follows:

Crude oil Export for external bids Goods prohibited by the state sugar
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Methods for computing tax refund
Every manufacturing type company should claim export VAT refunds using Exempt, Credit, Refund (ECR) method and file an ECR tax return if it exports its products
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Method for computing tax refund

Mechanism of ECR (Exempt, Credit and Refund) Method ()
Exempted VAT on export sales
Credit (i.e. input VAT must set off the output VAT)
VAT payable = Output VAT on domestic sales (Total input VAT -Non-creditable input VAT + creditable input VAT brought forward from previous period)
Caishuizhi [1995] No. 92 [1995] 092 ](8 July 1995) + Guoshuifa [1996] No. 123 [1996) 123
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535
Export VAT Refund (cont'd)

Non-refundable / non-creditable input VAT
= (Export Sales on FOB value IMP-Materials-D/F) x (17% - R) FOB = Free-on-board IMP-Materials-D/F = Value of materials imported on a duty free basis R= Export refund rate
[Caishui [2004] 52 (3/3/2004)]
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536
Export VAT Refund (cont'd)

Caishuizhi [1995] No. 92 [1995] 092 + Guoshuifa [2002] No. 11 Mechanism of ECR Method (cont'd)
Refund of input VAT
where there is un-utilized input VAT, i.e. VAT payable is negative, tax refundable, based on specific formula Refund application be made on monthly basis
53 7
537
Refund Formula
Formula to determine input VAT refundable If (A) (=Export sales x Refund rate - Non refundable amount*) < (B) (=unutilized input VAT) VAT refund = (A) (thus we have a restriction here) & remaining balance of unutilized input VAT (B-A) shall be carried forward to next period * Non refundable amount = tax exempt imported raw materials x refund rate
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Refund Formula
Formula to determine input VAT refundable If (A) (=Export sales x Refund rate - Non refundable amount) (B) (=unutilized input VAT) (namely we have a negative VAT as calculated] VAT refund = (B) (thus we have no
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restriction here)
Tax first, refund later

All other enterprises and foreign trading enterprises which are not entitled to ECR will apply Tax First, Refund Later Amount of goods purchased for export and the amount of export sales are booked separately, the amount of tax refund is calculated based on the amount of the input tax indicated on the VAT invoice and the specified refund rate Example: purchase price for goods (per VAT invoice)=100; Input VAT on purchase = 17, Export VAT Refund Rate (EVRR) = 5% ; Tax refundable = 5 If purchased from small-scale taxpayer, with special approval, Tax Refundable = sales amount inclusive VAT / (1 + tax rate at 4%) x EVRR (usually 3% for small-scale taxpayers)
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Tax first, refund later
All other enterprises and foreign trading enterprises which are not entitled to ECR will apply Tax First, Refund Later Amount of goods purchased for export and the amount of export sales are booked separately, the amount of tax refund is calculated based on the amount of the input tax indicated on the VAT invoice and the specified refund rate
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Appendix 1: Historical development on Export refund and refund rates for reference
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Export VAT Refund (Contd)
Caishui [2003] 222, current refund rates (with effect from 1 January 2004)

machinery, equipment, electronic products, vehicles, garments, 17% watches, china, toys , etc. 13% products not included in 17% or 13% and not agricultural products, 11% agricultural products, 5%
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With retrospective effect from 1 January 2003, commercial FIEs having import and export rights may apply for export VAT refund in the same way as an import and export enterprise when they export goods on their own accounts. Effective from 1 January 2004, enterprises exporting goods purchased from small scale taxpayers may apply for export VAT refund at refund rates stipulated in the Caishui [2003] No. 222 with a cap at 6%. Furthermore, SAT issued Guoshuihan [2005] No. 248 on 24 March 2005 (with effect 1 April 2005). Export enterprises exporting products purchased from small-scale VAT payers must present a VAT invoice to obtain a VAT refund. Small-scale VAT payers can request that the tax authorities issue a VAT invoice for products sold to export enterprises. It is clearly stated that export of software products is exempt from VAT starting from 1 January 2004, namely it is not entitled to any export VAT refund or credit.
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In December 2004, MOF and SAT have taken another step in export VAT refund rates of certain information technology products to 17% with retrospective effect from 1 November 2004. The scope covers the following:
Integrated circuits Diode, transistor and semi-conductor Mobile communication base station Ethernet switch Router Mobile communication handset Micro-processor System processor LCD display CRT display Hard disk drive Storage component Numerically controlled machinery
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In July 2004, MOF and SAT recently introduced a new trial measure for export VAT refund. 40 listed production enterprises in China (normally they are those with renowned names) have been selected and allowed to apply ECR export VAT refund policy on goods sourced from third parties. In other words, selected production enterprises may claim VAT refund for both self-manufactured goods and procured goods. Under which, production enterprises are allowed to expand their business scope to provide distribution services (e.g. wholesaling and retailing) from 1 June 2004 onwards.
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Caishui [2005] 75, 73 and 67, amend the export VAT refund rates of the following products (with effect from 1 May 2005) Coat, tungsten, tin, zinc and stibium products reduced to 8% Some steel products e.g. tariff number 7208, 7209 etc reduced to 11% Abolition of export VAT refund rate for rare-earth metals (e.g. on 20 April, 2005, no export refund for products with gold in part), oxides and salts, metallic silicons, molybdenum ore and refined ore, light and heavy magnesium, fluorite, talc,carborundum, wood granule, wood flour and wood chips
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On 24 August 2005, a Notice (Fagaijingao [2005] No. 1606) specifies that the tax refund for gasoline () and naphtha () is suspended. Implementation rules will be issued by the Ministry of Finance and SAT. The Notice is effective 1 September to 31 December 2005. Export VAT refund cannot apply to some chemical products() see Caishui [2005] No. 192, 29/12/2005
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On 14 June 2006, it was reported that SAT would slash export tax rebates to rein in the surging exports of resource-intensive products. The cuts mainly target energy-consuming and resource-intensive industries, especially those causing severe damage to the environment. On average, drop of two percent is possible in the tax rebates for sectors like textiles and metallurgy as well as iron and steel, while the new high-tech industries would find their rebates rates raised. A downward adjustment will help rein in Chinas surging exports and narrow foreign trade surplus. Between 2001 and 2005, the aggregated export tax rebates reached 1.19 trillion yuan, nearly 3.8 times as much as the period from 1996 to 2000.
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Caishui [2006] No. 139 (15 September 2006) Notice on Adjustment of Export VAT Refund Rates for Certain Products and Supplement to Prohibited Category for Processing Trade Caishui [2006] No. 145 (29 September 2006) Supplementary Notices on Issues Regarding Adjustment of Export VAT Refund Rate for Certain Products. Circular 139 and Circular 145 aim to deal with (1) those pollutioninducing and high energy-consuming products, resulting in the outflow of scare natural resources and damage to the local government, and (2) high-volume exports of low value-added products from labour-intensive industries, giving rise to an international trade friction and anti-dumping investigations. Circular 139 effective from 15 September 2006 giving grandfathering relief
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Key Adjustments of Circular 139 (1) Abolition of export VAT refunds for 258 types of product (most of which are either mineral products, high-pollution products or products made from non-renewable natural resources, e.g. natural gas, coal etc) (Note: Circular 130 also states that products that are no longer applicable for VAT refunds will fall with the prohibited category for processing trade purposes. As such, the importation of such goods will be subject to import VAT and Customs Duty. On 1 November 2006, Circular 82 was issued to further clarify the expansion of the Catalogue as mentioned in Circular 139 that products which include low quality, highly polluting and resourceintensive items. Circular 82 applies to all enterprises in China including those located in Customs Supervision Zones, i.e. Export Processing Zones, Free Trade Zones etc.))
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Key Adjustments of Circular 139 (2) Reduction of export VAT refund rates (for products from overheated or labour intensive industries, e.g. steel, cement and textiles etc..) (3) Increase in VAT refund rates (for hi-tech and processed agricultural products, e.g. IT products, biomedical products)
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On 24 January 2007, former SAT Commissioner Xie Xuren said: Proposals have also been raised that tax on the use of resources such as coal, oil and natural gas shall be extended to cover resources such as water, forestry products and grassland. As the countrys awareness of the need for resource conservation (including the use of farmland) grows, proposals have been raised to increase the rates and scope of the tax. On 3 February 2007, a new refund rate policy has been applied to steel products for export after the long-time conflict among China, USA and EU in view of the possibly imposed trade sanctions.
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Notice Regarding the Adjustment in Export Refund Rates for
Certain Commodities Caishui [2007] No. 90 (19 June 2007) with effect from 1 July 2007. The Notice was issued after consultation with the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOC) and the General Administration of Customs (GAC). The Notice introduces significant changes in Chinas export refund rates to echo the increasing pressure and critics from major trading partners with respect to the excessive trade surplus, together with the concerns of resources preservation and environmental protection in China.
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Key adjustments A total of 2,831 categories of commodity, accounting for 37% of all the items subject to PRC Customs Import and Export Tariff (export portfolio), will be affected by VAT export refund rate adjustments. Categories A (Withdrawal/abolition of export VAT refund entitlement for 553 commodities) most of which are produced by energy-inefficient methods, are highly polluting, or make use of scarce natural resources. This means that there will be no refund of VAT paid on inputs.
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Key adjustments The exporters of Category A commodities (previously enjoying refund rates of 5% - 13%) could be facing the heaviest burden because their exports would even be subject to deemed domestic sales VAT treatment. This change cover: leather, chlorine, dyes and other chemical products, some fertilizers, metal carbide and activated carbon products, lumber, one-time-use wooden products, unalloyed aluminum poles etc.
(Based on Caishui [2006] No. 139, these commodities may be added to the list of products prohibited from the processing trade procedure. In other words, they may also have import tariffs and import link tariffs imposed in the process of importation. Accordingly, enterprises engaged in the processing trade for these items may potentially confront a higher tax burden.)
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Key adjustments Categories B (Reduction of VAT Refund Rates for 2268 commodities) most of which are considered to derive from labour-intensive or potentially over-heated industries, or relate to sectors affected by international trade friction. The implication for exporters in this category is that part of the input VAT paid in the previous stage before export will become costs to them who may or may not recoup the same back from the foreign buyers through price increases. The commodities include some electronic machinery, clothing, shoes and hats, bags/luggage, toys, plastics, rubber and rubber products, some base metals and their products, bicycles, motor-cylces, vegetable oils etc. These products will have their VAT export refund rates reduced by percentages ranging from 2% to 8%.
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Key adjustments Categories C (Exemption applied to 10 commodities) which previously received VAT export refunds. It means that the VAT export tax refund has been fully repealed for the 10 items, but their export sale will still be VAT exempt. These 10 items include: peanut kernels, oil paintings, engraved plagues, postage stamps, etc.
In brief, no VAT would be refunded for export. However, deemed

domestic sales rules DO NOT apply.
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Effect of the Adjustments under Circular 90 (1 July 2007) As an international practice, most countries apply a zero rate to export transactions. This means that export sales are not only not subject to VAT, but in addition all input VAT incurred by a company on its purchases may be either credited against other VAT liabilities or refunded. The rationale behind this is two-fold. First, it ensures that the neutrality of VAT for the company and forces the ultimate consumer to bear it. Second, zero rating effectively acts as an incentive for exports since commodity prices to foreign customers are free of VAT. However, in China, its VAT system imposes additional tax costs on exporters. As indicated in the Circular 90, the suggested adjustments are extensive in commodity coverage and material in rate reduction. They will raise the tax costs for many exporting enterprises. Considering the extent of some of the decreases in the refund rates (as much as 8%), the profit and loss of some exporters could be devastated.
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Effect of the Adjustments under Circular 90 (1 July 2007) Whether the use of VAT refund rate adjustments as major economic measures by China will continue for a considerable length of time remains yet to be seen. To minimize these detrimental effects, the following actions may be considered: Review of the tariff coding, Evaluation of the business models e.g. to contract manufacturing from
import processing Conducting a transfer pricing review Use of EPZs Increase of bonded imports, etc
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Supplementary Notice on Reduction of Export VAT Refund Rate for Certain Commodities (Caishui [2007] No. 97) (July 2007) The Notice repeals the export VAT refund for salt, and adjusts the rate to 9% for revolvers, coke ovens and staplers.
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MOF and SAT issued Caishui [2008] No. 111 that increases the export tax refund rate for certain textile and garment exports from 11% to 13%, and for certain bamboo products to 11%. At the same time, the export tax refund is abolished for certain pesticide products, coating products, batteries, rosin, silver and refined zinc. The notice is effective 1 August 2008.
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Key items New refund rate (%)
Caishui [2008] No. 111, 30 July 2008, effective 1 August 2008

Certain textiles and clothing accessories Certain bamboo products Korean pine-nuts, certain agricultural pesticides, rosin, certain silver products, certain lacquer products, certain batteries 13 11 export VAT refund abolished
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Key items New refund rate (%) Caishui [2008] No. 138, 21 October 2008, effective 1 November 2008 Certain textiles, certain garments and toys Certain daily used/ornamental ceramic products Certain plastic products Certain furniture Certain anti-AIDS medicines, insulin and its salts, certain yellow collagen products, certain toughened glass, wire of tantalum, certain chains, certain sewing machines, certain fans, certain metal carbide knives for machines, certain books and notebooks AF4222_L7_VAT(B)_October 2011 14 11 9 11, 13 9, 11, 13
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Key items Certain rubber products and forestry products Certain modules and glassware Certain aquatic products Certain handbags, certain footwear and headgear, certain umbrellas, certain furniture, certain bedding, certain lamps, certain clocks and watches Certain chemical products, certain articles of stone, certain non-ferrous metal products New refund rate (%) 9 11 13 13 Caishui [2008] No. 144, 17 November 2008, effective 1 December 2008
11, 13
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Certain mechanical and electrical products AF4222_L7_VAT(B)_October 2011
11, 13, 14

Caishui [2008] No. 177, 29 December 2008, effective 1 January 2009

Inertial navigation instruments for airplanes, gyroscopes, instruments and apparatus for measuring or detecting ionizing radiations, nuclear reactors, industrial robots 17
Motorcycles, sewing machines and electricity conductors
14
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Caishui [2009] No. 14, 5 February 2009, effective 1 February 2009

Textile and garment 15
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Caishui [2009] No. 43, 27 March 2009, effective 1 April 2009 (Note: This is the sixth increase in the VAT export refund rate since the second half of 2008.)
Textiles and apparels CRT colour TV sets, uninterruptible power supplies, certain electronic information-related products, etc. Certain light industrial products 16 (from 15, see Caishui No. 14) 17 (formerly 14) 11
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New Guidance on Export Tax Exemption (Refund) Procedures
SAT issued Guoshuifa [2005] No. 68 on19 April 2005 providing guidance on the procedure governing export tax refunds. The Notice takes effect 1 May 2005 and specifies that, in the case of products exported by trade enterprises, if the enterprise fails to apply for an export tax refund within 90 days after the export date specified on the export customs declaration form, the enterprise must accrue output VAT and file VAT Return with the tax authorities accordingly.
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New Guidance on Export Tax Exemption (Refund) Procedures (Contd)
Trade enterprises should accrue output VAT or calculate tax payable according to the following formulas:
For general VAT payers Output VAT = (export FOB x exchange rate) / (1 + VAT rate) x VAT rate For small-scale VAT payers VAT payable = (export FOB x exchange rate) / (1 + VAT rate) x VAT rate
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Export Tax Refund Claim
The SAT and Ministry of Commerce jointly issued the Guoshuifa [2006] No. 24 on 13 February 2006, specifying that an export enterprise will not be eligible to apply for export tax refund/exemption if some conditions exist.
For example, with blank export tax refund/exemption documents, the export for goods of another enterprise, amending the bill of lading after customs clearance, not participating in export activities in substance or any acts contravening the laws and regulations on export tax refunds.
Circular 24 took effect on 1 March 2006.
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Appendix 2 Illustrative
example of VAT refund
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Guoshuifa [2002] No. 11 (6 February 2002) - Example

Total Input VAT RMB 300 Tax-exempt imported raw materials USD200 Domestic Sales RMB1000 Export Sales USD300 Official exchange rate USD1 = RMB8.3 VAT rate = 17%; Refund rate=13%
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Guoshuifa [2002] No. 11 - Example (Contd) (1st Step: Total tax payable)

Total tax payable = Output VAT on domestic sales (Input VAT non creditable Input VAT) Non creditable input VAT = Export sales x (VAT rate Refund rate) Tax-exempt imported raw materials (VAT rate Refund rate) Total tax payable = 1000 x 17% - 300 [300 x 8.3 x (17% - 13%) 200 x 8.3 x (17% - 13%)] = -96.8 (amount to be refundable in theory)
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Guoshuifa [2002] No. 11 - Example (Contd) (2nd Step: Calculated Refund)
Calculated Refund = FOB x Export Sales x Exchange rate x Refund rate Non Refundable amount Non Refundable amount = Tax-exempt Imported Raw Materials x Exchange rate x Refund rate Calculated Refund = 300 x 8.3 x 13% - (200 x 8.3 x 13%) = 107.9
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Guoshuifa [2002] No. 11 - Eg (Contd) (3rd Step: Refundable amount)
If total tax payable(-ve) =< Calculated Refund, Refundable amount = total tax payable (-ve); RMB96.8 No Restriction If total tax payable (-ve) > Calculated Refund, Refundable amount = Calculated Refund Restriction here; not applicable in this case NB comparison based on ABSOLUTE Value i.e. 96.8 < 107.9 (no restriction) If > 107.9, then subject to restriction at 107.9
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Appendix 3 Revised implementation rules effective 1/1/09 (most new rules have been updated to notes to lecture 6)
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Key Changes of Assessing Practice and Tax Filing under the Provisional Regulations on VAT
Revised rate for the amount of input VAT creditable with respect to purchase of agricultural products is 13% of the purchase price (increased from 10%) Input VAT recovery on freight charges paid for the transportation of purchased or sold goods is 7% Withholding agents for foreign enterprises without PE in China include their business agent, or the purchaser of taxable supplies
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Key Changes of Assessing Practice and Tax Filing under the Provisional Regulations on VAT (contd)

A new quarterly filing period introduced (under the former PR, the longest payment period was one month) All tax return filing and payment within 15 days after the end of each filing period (monthly or quarterly) instead of 10 days under the former PR) VAT payment due date for imported goods extended from 7 days to 15 days after the issuance of the payment notice by the customs authority
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Four Major Changes in Amended VAT DIR

Implementation of VAT Transformation to consumption-base from production-base Clarification of mixed sales and concurrently engaged in VATable and BTable businesses Support to Small-scale Taxpayers Improvement to administration
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Implementation of VAT Transformation to Consumption-base
Redefine the scope of fixed assets eligible for creditable input VAT in line with the definition of fixed assets in the CITL now both aligned with the China Accounting Standards Confirm that immovable properties such as buildings and structure do not fall in this scope Confirm that input VAT recovery is specifically disallowed for the purchase of small motor cars, motor cycles and yachts (because they are subject to Consumption Tax and may be used for private purposes) Agree that the input VAT for fixed assets with mixed use for VATable projects, and non-VATable projects (e.g. personal consumption) shall be fully creditable if the taxpayer is a General-VAT taxpayer and satisfies other administrative requirements Allow the excess input VAT can be carried forward to offset future output VAT and no refund of excess input VAT shall be granted
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Clarification of Mixed Sales and Concurrently Engaged in VATable and BTable Businesses

Concept of Principal Business remains to determine whether a taxpayer is subject to VAT or BT Depend on the onus of separately accounting for the taxable turnover for VAT and BT Give the in-charge state tax bureau the authority to deem the amount of turnover subject to VAT if the taxpayer fails to segregate the turnover for the two businesses (instead of the old practice to bring the whole turnover to VAT) Identify the relevant non-creditable input VAT portion; otherwise a prescribe apportionment formula to compute a deemed noncreditable input VAT (namely the amount of input VAT that cannot be correctly identified for VAT activities and VAT exempt projects or BTable services)
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Support to Small-scale Taxpayers

The threshold for a General-VAT Taxpayer is reduced to: RMB 0.5 million (from RMB 1 million) for industrial taxpayers RMB 0.8 million (from RMB 1.8 million) for retail/trading taxpayers Aim to allow more Small-scale Taxpayers to be qualified as General-VAT Taxpayers this they can use of the creditable system for merchandises, raw materials, and fixed assets, export refunds, etc, to pass on the tax burden to the next party in the supply chain
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Improvement to Administration
Narrow down the scope of goods suffering from abnormal losses (e.g. delete the ambiguous term called other abnormal losses and loss from natural disaster in the former DIR) Aim to avoid unnecessary disputes between the taxpayers and tax bureaus
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VAT Transformation
The most important change in the VAT regime is the transformation from the production-based VAT system into the consumption-based VAT system effective 1 January 2009. Effectively, input VAT incurred on fixed assets is eligible for credit against output VAT starting from 1 January 2009. The forecast on the budgetary impact due to the transformation would amount to RMB 120 billion. VAT regime is now playing an increasingly important strategic role in the adjustment of the Chinese economy, rather than merely a tax raising tool.
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Detailed Features of the VAT Transformation

Nation-wide coverage Applicable to virtually all industries Full input VAT recovery Solve the problem of multiple taxation (because the input VAT under the production-based system would be capitalized as costs of fixed assets) Reduce the tax burden on investing on equipment thus not undermining the price competitiveness of Chinese companies Encourage domestic consumption Encourage capital investment Promote advancement of technology Guide structural developments Stimulate economic growth
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Key Changes VAT Transformation under the Provisional Regulations on VAT

Input VAT incurred on the purchase of fixed assets has been removed from the list of non-creditable input VAT Import VAT exemption for fixed assets imported for contract processing, assembly or compensation trade has been cancelled (affecting those processing factories in the Pearl River delta region financially speaking an increase of their operating costs as the processing factories are exempt from VAT on their processing fees and therefore would not be able to claim input tax credit on the import VAT to be payable on their imported equipment) The VAT rate for Small-scale taxpayer is reduced to 3% (from 4% or 6% for commercial enterprises and manufacturing enterprises respectively) because these enterprises will not be benefited from the transformation which is only applicable to General-VAT taxpayers thus alleviate their VAT burdens
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Caishui [2008] No. 170
Circular 170, issued jointly by the MOF and SAT on 19 December 2008, mainly clarifies the details for the implementation of the consumption-based VAT system. It clarifies that input VAT incurred for acquisition of FA (including donation and investment) and self-manufactured FA (including expansion and installation) are both creditable against output VAT. The amount of creditable input VAT refers to those incurred by the taxpayers on or after 1 January 2009 and recorded on VAT invoices issued on or after 1 January 2009. For locations where the Trial Run of consumption-based VAT system has been adopted prior to 2009, the amount of input VAT on FA which has not been refunded as at 31 December 2008 may be treated as creditable input VAT in January 2009.
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Caishui [2008] No. 170 (contd)
Circular 170 changes the VAT treatments on the sales of the self-used FA on or after 1 January 2009 as follows:
For General-VAT taxpayers: Output VAT = sales proceeds* x 17% For Small-scale VAT taxpayers: VAT payable = Sales proceeds* x 3% * Net book value of the FA should be used as the sales proceeds for the deemed sales cases.
Circular 170 requires a claw-back of input VAT credit for FA whose input VAT credit has been claimed but subsequently fall into the category of non-creditable input VAT as stipulated, e.g. the FA are subsequently used solely for non-VATable activities.
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4 methods for levying VAT on sale of fixed assets
Fixed assets sold are purchased after 1 January 2009, VAT shall be levied at the applicable VAT rates (17% or 13%), since the input VAT on such fixed assets are creditable. Fixed assets sold were purchased on or before 31 December 2008, and the taxpayer has not joined the fixed assets VAT refund pilot scheme, VAT shall be levied at 2%, since the input tax on such fixed assets is not creditable.
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4 methods for levying VAT on sale of fixed assets
Where the taxpayer has already joined the fixed assets VAT refund pilot scheme, and the fixed assets were purchased or self-produced before this scheme began, VAT shall be levied at 2%, since the input tax on such fixed assets is not creditable. Where the taxpayer has already joined the fixed assets VAT refund pilot scheme, and the fixed assets were purchased or self- produced after this scheme began, VAT shall be levied at the applicable VAT rates (17% or 15%), since the input tax on such fixed assets is creditable.
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Claw Back of Input VAT on Tax Exempt Equipment
Guoshuihan [2009] No. 158, 30 March 2009 Notice regarding input VAT credits issues related to the claw-back of input level VAT on tax-exempt equipment for its advance release from customs supervision Imported duty-free equipment should be under the supervision of customs for a specified period. SAT confirmed that, for taxpayers that imported duty-free equipment for self-use purposes before 31 December 2008, the input VAT repaid and indicated on the VAT certificate issued by customs after 1 January 2009 can be credited against the output VAT. Subsequent sales of the duty-free equipment released early from customs supervision will be subject to VAT.
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Caishui [2008] No. 176
Circular 176 was jointly issued by the MOF and SAT on 25 December 2008 to formally cancel the VAT refund policy on purchase of domestically-made equipment (available under Guoshuifa [1999] No. 171) by FIEs effective 1 January 2009. However, the Circular grants a 6-month grandfathering period for FIEs affected by such policy change. It also prohibits the FIEs to claim credit on the input VAT already refunded.
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The affected FIE is allowed to continue to apply for the VAT refund before 30 June 2009 (namely a 6-month grandfathering period) if it satisfies all the following conditions:
The FIE has obtained the Project Confirmation Letter on or before 9 November 2008 (the day before the Amended VAT Regulations were released by the State Council) and lodged a record with the in-charge tax bureau on or before 31 December 2008. The FIE actually purchases the domestically-made equipment, obtains the VAT invoice, and applies for the VAT refund with the incharge tax bureau on or before 30 June 2009. The equipment has been included in the <Purchase List of Domestically-made Equipment for the Project> of the FIE.
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Circulars on the VAT Treatment of Fixed Assets Repealed and Ceased to be effective from 1 January 2009

Caishui [2004] No. 156 Caishui [2004] No. 168 Caishui [2004] No. 226 Caishui [2004] No. 227 Guoshuihan [2004] No. 143 Caishsui [2005] No. 28 Caishui [2005] No. 176 Caishui [2006] No. 15 Caishui [2006] No. 156 Caishui [2007] No. 75 Caishui [2007] No. 128 Guoshuifa [2007] No. 62 Caishui [2008] No. 94 Caishui [2008] No. 108 Caishui [2008] No. 141
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Notice [2008] No. 43 and Notice [2008] No. 103
Notice 43 (jointly issued by the MOF, SAT and GAC) and Notice 103 (issued by the GAC) on 15 December 2008 formally cancel the VAT exemption treatment for the importation of equipment by taxpayers having the following encouraged projects starting from 1 January 2009:
a) b) c) d) e) f)
g)
h)
Encouraged domestic and foreign invested projects Projects funded by foreign governments and international financial organizations Enterprises engaged in processing trade with the foreign businesses providing equipment for no consideration Foreign invested projects in Central and Western China supported and prescribed by the Central Government Technological innovation projects carried out by FIEs and foreign invested R&D centres using their own capital Software production enterprises and integrated circuits production enterprises Urban mass transit projects Other projects eligible for the VAT exemption treatment
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Notice [2008] No. 43 and Notice [2008] No. 103 (contd)

Notice 43 and Notice 103 also provide some grandfathering treatment of a 6-month period for the affected projects under certain conditions. For example, for projects under items a, b, d and g which have obtained the Project Confirmation Letters on or before 9 November 2008 are still eligible for the VAT exemption provided that the equipment is imported and declared on or before 30 June 2009. For projects under item c where the processing enterprise has filed for record the processing trade customs duty handbook for the equipment on or before 31 December 2008, the 6-month grandfathering period is also granted. This is particularly welcome by businesses with processing arrangements. It has been clarified that the customs duty exemption treatment will not be removed but still remains, even though the VAT exemption treatment for the importation of equipment is cancelled.
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Planning Tips to Alleviate the Adverse Cash Flow Impact
Alternative ways of acquiring FA Leasing arrangement for imported equipment to stretch the payment of the import VAT over the term of the lease and thereby lessen the cash flow impact (the downside includes the financing costs, and the tax implications to the lessor on the lease payments, etc.) Setting up new manufacturing facilities in bonded zones thus exemption for any VAT and customs duty on equipment imported into the zones (the arrangement must match with the business operations in terms of access to labour, suppliers and potential customers and sales/distribution channels) Evaluate whether contract processing is tax effective if they need to replace capital equipment frequently Proper schedule of acquisition plan Matching the timing of construction, commissioning and production, sales etc, particularly for those companies with heavy capital on FA Improve administration of VAT filing VAT invoices for procurement of FA be properly obtained and retained for VAT filing purposes Customs compliance at all times as equipment is under customs supervision AF4222_L7_VAT(B)_October 2011
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Appendix 4 Exemption policy for imported capital equipment
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VAT and Custom Exemption on Importation of Machinery
FIE that used to be exempt from VAT and import duties on the following, Guofa (1997) 37: Capital equipment imported by foreign investment projects that transfer technology and fall within the Encouraged Category and Restricted B Category under the Catalogue of Foreign Investment Industrial Guideline ) Catalogue for their own use within their total amount of investment, except those commodities listed in the Catalogue of Imported Goods Not Qualified for Tax Exemption for Foreign Investment Projects Equipment for use in projects sponsored by foreign governments or international financial organisations and equipment supplied by a foreign investor at no cost for processing trade, excluding items listed in the Catalogue of Imported Goods Not Qualified for Tax Exemption for Foreign Investment Projects. Duty and import VAT shall be exempt with respect to technologies and matching components parts imported along with the equipment in accordance with the contracts for projects in line with the aforesaid provision
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The Catalogue of Foreign Investment Industrial Guidelines lists industry and product sectors for which foreign investment is encouraged, as well as those in relation to which foreign investment is restricted The Catalogue was revised in March 2002, November 2004, and October 2007. The Restriction A and B were combined into one Restricted category in the revision of 2004. The import of equipment under the Restricted Category no longer qualified for tax exemption. Under the most updated version of the Catalogue, only projects under the Encouraged category are entitled to tax exemption granted under Goufa (1997) 37
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Shushui (1999) 791, FIE under the Encouraged Industries reform, foreign investment R&D centres, advanced technology FIEs, and export oriented FIEs, can import equipment and related technology, fittings and spare parts free of Customs duties and VAT if the following conditions are met: Source of funds: self-owned funds financing Usage of imported commodities: renewal or maintenance to the existing equipment within the originally approved business scope (excluding the renewal of the complete set of equipment and production lines); and Scope of the imported commodities: equipment that cannot be produced in China, or those that can be produced in China but do not meet the capacity requirements
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However, the abovementioned exemption policy is not applicable under the new PRVAT effective from 1 Jan 2009, since the recovery of VAT on fixed assets is now allowed
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R&D Investment, Caishui (2009) 115, import VAT exemption on equipment imported and a full VAT refund on domestically manufactured equipment purchased by R&D centres. This incentive expired on 31 December 2010. Caiguanshui (2009) 55 stipulated that the importation of key spare parts and materials by domestic enterprises for the production of encouraged technological equipment and productions are exempt from import VAT and Custom duty from 1 July 2009
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Part C Consumption Tax
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Consumption Tax (CT) -Overview
On manufacturers of, importers of, or units or individuals commission processing of special non essential or luxury goods (such as cigarettes, alcohol for example, fruit beer is also subject to consumption tax see Guoshuihan [2005] No. 333 on 18 April 2005, cosmetics, jewelry, and automobiles) Ad valorem - Tax rates: 3% to 50% depending on the types of goods or specific amount method Exported goods are exempted generally
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SAT issued on 25 August 2005 a Notice (Guoshuifa [2005] No. 133) regarding the issuance of CT Administration Measures (Trial) of Gasoline and Diesel (Trial Measures). The Trial Measures take effect 1 September 2005. New CT on vehicles will be implemented in May 2006 with 7 categories of cylinders the higher volume the higher rate ranging from 3% to 20% for environmental consideration For energy and environmental purposes, MOF and SAT issued Caishui [2008] No. 105 and Caiguanshui [2008] No. 73 adjusting the CT rates (including the applicable CT on importation) for passenger vehicles. Effective 1 September 2008, for example, the adjusted rates for cylinder capacity of 1.0L or less, the rate is adjusted from 3% to 1%. For those between 3.0L to 4.0L, and over 4.0L, the rates are adjusted significantly from 15% to 25% and from 20% to 40% respectively.
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Caishui [2006] No. 33 on 21 March 2006 makes significant amendments to the CT with effect from 1 April 2006. The purpose of the amendments is to correct problems with existing taxable categories by aligning the definitions of taxable items and tax rate structures with prevailing industry and environmental protection policies. The amendments also aim to correct changes in consumption standards with respect to items previously considered to be high level luxury items but which are now considered common consumption items.
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Five taxable items are added to the category of industrial oil: naphtha, menstruum oil, fuel oil, aviation kerosene and lubricating oil. Disposable wooden chopsticks and solid wood floor boards also are added as taxable items. Luxury products, such as golf balls, golf instruments, luxury watches and yachts are included as taxable items Skin-care and hair-care products are removed from the list of taxable items. Increasing CT rates for energy-consuming cars and vans with large cylinder capacities.
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SAT Responds to Consumption Tax Issue on Biological Diesel Oil - Guoshuihan [2006] No. 1183 The SAT clarified in the Commentary on the Scope of Taxable Items for Consumption Tax on Petrol and Diesel Oil (Guoshuifa [1998] No. 192) that biological diesel oil made from animal and plant oil, after extraction, concentration and synthesis, does not fall within the scope of taxable items for consumption tax purposes.
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The General Administration of Customs issued GAC Bulletin [2008] No. 14 to confirm the imposition of CT on imported processed oil such as import mensruum oil, naphtha, lubricants, and fuels (except wax oil) at the statutory tax rate as from 5 March 2008. However, import naphtha is exempt from CT from 5 March 2008 through 31 December 2010.
61 1
Consumption tax time of sale (manufactured goods)

At time of sale Credit and instalment, proceeds are receivable by contracts Settlement in advance, goods are shipped for transit L/C, goods are shipped and collection procedures are completed Goods used in further production of taxable goods no tax Goods used for other purposes taxable, e.g. manufacture of non-taxable goods, used in provision of labour services, gifts, etc Combined goods, tax at highest applicable rate
61 2
Consumption Tax Goods processed on commission basis

Tax liability arises upon delivery of processed goods to the taxpayer Withheld and paid by the party commissioned to process the goods If no withholding, the commissioning party be responsible. No consumption tax when goods are sold
61 3
Consumption Tax Imported Goods

Custom declaration Customs Authorities Cost + Additional fee and customs duty
61 4
Provisional Regulations and Detailed Implementation Rules of Consumption Tax (Amended)

The CT PR was amended on 10 November 2008 The amended CT DIR was then released on 15 December 2008 in order to ensure a smooth implementation of the amended CT PR The amended CT PR and DIR will be effective 1 January 2009
61 5
Key Changes of Assessing Practice and Tax Filing under the Provisional Regulations on CT

Setting out the compound CT rate computation method Revision of the list of items subject to CT and the applicable CT rates A new quarterly filing period introduced (under the former PR, the longest payment period was one month) All tax return filing and payment within 15 days after the end of each filing period (monthly or quarterly) instead of 10 days under the former PR) CT payment due date for imported goods extended from 7 days to 15 days after the issuance of the payment notice by the customs authority
61 6
Transfer Pricing Rules in China

AF4222 - China Tax Framework Lecture 8
Outline

Transfer Pricing Regulatory Framework Transfer Pricing in Final Measures Covered transactions Related parties Mandatory Reporting and Documentation requirement Transfer Pricing Adjustments Reasonable Pricing Methods Advance pricing arrangement (APA) Cost sharing agreement (CSA) Appendix DIPN 45
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Transfer Pricing Regulatory Framework
Art 41 of Enterprise Income Tax Law (ETIL) (effective 1/1/2008): tax authorities have the power to adjust the taxable income of an enterprise or its related party where the transactions between them are not in accordance with the arms length principle. Art 110 of Enterprise Income Tax Law Implementation Rules (effective 1/1/2008) provides that the arms length principle is the principle followed in business dealings between unrelated parties conducted in accordance with common business practices and having fair transaction prices Guo Shui Fa (2009) No. 2 (ie the Special Tax Adjustments Implementation Measures (Trial), took retrospective effect from 1/1/2008.
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Transfer Pricing in Final Measures
Draft version entitled The Regulation of Special Tax Adjustments (Trial) (13 chapters and 120 articles) for public comments an consultation on 21 March 2008 Guoshuifa [2008] No. 114, new related party transaction (RPT) forms released on 16 December 2008 (see Lecture No. 2A) Final version of the Implementation Measures for Special Tax Adjustments (Trial) including contemporaneous transfer pricing documentation (TPD) requirements, [Guoshuifa [2009] No. 2, 8 January 2009], released by SAT on 9 January 2009 The Final Measures are part of the New Corporate Income Tax Law regime which became effective 1 January 2008. The Final Measures establish the framework for transfer pricing documentation under the new CITL
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Transfer Pricing in Final Measures (contd)
The Final Measures consolidate the contents of previously issued TP circulars and some these are therefore revoked, while others remain in effect. For example, transfer pricing regulations - Guoshuifa [1998] No. 59 and Guoshuifa [2004] No. 143 were repealed effective 1 January 2008 accordingly. Similarly, advanced pricing agreement rules Guoshuifa [2004] No. 118 issued on 3 September 2004 was also repealed Deadline for RPT disclosure forms (see Guoshuifa [2008] No. 114 Intercompany Forms Notice which specifies the format for the disclosure forms) 31 May 2009 Deadline for TPD 31 December 2009 Since then, Annual Updates
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Transfer Pricing in Final Measures (contd)
The Final Measures contain 13 chapters and 118 provisions covering various aspects of Chapter 6 of CITL, retrospective effect from 1 January 2008. The context relating to transfer pricing includes: Chapter 2: Reporting of Related Party Transactions Chapter 3: Administration of Contemporaneous Documentation Chapter 4: Transfer Pricing Methods Chapter 5: Transfer Pricing Investigations and Adjustments Chapter 6: Administration of Advance Pricing Arrangements Chapter 11: Corresponding Adjustments and International Consultation
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Covered transactions
Art 10 of Circular 2:
The sales and purchase, transfer and use of tangible properties between related parties The transfer and use of intangible properties Capital financing The provision of services
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Related parties definition (1)

Art 9 of Circular 2 provides a detailed definition of related parties with reference to Circular (2008) No 114 as below: (i) One party directly or indirectly holds 25% or more shares of the other party, or 25% or more shares of both parties are commonly owned either directly or indirectly by a third party. Where party A holds the shares of party B indirectly through an intermediary, provided that party A holds 25% or more shares of the intermediary, the shareholding percentage of the intermediary in party B is taken as the shareholding percentage of party A in party B.
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Art 9 of Circular 2 provides a detailed definition of related parties with reference to Circular (2008) No 114 as below: (ii) Debt provided to one party by the other party (except an independent financial institution) accounts for 50% or more of the debtors paid-in capital, or 10% or more of the debt of one party is guaranteed by the other party (except in independent financial institution) (iii)50% or more of one partys high-level management or at least one senior member of one partys board of directors who is able to exert control over one partys board of directors is appointed by the other party, or the above-mentioned personnel of both parties are appointed by a third party
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Art 9 of Circular 2 provides a detailed definition of related parties with reference to Circular (2008) No 114 as below: (iv) 50% or more of one partys high-level management are also the high-level management of the other party, or at least one senior member of one partys board of directors who is able to exert control over one partys board of directors is also a senior member of the partys board of directors (v) The normal production and business operations of one party are dependent on intangibles such as industrial patent, technology know-how or other licensed intangible properties provided by the other party
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Art 9 of Circular 2 provides a detailed definition of related parties with reference to Circular (2008) No 114 as below: (vi) The sale and purchase activities of one party are primarily controlled by the other party (vii) The provision and receipt of services of one party are primarily controlled by the other party (viii) One party has substantial control over the production and business operations of the other, or both parties have interests, including the relationships where, despite the shareholding percentage under the first point above not being satisfied, the majority shareholders of both parties have basically identical economic interests pr family
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Why does the SAT want these regulations?
Opening up of business regulations in China has promoted international trade transfer pricing regulations help protect Chinas tax base Broader anti-avoidance measures assist in laying legal framework for future cross-border development local companies investing abroad China operations of MNCs moving up the value chain An opportunity to improve on past practices move taxpayer mindset from complacency to active compliance greater focus on substance establish workable procedures for taxpayers and all levels of tax bureaus
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Practically what does this mean?
Compliance New CIT regime RPT forms TPD requirements Challenges Understanding transfer pricing risk Documentation of poor financial performance / complex transactions Transfer pricing investigation / audit Opportunities Review transfer pricing policies Transfer pricing planning opportunities Use of APA, CSA and MAP
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Mandatory Reporting and Documentation requirement annual reporting
An enterprise shall submit a form detailing related party transactions occurred during the year in an appendix to its annual income tax return filing (based on draft Documentation Requirements):

A list of related parties and their relationship with the taxpayer; Country and region where the related parties are situated; Terms and transactions between related parties; Types of these transactions; The amounts of the transactions between the related parties and their proportion to all transactions of the transactions of the same type; Profits and losses arising from these transactions; Transfer pricing method used An indication of whether the requirements, to prepare and retain T/P documentation to be provided on request, are met
Annual return to be filed within 5 months after year end Similar to Australias Schedule 25 form Penalty for non-compliance: fine at a maximum of RMB10,000 (Administrative Law for Levy and Collection of Tax, Art 60)
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Contemporaneous Documentation (1)
An enterprise (under investigation), its related parties and other enterprises involved in the investigation shall provide relevant documents when required by the tax bureau (CITL, Art 43), which include
Contemporaneous documents such as pricing, standards for determining expenditures, computation methods, explanatory notes, etc; Documents relating to resale price or ultimate sale price in respect of properties, use right of properties, services of related party transactions, etc; Information such as product price, pricing method, profit level, etc that are comparable to the enterprise being investigation Other relevant information
Other enterprises involved in the investigation refer to enterprises similar to the enterprise being investigated in terms of the business operation and modes The documents shall be provided within the time as agreed with the tax authorities (30 days + 45 days extension) (CITIR, Art 114)
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Contemporaneous Documentation (2)
Based on draft Documentation Requirement, the following is required:
Global organization structure, including effective tax rates of the related parties; Detailed analysis of business operations; Details of related party transactions; Comparability analysis; Selection and application of TP method; including reason why other TP methods are rejected; Details of Cost Sharing Arrangement if applicable; and Other relevant documents
Similar to OECD requirements

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Contemporaneous documentation (3) - exemption
All enterprises in China must also prepare contemporaneous documentation by 31 May every year. The documentation should be kept for 10 years starting from 1 June of the year in which the related party transactions took place (for the year 2008, the due date is 31 Dec 2009). The following enterprises are exempt from such requirement by Circular (2009) No. 2: Enterprises with annual related party sales and purchases lower than RMB200 million and with annual amount of other related party transactions lower than RMB40 million; Enterprises with related party transactions covered under an effective advanced pricing arrangement; and Enterprise with 50% or less of their shares held by foreign shareholders which only have related party transactions with domestic related parties
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Contemporaneous Documentation (4) loss making enterprises
Circular (2009) No. 363 requires loss making enterprises established by MNCs performing limited functions and assuming limited risks, e.g. single function of manufacturing, to prepare contemporaneous documentation These limited function and risk enterprises should deserve a reasonable level profit The exemption under Circular (2009) No. 2 is not applied to these enterprises
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TPD reasons to maintain and submit
Failure to maintain contemporaneous TPD (and submit on request) may result in Chinese tax authorities deeming an enterprises taxable income, i.e. adopt the deemed profit method Special tax adjustments will result in additional tax, plus an interest levy that includes both a financial component at the normal PBOC rate (on 31 December of the year of the underpaid tax) and a 5% penalty component (if there is no documentation) The interest rate is levied on any adjustments on a daily basis, calculated from 1 June after the end of the adjusted year until the date of the payment and the interest is non-deductible The penalty interest may apply when the adjusted related party transaction amount surpasses the documentation preparation exemption threshold, even if the taxpayer acted in good faith but mistakenly believed that it was exempt from the contemporaneous documentation requirement (TPD). Therefore, MNCs should be cautious when analyzing the relevant transactions in determining if they constitute as related party transactions and assessing the potential risks for Chinese transfer pricing purposes
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TPD reasons to maintain and submit (contd)

Penalty component: will be waived if provide contemporaneous TPD (or if exempted from TPD) Subject to different levels of fines and surcharges (ranging from below RMB 2,000 up to RMB 50,000) for failure to provide or refuses to prepare certain RPT forms and / or TPD Art 29 of the Final Measures states that enterprises who fail to prepare contemporaneous documentation should be selected for audit Risk of audit of other tax issues (e.g. customs, VAT, BT etc)
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TPD overview of contents

1. 2. 3. 4. 5.
Organizational structure Description of business operations Description of RPTs Comparability analysis Selection & application of TP method
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Organizational structure

Relevant organizational and ownership structure Description of relationship with related parties and changes Description of related parties with whom the enterprise has transactions Relevant income taxes and applicable tax rates and preferential tax treatment of related parties
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Description of business operations

Overview of business Composition of principal business operations and proportion to the total business Market position and market environment Internal organizational structure, functions, assets and risk profile (including Form of Enterprises Function and Risk Analysis) Consolidated financial statements of the group
* For simplifying the information required, the SAT, in the Final Measures, has scaled back the number of items on business operations from nine to five.
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Description of RPTs

Description of the type of transactions, participants, timing, amounts, currencies, terms, etc Description of the trading mode, changes and reasons for change Description of transaction flow Description of intangibles involved Copy of relevant contracts and description of their implementation Economic and legal factors influencing pricing Segmented financial data (including Form of Enterprises Function and Risk Analysis)
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Comparability analysis

Factors considered in the comparability analysis Relevant information on activities of comparable companies Description of comparable transactions Source of comparables information, selection criteria and reasons Adjustments made to comparables and underlying reasons
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Selection & application of TP method

Transfer pricing method applied and its underlying reason Description of supportive comparable information for the selected method Assumptions and judgments made in establishing arms length prices or profit Application of transfer pricing method and results of comparability analysis. Explanation of compliance with arms length standard Other supporting information for the use of the TP method Onus of proof to taxpayers to justify the reasonableness of the transfer pricing method they adopt
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Selection & application of TP method (contd)
Transfer pricing method Comparable uncontrolled price method (CUP) (Art 23) Resale price method (RPM) (Art 24) Cost plus method (CPLM) (Art 25) Transactional net margin method (TNMM) (Art 26) Profit split method (PSM) (Art 27) Other methods that are consistent with the arms length principle * It is pointed out that in China, as in many countries, the TNMM is used over 90% of the time in practice. Also it should be noted that SAT is following a best method approach and the taxpayer will have to justify the selection of the method. * For the TNMM, four examples of profit level indicators are given: return on assets, operating margin, net cost plus and the berry ratio (Art 26) * The use of a capital intensity adjustment during the audit process is discouraged (art 38) and the approval of the SAT must be obtained. However, the taxpayer should not surrender but take an aggressive position and use the capital intensity adjustment if required recognizing that it may be challenged under audit.
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TP Method: Selection criteria / comparability factors Characteristics of the assets or services involved in the transaction Functions and risks of each party engaged in the transaction Contractual terms and conditions Economic circumstances Business strategies
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In practice, the Chinese tax authorities usually require the transfer pricing methodologies be applied on a transactional rather than a whole of entity basis unless the transactions can be aggregated (e.g. if the business activities of the transactions are closely related to each other)
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Transfer Pricing adjustments (1)
Transfer pricing investigations are carried out at local level, with 3 stages: selection of audit targets, investigation, adjustment and supervision. The limitation period of making adjustments is 10 years from tax year in which the relevant transaction took place
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Transfer Pricing adjustments (2) first stage
The tax authorities review the Annual Related Party Transactions Disclosure Forms and select audit targets. Enterprises which are likely to be selected are: Enterprises with a large amount of or multiple types of related party transactions Enterprises with long-term losses, marginal or fluctuating profit Enterprises with profit levels lower than industry average Enterprises with profit levels which obviously do not match the functions they perform and the risks they assumed Enterprises having transactions with related parties established in tax havens
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Transfer Pricing adjustments (3) first stage (2)
The tax authorities review the Annual Related Party Transactions Disclosure Forms and select audit targets. Enterprises which are likely to be selected are: Enterprises failing to report annually on related parties transactions or to prepare contemporaneous transfer pricing documentation; and Other enterprises that obviously do not comply with the arms length principle. Transactions with domestic related parties having same tax burden are not audit targets
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Transfer Pricing adjustments (4) second stage information gathering

The tax authorities conduct on-site investigation and request information from the audit target. The tax authorities has authority to obtain foreign based information through the information exchange procedures under tax treaties
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Transfer Pricing adjustments (5) third stage TP assessment (1)
TP assessment is made based on four principles:

There should generally be no capital adjustment in comparable analysis A contract manufacturer bearing no operation decision, research development or sale function should have a minimum level of profit. For a contract manufacturer that makes a loss, the tax authorities will deem a profit level by selecting the appropriate comparable prices or comparable enterprises based on economic analysis Each related party transaction should be individually considered and related party transactions between the same related parties cannot be set-off Where the profit level of enterprise is analysed and assessed with the quartiles method, the tax authorities will in principle adjust the profit level of the enterprise to no lower than the median of the profit level of comparable enterprises
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Taxpayers can negotiate with the tax authorities before TP assessment is finalised and issued Tax authorities will issue written notice stating the type and amount of tax adjusted, what and how accounting entries are adjusted, penalty interest charged, time limit for tax payment and the right to apply for administrative reconsideration. Corresponding adjustment is allowed if no withholding tax on outward remittance of interest, rent, etc. to offshore related parties is involved. If the related party is a resident of a treaty partner, the mutual agreement procedures can be used within 3 years for applying for the adjustment.
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An enterprises subject to TP adjustment will be supervised for 5 years. During that period, the enterprise is required to submit its contemporaneous documentation annually by 20 June every year following the relevant tax year. The tax authority will have focused analysis on:

The investment and operation situation and its changes; Changes in the reported amount of tax payable; Changes in the operational results; and Changes in related party transactions
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Penalties of TP adjustment (1)
Where tax authorities make tax adjustments resulting in overdue taxes, the overdue taxes shall be settled and subject to interest stipulated by the State Council (Art 48 of Enterprise Income Tax Law) A daily interest levy is applied to the amount of overdue tax starting from 1 Jan 2008. The interest period is from 1 June after each tax year until the date of settling the overdue tax The interest rate is the basic RMB lending rate, published by the Peoples Bank of China, plus 5% penalty interest. Where the enterprise provides contemporaneous documentation and other relevant documents in accordance with EITL, EITLIR & Circular (2009) No. 2, the 5% penalty interest does not apply
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Penalties of TP adjustment (2)

The interest levy is not deductible for EIT purposes Additional interest levy of daily surcharge of 0.05% if the enterprises fails to settle the overdue taxes and the interest levy within the stipulated time.
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Appeal for TP adjustment
Pay tax and apply for administrative reconsideration, which is determined by the tax authority one level senior to the tax authority that issued the TP adjustment The reconsideration institution will decide whether to accept the case within 5 working days of the application. It will deliver the decision within 60 days of accepting the application, which may be extended for a max. of 30 days If the reconsideration decision is unsatisfactory, the taxpayer may appeal to the Peoples Court with 15 days of the receipt of the reconsideration decision
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Reasonable Pricing Methods
Reasonable methods to be used by tax authorities in making adjustment as mentioned in CITL, Art 41 are further elaborated in CITIR, Art 111 to include:
(1) (2) (3) (4) (5) (6)
Comparable uncontrolled price method - price of identical or similar business activities among non-related parties; Resale price method, deducting gross profit of identical or similar business activities from re-sale price to non-related parties Cost-plus method cost plus (reasonable expenses + profit mark-up) Transaction Net Margin Method net income level of identical or similar business activities among non-related parties Profit-split method pricing by reasonable allocation of consolidated profit (or loss) for an enterprise and its related parties; and Other methods in compliance with the arms length principle
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Reasonable Pricing Methods (1)
Circular Guo Shui Fa (2009) No. 2 does not prescribe the method to be used for a given type of related party transaction specifically. Therefore, the taxpayer can choose one method which is reasonable and justifiable. Some general factors mentioned in Circular (2009) No. 2: The characteristics of the assets or services forming the subject of the transactions; The function and risks assumed by all parties to the transactions; The contractual provisions; The economic circumstances; and The business strategies
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Circular Guo Shui Fa (2009) No. 2 gives certain guidance as follows: Comparable Uncontrolled Price is applicable to all types of related party transactions Resale price method is usually applicable to resale with simple processing or pure sale and purchase operations, seller does not perform substantial value-adding processing Cost-plus method is applicable to sale, purchase, transfer and use of tangible properties, the provision of services and capital financing
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Circular Guo Shui Fa (2009) No. 2 gives certain guidance as follows: Transactional net margin is applicable to sale, purchase, transfer and use of tangible properties, transfer and use of intangible properties and provision of services Profit-split method is usually applicable to situations where all parties to a related party transactions are highly integrated and it is difficult to separately assess the transaction result of each party
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Comparable Uncontrolled Price (CUP) Method
The CUP method establishes an arms length price by reference to sales of similar products made between unrelated persons in similar circumstances.
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Comparable Uncontrolled Price (CUP) Method (contd)

Example PCo is a corporation organized in Country X. It manufactures wooden chairs in Country X at a cost of 40 and sells them to unrelated foreign distributors at 47 each. It also sells nearly identical chairs to SCo, a controlled foreign subsidiary, which resells the chairs to unrelated consumers at 70. The arms length price on the sale to SCo is 47. PCo would have a profit of 7 (47-40), and SCo would have a profit of 23 (70-47).
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Resale Price Method
Sets the arms length price for the sale of goods between related parties by subtracting an appropriate markup from the price at which the goods are ultimately sold to unrelated parties. (comparable market mark-up)
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Resale Price Method (contd)

Example Assumptions: 1) PCo in the previous example makes no sales of furniture to unrelated parties and there are no comparable sales between unrelated third parties 2) The only activity performed by SCo is to resell the chairs in a foreign market. The resale price method is suitable.
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Resale Price Method (contd)

(Cont) If export distribution firms operating independently earn commissions of 20% on the purchases and sale of products comparable to the wooden chairs, a 20% markup figure might be used in computing arms length price on sales from PCo and SCo. The final resale price of chairs is 70, then the arms length price is 56 (70 minus 20% of 70). PCo would have a profit of 16 (56-40) and SCo would have a profit of 14 (70-56).
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Cost Plus Method
Uses the manufacturing and other costs of the related seller as the starting point in establishing the arms length price. An appropriate amount of profit is added to these costs by multiplying the sellers cost by an appropriate profit %. (market mark-up to manufacturer/seller) This % is determined by reference to the gross profit % earned by the seller in transactions with unrelated parties or by comparable unrelated parties in transactions with unrelated parties.
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Cost Plus Method (contd)

Example Assumptions: 1.PCo in the previous example sells furniture to SCo without any brand name affixed. 2.SCo affixes its valuable brand name on the furniture and sells the furniture to customers in foreign market. The cost plus method is suitable.
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Cost Plus Method (contd)

(Cont) The practice in industries similar to wooden chair manufacturing is to obtain a gross profit of 25% of the costs of production. PCos average cost of producing a chair determined under generally accepted accounting principles (GAAP), is 40. The arms length price on sales of chairs from PCo to SCo is 50 (125% of 40).
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Summary
CUP Method 1) PCos cost of goods sold 2) SCos sales price to related customers 3) PCos sale price to SCo 4) Profit to PCo(Line(3)-Line (1)) 5) Profit to SCo(Line(2)-Line (3)) 6) Total profits to PCo and SCo 7) Earner of entrepreneurial profit 40 70 47 7 23 30 Shared Resale Price Method 40 70 56 16 14 30 PCo Cost Plus Method 40 70 50 10 20 30 SCo
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Profit Split Method
Under the profit-split method, the worldwide taxable income of related parties engaging in a common line of business is computed. The taxable income is then allocated among the related parties in proportion to the contribution they are considered to have made in earning the income.
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Profit Split Method (contd)
In theory, profit-split method is employed when none of the 3 traditional transaction based methods can be applied. However, tax authorities in China increasingly use this method for quick settlement of TP audit cases. A distinctive feature of the method is that it applies to aggregate profits from a series of transactions and not to individual transactions.
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Example PCo and SCo are related companies engaged in the production and sale of pharmaceuticals. PCo engages in extensive research operations and uses patent processes to manufacture the pharmaceutical products, which it sells to SCo. SCo repackages the products for retail sale, attaches its valuable trade name, and resells them through an extensive marketing operation.
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(Cont) Assumptions: 1) PCo does not make sales to unrelated parties, and there are no comparable sales of equivalent products to other unrelated parties. 2)The repackaged products sold by SCo are not comparable to products sold by unrelated parties.
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(Cont) Assume that PCo has costs of 300 and SCo has costs of 100. Sales proceeds from aggregate sales by SCo to unrelated customers is 600. The corporation group has net profits of 200 [namely 600-(300+100)]. If PCos contribution to the enterprise accounts for approximately 75% of the total net profits, then a 75/25 split of the profits might be appropriate. PCos profit is 150. SCo s profit is 50.
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Transaction Net Margin Method
Under the Transaction Net Margin Method (TNMM), the taxpayer must establish, for itself or a related party (the tested party), an arms length range of profits on a set of transactions. If the tested partys reported profits on those transactions fall within that range, then its transfer prices will be accepted by the tax authorities.
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Transaction Net Margin Method (contd)
In general terms, the profits of a tested party are determined under TNMM by determining the ratio of profits to some economic indicator for an unrelated person and then applying that ratio to calculate the profits of the tested party.
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Example The unrelated person has taxable income of 80 and invested capital of 800 and that invested capital is the economic indicator being used in applying TNMM. If the tested party has invested capital of 500, then under a simplified version of TNMM, its arms length profits will be 50 (500*80/800).
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There are several ways to determine a range of profits 1) Rate of return on capital employed by two or more unrelated parties engaging in activities that are broadly similar to the activities of the taxpayer. 2) Ratio of operating profits to gross sales receipts for two or more comparable related persons and then apply these ratios to its own (or the tested partys) sales. 3) Ratio of gross profit to operating expenses for two or more related persons and then apply these ratios to its own operating expenses.
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What is Function and Risk Analysis?
Finding and analyzing facts about a business in terms of its functions, risks and assets (both tangible and intangible) in order to identify the value-added activities undertaken by the covered entities and to assess the reasonableness of compensation it/they receives from related party transactions.
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Why Function and Risk Analysis?
Understanding function undertaken and risk borne and assets employed by each associated enterprise Function, risk and asset have impact on profitability Provides information and insight to characterize RPTs and identify comparable non RPTs
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Advance pricing arrangement (APA)
A restatement of the Guoshuifa [2004] No. 118. (Note: Advanced pricing agreement rules Guoshuifa [2004] No. 118 issued on 3 September 2004 was then repealed accordingly.) Intention for APA programme to become more taxpayer friendly and highly encouraged Chapter 6 of the Final Measures relaxes the criteria for APA application, in particular removing the operating period requirement. Enterprises no longer need to have 10 years of operating history before applying. The ban on enterprises with major tax evasion history is lifted as well Six stages for APA: Pre-filing meetings, formal application, examination and evaluation, negotiations, signing of agreements, and supervision of implementation The process will probably take about 10-14 months from formal application to formal agreement
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Advance pricing arrangement (APA) (contd)
Final Measures provides guidance with respect to requirements and procedures associated with APAs: Eligibility for those enterprises with RPTs not less than RMB 40 million (formerly RMB 100 million), compliance with RPT disclosure requirements and TPD 3-5 consecutive years (previously 2-4 years in the Draft Measures) Respected by both STBs and LTBs at all levels thus enhancing certainty and creditability of APA Pre-filing meetings can be held anonymously (no-name basis) (art 50) For those unsuccessful cases, any non-factual information cannot be used for future tax investigations Providing 10 types of information as part of APA application, including: 3 years worth of financial statements; whether the enterprise has been involved with double taxation issues in the past and the justification for the TP methods proposed for the APA (Art 51)
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Advance pricing arrangement (APA) (contd)

MNCs with multiple establishments in China should coordinate APAs on a national basis Enterprises under APA exempt from TPD requirements (limited documentation reporting requirements) (but specific requirements for APA within 5 months of the following year) Roll-back provision introduced, i.e., can be retroactively applied to the year of application or any prior years (same nature of RPTs) - thus help resolve outstanding historical TP issues
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Cost sharing agreement (CSA)

Chapter 7 of the Final Measures consisting of 12 articles Closely follow the OECDs transfer pricing guidelines (see Lecture No. 2A) and those of the IRS in the USA Can be for joint development of IP or sharing of services Intended primarily to promote IP development in China Application of CSAs to service activities fairly restrictive, e.g. generally suitable for group procurement and group marketing planning (Art 67) thus other types of service cost share in practice are of high uncertainty in the foreseeable future Subject to special administrative and documentation requirements registration with tax authorities within 30 days of execution (Art 69) contemporaneous documentation to be submitted by 20 June of the following year (Art 74) The CSA as a tool for IP planning and management Due to the significance and timing of CSAs to the profit / loss and the taxation of an enterprise, the Final Measures specifically stipulate that if the operating period of the enterprise is less than 20 years from the signing of the CSA, the costs shared should not be deducted before tax (Art 75)
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TPD.it is more than just compliance
What is happening? 31 May 2009 deadline for filing RPT forms 31 December 2009 deadline for preparing TPD How do Final Measures impact me? Understand TP risk Consider TP adjustment Penalty protection What should I do? Take proactive approach Consider planning opportunities Establish efficient TPD compliance plan
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Transfer pricing investigation in 2010

In 2010, Chinese tax authorities concluded 178 formal T/P investigation, an increase of 11 cases, or 6.6% from 2009 Significance of additional tax liability increased compared to 2009: 50 cases in 2010 led to an additional tax liability of more than RMB 10 million each, compared to 40 such cases in 2009; 6 cases in 2010 with additional tax adjustment exceeded RMB 100 million (4 cases of such kind in 2009) More cases of domestic company Evolution from traditional buy-sell to other transactions Tax authorities shifted their focus to pre-transaction TP risk management and services (from post-transaction TP investigations)
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Transfer pricing investigation in 2010

A greater number of companies have been required to submit documentation Tax authorities are setting up databases for compiling the information collected from TP documentation, to strengthen 3-inone anti-avoidance system: administration + investigation + servicing
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Transfer pricing enforcing plan for 2011 of Chinese tax authorities

Greater attention to domestic companies, particularly those having overseas operations Continues industry-wide T/P investigation approach; shift focus from manufacturing and processing to trading, servicing and finance activities. Set-up more industry-specialized investigation teams. Shift from buy-sell to intra-company share transfer, transfer of intangible property, financing arrangements, etc. Expand efforts on CSA, CFC, thin-cap and GAAR Increase cases in Central and Western regions
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References
Deloitte Touche Tohmatsu, 2009, The New Chinese Special Tax Adjustments Rules What are the Implications? Tax Analysis, Issue P49/2009, 11 January, Hong Kong Ernst & Young, 2009, China Transfer Pricing: Guoshuifa (2009) No. 2: Implementation Measures for special tax adjustments (the Final Measures), Tax Alert, 9 January, Hong Kong KPMG, 2009, China releases final Transfer Pricing rules, China alert, Issue 8, January, Hong Kong KPMG, 2009, New TP Regulations KPMGs Analysis, January, Hong Kong PricewaterhouseCoopers, 2009, Unveiling of Long-awaited Special Tax Adjustments Implementation Measures, News Flash, Issue 1, January, Hong Kong PricewaterhouseCoopers, 2009, Chinas new transfer pricing measures: Understanding the rules, challenges & next steps, Webcast, 5 February, Shanghai
AF4222_L8 TP Oct 2011
References
CCH, China Master Guide 2011/12, 9th Edition, Hong Kong, CCH Hong Kong Limited, 2008 (Chapter 19 relevant paragraphs) CCH, China Tax & Customs Law Guide, 2011 Ni, Yongjun (Peter) and Peter Guang Chen, China Taxation: Law, Practice and Planning, Hong Kong, Sweet & Maxwell Asia, 2005 (Part 17) Arnold, B.J. and M.J. Mclntyre, International Tax Primer, 2nd Edition, The Hague: The Netherlands, Kluwer Law International, 2002 (Chapter 4) Publications in websites from Big 4 Other relevant articles
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Appendix DIPN 45
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T/P adjustment in HK DIPN 45 - Definition

Economic double taxation and juridical double taxation. Economic double taxation means two enterprises residing in different states are assessed to tax on the same profit or income, may be thru T/P adjustment. Juridical double taxation means an enterprise is charged to tax on the same profit or income in two different states where a transfer pricing or profit re-allocation adjustment is made in a non-DTA context, there are no procedures to provide any relief from the resultant double taxation In Hong Kong, generally relief for double taxation can only be obtained under a double taxation agreement/arrangement, IRO does not contain any provision granting unilateral tax credit relief, but only tax deduction for tax paid overseas in certain limited circumstance.
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DIPN 45 Relief for economic double taxation (1)
Claim for corresponding adjustment must be made by the taxpayer within six years after the end of the relevant year of assessment under section 79 of the IRO, which allows tax paid in excess to be refunded under certain conditions. relief for economic double taxation can only be sought by way of a corresponding adjustment, but not for a retrospective price adjustment.
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DIPN 45 Relief for economic double taxation (2)
a retrospective price adjustment would not represent outgoings or expenses incurred in the production of chargeable profits and hence deductible under section 16. the relevant assessment cannot be re-opened under section 70A as the retrospective price adjustment constitutes neither an error nor omission made in the taxpayers return or statement filed with the IRD for the year concerned.
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DIPN 45 relief for judicial double taxation
For the claim to revise the non-taxable offshore profits attributable to the overseas PE of a Hong Kong resident (i.e. to increase the offshore profit), the relevant adjustment is made under the Business Profits Article and section 79 of the IRO. The time limit for invocation of section 79 is six years after the end of the relevant year of assessment. For the claim for an additional tax credit, the relief is granted under the Methods for Elimination of Double Taxation Article of the DTA and section 50 of the IRO. The time limit for the claim in Hong Kong under section 50 is within two years from the time the other state made the adjustment.
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DIPN 45 mutual agreement procedure (1)
CIR would only be obligated to make corresponding adjustments up to the extent to which she agrees that the tax adjustments made by the other state represent the arms length principle. If the Commissioner does not fully agree with the adjustment of the other state, it is expected that the two authorities would communicate with each other so as to resolve the issue. a taxpayer can formally invoke the Mutual Agreement Procedure Article of the DTA
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A taxpayer has to initiate the procedure with the competent authority of their resident state within three years from the time of the first notification to them of the actions giving rise to taxation not in accordance with the DTA. The competent authority will then consider and resolve the case on its own if possible or where necessary, endeavour to resolve the issue with the competent authority of the other side (however without the obligation of necessarily reaching agreement with the competent authority of the other side).
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Mutual agreement procedure is available in addition to the objection rights or other avenues for redress that a taxpayer may have under the domestic law of the state to which they are subject to. Any agreement reached under the procedure shall be implemented notwithstanding any time limits in the domestic laws of both sides.
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Double Taxation Arrangement between Hong Kong and China
China Tax Framework (AF4222) Lecture No. 9
Major Parts

A. Tax Treaty Network Between China and Other Countries B. Double Taxation Arrangement (DTA) Between the Mainland of China and Hong Kong (11 February 1998) C. Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (21 August 2006)
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Tax Treaty Network Between China and Other Countries
Part A
The main function of Chinas tax treaties is to allocate crossborder income to the country in which it is to be taxed

either the country in which the income originates, or the country in which the relevant taxpayer is resident
For enterprises, Chinas tax treaties provides the tax treatment of:

cross-border business profits of enterprises; international shipping and air transport profits; deemed profits of associated enterprises gains from immovable or movable property
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Need to agree on international tax issues, to resolve tax conflicts in relation to cross-border transactions, and to formalize those agreements, in bilateral tax treaties. Chinas first bilateral tax treaty was with Japan in 1984. Since then, China has negotiated and concluded bilateral treaties with numerous countries / regions (95 treaties as of September 2010) for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and /or capital. China and Hong Kong entered a special tax arrangement in February 1998 (the Limited Arrangement). (See Part B in this lecture.) In February 2000, the two parties signed the Air Services Arrangement between the Mainland of China and the Hong Kong Special Administrative Region. Then, it was further developed into a more comprehensive one in August 2006 to take into account the treatment on passive income, capital gains, clarification issues, and transfer pricing adjustment etc. (See Part C in this lecture.)
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Tax Treaty Network Between China and Other Countries (contd)

General Application of Treaties Persons eligible for treaty benefits (e.g. residence requirement normally managed or controlled, anti-treaty-shopping provisions) Tax covered (income tax and capital tax both China and foreign taxes) Territory scope Entry into force and termination Treaty interpretation (e.g. inconsistency with domestic law, authenticity of treaty texts in different languages, reference to OECD and UN model treaties, and also see Guoshuifa [2010] No. 75 (1 September 2010) - Protocol between China and Singapore) Non-discrimination provisions (e.g. against nationals of the other contracting state and permanent establishment (PE)) Mutual agreement procedure and exchange of information (e.g. resolution of disputes by mutual agreement and limitations of information exchange)
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Methods of Eliminating Double Taxation Tax credit (i.e. the home country of which the taxpayer is a resident would allow the taxpayer to claim a credit for the tax paid to the host country against the tax otherwise payable in the home country on the income derived from the host country see Article 23 of EITL, Articles 77, 78 and 79 of the EIT Implementing Rules) Elimination of double taxation of dividends, interest and royalties (e.g. employ the credit method, or even fixed rate tax credit method) Tax exemption (i.e., exempt certain categories of income, such as business profits, income from immovable property) Tax deduction (i.e. allow foreign tax paid as deductible for calculating taxable income for the home country taxation purpose) Tax rate reduction (e.g. half rate of corporate income tax etc.)
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Methods of Eliminating Double Taxation (contd) Tax sparing relief Under the tax sparing credit method provided in Chinas treaties, the foreign investors home country deems the foreign investor as having paid the normal China taxes on its income derived from China, as if the applicable tax holidays or exemptions available in China did actually apply, and thus allows a foreign tax credit for such hypothetical China taxes even though no such taxes have been, or are required to be, paid. Accordingly, the home country effective tax rate on the foreign investors income derived from China would be significantly reduced, producing a net benefit to the foreign investor for investing in China. Currently China has signed unilateral tax sparing relief agreements with Japan, UK, Canada, Demark, Singapore, Australia etc. Bilateral agreements with Italy, Thailand, Malaysia, Mauritius, Korea, India etc. Some countries or economies .which do not adopt tax sparing: USA, Brazil, Bangladesh, Egypt, Hong Kong, Spain, Austria etc.
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Double Taxation Arrangement (DTA) Between the Mainland of China and Hong Kong (11 February 1998)
Part B
Commencement of the Limited DTA

This limited DTA issued on 11 February 1998 Order made by Chief Executive on 24 February 1998 under section 49 of IRO In China, for income derived on or after 1 July 1998 In Hong Kong, for income derived on or after 1 April 1998
Purpose of the Limited DTA (1998)
To allocate the right to tax between the two jurisdictions on a basis that avoids double taxation of income Follow OECD and UN
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Double Taxation Relief Provided for

Business profits Shipping, air and land transport income Income from independent personal services; and Income from dependent personal services
in a form of tax credits

Major Contents of the Limited DTA (1998)

Article 1 Hong Kong enterprise is taxable only in Hong Kong unless the enterprise carries on business in China through a permanent establishment (PE) To the extent of profits attributable to that PE Very loose definition of PE Building, construction and installation project not PE if < 6 months (from date of commencement work up until the date of completion and handover to the user, and suspension period is included) Consultancy services (including consultancy services for improvement of existing production facilities and products, selection of technical knowhow, or enhancement of supervisory and management skills as well as feasibility studies, for example, for a particular client,) not PE if < 6 months within any 12-month period (during the course of a service contract)
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Domestic Law Establishment
Limited DTA Permanent Establishment

preparatory or auxiliary
storage and delivery of goods purchasing goods and signing purchase contracts storage of goods for processing*
preparatory or auxiliary
storage and delivery of goods purchasing goods and signing purchase contracts
Nontaxable
Taxable
Nontaxable
habitually exercise authority to sign sales contracts
habitually exercise authority to sign sales contracts
Taxable
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Major Contents of the Limited DTA

Article 2 Income from aviation, shipping and land transport operations carried out by Hong Kong enterprises in China exempt from FEIT and BT Exempt from BT a special treatment (when making reference to other tax treaties in the world)

Article 3 Income derived by a Hong Kong resident not be subject to IIT if he or she stays in China for a period < or = 183 days in the calendar year (formerly 90 days) On condition that the income not derived from a China establishment
Hong Kong residents working in the Mainland

Frequent travelers and if remuneration not paid by PRC entities / borne by PE in China
Before the DTA

> 90 days taxable
After the DTA
Better off
>183 days - taxable
Yes
If remuneration paid by PRC entities / borne by PE in China Service provider Company employees / Freelancers Directors fee Tax relief
Day 1 - taxable
Day 1 - taxable
No
Day 1 - taxable
P/E or fixed base taxable > 183 days - taxable Locality of office Tax credit relief? In addition to the existing 2 reliefs?
Yes
Locality of office 60-day visit rule and s.8(1A)(c)
No ?
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Article 4 Tax credit for Hong Kong residents if double taxation exists Amount of tax credit limited to the amount of Hong Kongs tax in the absence of a credit
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Article 5 Resolve by consultation any difficulties arising from implementing the DTA and other issues of elimination of double taxation not covered by the DTA
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Article 6 Taxes covered In China IIT, FEIT/EIT In Hong Kong Salaries Tax, Profits Tax, and Personal Assessment Tax
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Items Not Covered in the Limited DTA

Interest Royalties Rents Dividends Capital gains Exchange of information
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Other Related Publications for the Limited DTA
DIPN No. 32: Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation on Income (June 1998) Notice regarding the Interpretation and Implementation of the Relevant Provisions under Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation of Income (Guoshuihan [1998] No. 381, 2 July 1998) (Circular 381)
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Inland Revenue Department (1998), Arrangement between the Mainland of China and the HKSAR for Avoidance of Double Taxation Guide for Personal Services (See http://www.info.gov.hk/ird) Inland Revenue Department (1998), Arrangement between the Mainland of China and the HKSAR for Avoidance of Double Taxation Guide for Enterprises (See http://www.info.gov.hk/ird)
Inland Revenue Department (2005), Arrangement between Mainland of China and the HKSAR for Avoidance of Double Taxation - A Guide for Hong Kong Residents Working Across the Mainland Border (July 2005 1st version in December 2003) (See http://www.info.gov.hk/ird)
Pending Issues of the Limited DTA

Exchange of Information e.g. 1995 OECD version vs. 2000 and more liberal 2004 version? Transfer Pricing Issues e.g. transfer pricing adjustments rely on Mutual Agreement Procedures? Permanent establishment extension? Meaning of a Resident Company control and management vs. control or management? Withholding tax reduced rates? Tax credits on dividend income to PRC investors?
Pending Issues of the Limited DTA (contd)

Interest and royalty income reduced rates? Shipping income how to differentiate respective income derived from HK and China? Capital gains tax exemption or reduced rate? Business tax extended to other non-transportation transactions Taxation on Professionals Exchange of education teachers and researchers Taxation on Artists Evasion of IIT on both sides e.g. amendment to Paragraph 2 of Article 3 of the DTA to close the loophole
Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (21 August 2006)
Part C
Purpose of the Comprehensive DTA
To allocate the right to tax between the two Sides on a reasonable basis so as to avoid double taxation of the same item of income in both Sides. The provisions of the Comprehensive Arrangement have been made by reference to those contained in the Model Tax Conventions of the OECD and the UN. In handling problems arising from any inconsistency between the Comprehensive Arrangement and the IRO, priority will be accorded to the Arrangement to ensure compliance with its provisions. The Comprehensive Arrangement should not affect existing concessional practices in Hong Kong, e.g. the 50:50 basis under the DIPN No. 21 (March 1998) (the current version of DIPN No. 21 was issued in December 2009).
Coverage of the New Comprehensive DTA
Direct Income earned by businesses and individuals (such as operating profits and employment income) Indirect Income (such as dividends, interest and royalties) Same income will not be doubly taxed in the two tax jurisdictions
Details of the New Arrangement
Top rates for withholding tax for dividends received by a Hong Kong resident from investments in Mainland enterprises will be reduced from 20% to 10%, and a Hong Kong business from 10% to 5% (if the Hong Kong business holds at least 25% of the capital of the Mainland enterprise). [See Article 10 Dividends.]
Details of the New Arrangement (contd)
Top rates for withholding tax for interest received by a Hong Kong resident from the Mainland will be reduced from 20% to 7%, and a Hong Kong business from 10% to 7%. [See Article 11 Interest.]
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Top rates for withholding tax for royalties received by a Hong Kong resident and a Hong Kong business from the Mainland will also be reduced from the respective 20% and 10% to 7%. [See Article 12 Royalties.]
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The taxing right for gains received by a Hong Kong resident or a Hong Kong business from the transfer of shares in a Mainland enterprise is allocated exclusively to Hong Kong [See Article 13 Capital Gains.] Will be taxed in both jurisdictions (with tax credit arrangement) if the Mainland enterprise:
-
Mainly related to immovable property in China, or Shares transferred > or = 25% of the share holding
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2(1) of Article 14 Income from Employment: the recipient is present in the Other Side for a period or periods not exceeding in the aggregate 183 days in any 12-month period commencing or ending in the taxable period concerned; and
(Note: Guoshuihan [2007] No. 403 or Circular 403 clarifies that if the commencement date and cessation date of 12-month period fall into two tax years (namely wef 1 January 2007 on Chinas side), the employment income derived in China during all the months within those two tax years shall be subject to IIT. In other words, those months beyond the 12-month period should fall into IIT net as well. Circular 403 was released on 4 April 2007. See slides subsequently.)
Major Changes (in summary)

Withholding tax for dividends received from investments in mainland enterprises Before By an HK resident 20% Now 10%
By an HK company
10%
5%
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Major Changes (contd)

Withholding tax for interest received from the mainland Before By an HK resident 20% Now 7%
By an HK company
10%
7%
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Withholding tax for royalties received from the mainland Before By an HK resident or company 20% Now 7-10%
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Before the agreement, a Hong Kong resident or company were required to pay up to 20% and 10% WHT respectively for dividends, interest and royalties gained from mainland investments Under the new arrangement, the top rates are reduced to a range of 5 to 10%, lower than the 7 to 12% adopted by Macau and Singapore

Dividends WHT Rates Interest WHT Rates* Royalties WHT rates
Individual
Company
Banks and Financial Institutions
Other company and individual
Hong Kong
10%
5%
All 7%
10%
10%
Singapore
12%
7%
7%
10% 7%
Macau
10%
10%
7%
10%
* The interest income may be exempted if the beneficiary is government, local authorities and central bank. AF4222_L9 PolyU_DC October 2011

Tax on selling shares in a mainland company By an HK resident or company
Before Both authorities have taxing rights [HK no tax payable, China 10% of profit]
Now Taxing right allocated exclusively to HK [i.e., no tax payable]
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An article on the exchange of information between the SAT and HKIRD (Article 24) Information limited to that is necessary for carrying out the provisions of the domestic laws concerning taxes covered by the new arrangement (very restrictive) to ensure that the use of taxpayer information will not be abused OECD 1995 version* Vs. 2004 version

1995 OECD Model Treaty (1) It restricts what can be exchanged to that necessary in order to carry out the provisions of the Arrangement, or to apply the domestic laws of the Mainland and Hong Kong as regards the taxes covered by the Arrangement. (2) The information so exchanged should be limited to that which is obtainable under the laws of each jurisdiction and in the normal course of administration (3) The information requested should not require the other taxing authority to carry out administrative measures at variance with the laws and practice of their jurisdiction and should not involve the supply of information which would disclose any business secrets.
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2004 OECD Model Treaty It empowers one taxing authority to request the other to use its information gathering measures to obtain information not normally required by the other authority for its own tax purposes. Treaty partners are always free to include their clause of choice and Hong Kong taxpayers will no doubt be relieved that after many rounds of negotiation the more restrictive 1995 OECD Model clause has been adopted.
Commencement of the New Arrangement
Subject to completion of ratification procedures for both sides before 31 December 2006 (Note: Correspondences between the two sides
were made on 10 November and 8 December 2006 respectively. Thus, the New Comprehensive Arrangement entered into force on 8 December 2006.)
Hong Kong: Y/A 1 April 2007 China: 1 January 2007
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DIPN No. 44 Arrangement Between the Mainland of China and the HKSAR for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (December 2006)*
Introduction Arrangement for the Avoidance of Double Taxation Relationship between the Comprehensive Arrangement and the Ordinance Implementation Dates and Applicable Text Article 1 Persons covered Article 2 Taxes covered Article 3 General definitions * Repealed already by new versions
DIPN No. 44 Arrangement Between the Mainland of China and the HKSAR for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (December 2006)

Article 4 Resident (including individuals, company, certification of resident status) Article 5 Permanent establishment (including concept, building site, provision of services, auxiliary activities, business agent etc.) Article 6 Income from immovable property Article 7 Business profits (including allocation of taxing rights, business profits and methods of computing profits)
Article 8 Shipping, air and land transport Article 9 Associated enterprises (adjusting the profits of an enterprise of one side, making an appropriate adjustment to the profits of an enterprise of the other side) Income from Investment, Dividends, Interest and Royalties Article 10 Dividends Article 11 Interest Article 12 Royalties Article 13 Capital gains Article 14 Income from employment (including exemption condition, working across the border etc.) Article 15 Directors fees Article 16 Artistes and sportspersons
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Article 17 Pensions Article 18 Government service Article 19 Students Article 20 Other income Article 21 Methods for elimination of double taxation Article 22 Non-discrimination Article 23 Mutual agreement procedure Article 24 Exchange of information Article 25 Miscellaneous provisions Article 26 Entry into force Article 27 Termination Conclusion
Controversy and Resolution of Discrepancy from the New Comprehensive DTA
On 4 April 2007, the SAT released Guoshuihan [2007] No. 403 to provide interpretation and implementation guidelines on the New DTA on the side of China. (1) The counting of 6 months for the purposes of Article 5(3) (see abolishment in April 2011) (2) The different interpretations of the 25% holding in shares and immovable property company for the purposes of Article 13 on Capital Gains
Controversy and Resolution of Discrepancy from the New Comprehensive DTA (contd)
DIPN No. 44 (revised in April 2007) to reflect the concessions made by the SAT as a result of IRDs successful negotiation with SAT to narrow down the differences. As stated in the DIPN No. 44 (revised in April 2007), both SAT and IRD will keep a continuous dialogue on the implementation of the comprehensive DTA.
(1) The counting of 6 months for the purposes of Article 5(3)

Permanent establishment no clear definition of 6-months within any 12-month period Circular 403 stipulates that for a project lasting not longer than 12 months, when determining 6 consecutive or cumulative months in any 12-month period, the entire period starting from the first month when the first employee arrives China till the last month when the last employee leaves China should be counted In other words, even if the employees are present in China for 1 day in a particular month, that would still be regarded as a month. SAT counts the number of months. However, it is subject to the exclusion of a period or periods of absence from China for this purpose, e.g. any period of 30 consecutive days without any services rendered by any employee working in China for the project can be excluded as a month.
The counting of 6 months for the purposes of Article 5(3) (contd)
For a project lasting longer than 12 months, the relevant period for applying the aforesaid test is any 12-month period rolling either forward or backward from the date of any arrival or departure of an employee or other personnel rendering services for the project. Conversely, the IRD considers that the term month to be a period of 30 days and therefore the relevant days of presence should be counted separately and then added together to ascertain if they in aggregate exceed 180 days (i.e. 30 days x 6) within any 12-month period. Day is the counting unit. Hong Kong enterprises are advised to monitor their PE exposure given the SATs position before any further consensus on this matter (see DIPN No. 44 revised in April 2007).

The Mainlands view (Original interpretation) Relevant period = month of arrival to month of completion of project and employee left the Mainland If no services provided for a period of 30 consecutive days one month can be deducted If total more than 6 months PE in the Mainland
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Hong Kongs view (Original Interpretation) Month = a period of 30 days If within any 12-month period, the cumulative number of days during which services have been provided in HK exceeded 180 days PE in HK
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Example First staff to provide services on 16 April 2007 No staff for the project during 16 June 2007 15 July 2007 and 1 October 2007 31 October 2007 Last staff pulled out from China on 15 November 2007 According to Circular 403, a total of 8 months with employee(s) present and rendering services in China thus regarded as more than 6 consecutive or cumulative months in a 12-month period in China However, two months can be excluded for this test the first 30 consecutive days and the second 31 consecutive days (total 61 days) Hence, as a result, the HK enterprise should be regarded as having a PE in China for more than 6 months (namely 8-2). According to IRD, the exact number of days in China is 153 days thus less than 180 days (equivalent to 6 months) and no PE in China is concluded for this consultancy project.
(2) 25% holding in shares and immovable property for the purposes of Article 13 on Capital Gains
Under Article 13, the taxing right for capital gains derived by a HK resident investor from the disposal of an interest of less than 25% in the shares of a Chinese company (the assets of which are not comprised mainly, directly or indirectly, of immovable property on the Mainland), is allocated to Hong Kong. According to Circular 403, China tax exemption would not be granted in the case where the HK seller of the shares in a Chinese enterprise has held 25% or more of the total shares in that Chinese enterprise during a prescribed period of time, even if the shares in that particular disposal being less than 25% of the total shares. In other words, SATs view is to adopt a test of has ever had at any time. However, IRD considers that the 25% threshold refers to the percentage of each disposal of shares, regardless of the total shareholding that an investor maintains in the company concerned. Discussion is made whether this has ever had test should be restricted to a certain period of time. As for immovable property, discussion is made how to define the threshold of mainly.
Second Protocol to the Arrangement for the Avoidance of Double Taxation with the Mainland
The Mainland and Hong Kong have different views on the interpretation of some of the Articles upon implementation of the DTA (signed on 21 August 2006). After negotiation by exchange letters on 11 September 2007, both sides reached an agreement on the necessary amendments to the DTA and signed the Second Protocol in Beijing on 30 January 2008. It clarifies the 3 following points (see next slides for details):
The use of 183 days instead of six months for determining a PE for consultancy services rendered (namely the so-called Services PE) The test of 50% of immovable assets within three years for gains from the alienation of shares in a Mainland company The test of 25% of the entire shareholding within 12 months for gains from the alienation of shares in a Mainland company
An order for the 2nd Protocol was gazetted on 18 April 2008. The 2nd Protocol became effective on 11 June 2008. As a result of this new development, DIPN No. 44 was further revised with its latest version in August 2008.
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Second Protocol to the Arrangement for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income with the Mainland (30 January 2008) DIPN No. 44 (Revised) (August 2008)
In determining whether a Hong Kong enterprise providing services, including consulting services, in the Mainland is liable to the Enterprise Income Tax, both sides have now agreed to substitute "183 days" for "six months" as the basis of calculation. In other words, Hong Kong enterprises would be considered as having a permanent establishment on the Mainland and be chargeable to tax if they provide services for an aggregate of 183 days in any 12-month period on the Mainland. The meaning of "month" was subject to different interpretations previously, for example the provision of services for only a few days within one calendar month on the Mainland might be counted as one month. The use of "day" in the present definition is clear and simple. One should recognize that this new 183 days for six months does not apply to the Building, construction and installation project under this 2nd Protocol. In other words, whether the project treated as a PE or not still follows the previous reference period, namely not PE if < 6 months.
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DIPN No. 44 (August 2008) Provision of Services by an Enterprise

The scope of consultancy services includes: Improvement of existing production facilities and products, selection of technical know-how, or enhancement of supervisory and management skills, etc.; Feasibility studies of investment projects and selection of design plans The counting of a period or periods aggregating more than 6 months within any 12-month period may commence with any month during the course of a service contract. But there is no definition of the term month in the Comprehensive Arrangement. Hence, before the Second Protocol, the Mainland and Hong Kong have adopted different counting methods (see previous slides).
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With effect from 11 June 2008, the term 6 months was repealed and substituted by 183 days under Article 3 of the Second Protocol. In other words, if within any 12-month period the cumulative number of days during which services have been provided by an enterprise of One Side in the Other Side exceeds 183 days, that enterprise will be regarded as having a permanent establishment in the Other Side. For the transitional arrangement, Hong Kong agreed with the Mainland that the new 183 days rule will only apply to those services which commenced after, the effective date of the Second Protocol. For those enterprises which have commenced to provide services in Hong Kong prior to 11 June 2008, the original 6 months rule will still be adopted in determining whether they have a permanent establishment in Hong Kong. Both Sides will in practice use the days of presence method.
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Example 183 days rule For the purpose of a service project, Company A sent its employee Mr. Chan to the Mainland. Mr. Chan arrived in the Mainland on 1 Nov 2007 to commence a project. The project was completed on 4 May 2008 and Mr. Chan left the Mainland on the same day. During the relevant period from 1 Nov 2007 to 4 May 2008, Mr. Chan visited the Mainland for the first 4 days of each month and stayed in Hong Kong for the rest of the period. Question Would Company A be regarded as having had a PE in the Mainland?
DIPN No. 44 (August 2008) Provision of Services by an Enterprise Example - Answer According to the original interpretation, Company A would be regarded as having had a PE in the Mainland as there was no period of continuous absence of 30 days or more from the Mainland. The services in the Mainland would have been regarded as having continued for 7 months.

Example - Answer However, if the project commenced after the effective date of the Second Protocol 11 June 2008, say 1 November 2008 for the same duration of the project in this Example, the new 183 days rule will apply. Thus, under the new interpretation, applying the 183 days rule, Company A will not be regarded as having had a PE in the Mainland as Mr. Chan only will stay in the Mainland for a total of 28 days.
Abolishment of Provisions in Circular 403

Most DTAs concluded by China have adopted the 6-month duration threshold for determining a Service PE in China of a foreign company. According to Circular 403, as discussed previously, in counting the 6-month duration threshold, the month during which an employee first arrives in China to work on a project to the month when the service is completed and the employee leaves China shall be the relevant counting period. If, during that period, no services are rendered in China on that project by any employees for a period of 30 consecutive days, one month can be deducted. As a result, even if an employee is present in China for one day in a particular month, that could still be regarded as one month. Though Circular 403 was formulated primarily to interpret certain articles in the China-HK DTA, it also stated that other DTAs could refer to the interpretations in the circular if they treaty articles are same as those set out in China-HK DTA.
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October 2011
Abolishment of Provisions in Circular 403 (contd)
Such interpretations are disadvantageous to many treaty residents providing short-term services in China and have caused a lot of controversies and disputes between treaty residents and the Chinese tax authorities. It is good to see that in April 2011, the SAT issued the Public Notice [2011] No. 2 to repeal this counting method of 6-month duration threshold together with the clause which allows the interpretations in Circular 403 to apply to similar articles in other DTAs. This abolishment of the counting method for the 6-month duration threshold set out in Circular 403 is reasonable because the China-HK DTA has already replaced the 6-month duration threshold with a 183-day duration threshold. (See the Second Protocol on 30 January 2008.) The abolishment of both provisions in Circular 403 is welcome by all treaty residents with China.
Reference: PWC, News Flash, Issue 9, April 2011
AF4222_L9 PolyU_DC
October 2011
DIPN No. 44 (August 2008) Capital Gains from the Alienation of Shares of a Company Mainly Consisted of Immovable Property
Paragraph 4 of Article 13 Gains derived from the alienation of shares in a company the assets of which are comprised, directly or indirectly, mainly of immovable property situated in One Side may be taxed in that Side. Benchmark in determining whether the assets of a company are comprised mainly of immovable property 50% Both Sides held different views as to the relevant point in time for deciding whether the value of immovable property was equal to or exceeded 50% of the value of the total assets of the company
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October 2011
Paragraph 4 of Article 13 Hong Kongs view :
Time of the alienation of shares
The Mainlands view :
Any time in the period during which the alienator held any shares in the company
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October 2011
Paragraph 4 of Article 13 Under the Second Protocol, both Sides agreed to set a time frame of 3 years When not less than 50% of the assets of the company consisted of immovable property in the Mainland at any time within the 3 years before the alienation of the shares of a company, the Mainland may tax the gains derived from the alienation In calculating the value of assets, both Sides have agreed to adopt the year-end book value of each accounting year Such agreement was confirmed by both Sides through an exchange of note executed on 11 September 2007
Example Capital Gains On 1 May 2004, a HK resident Mr. Wong bought shares in Company B, which closed its accounts annually on 31 December. Company B held immovable properties in the Mainland, with the properties representing, as per the accounts, the following percentages of total company assets: 2004 60% 2005 40% 2006 40% 2007 40% Mr. Wong sold the shares of Company B on 23 June 2008 and made a profit. Question Would the gains received by Mr. Wong from the alienation of the shares be subject to tax in the Mainland under Article 13(4)?
DIPN No. 44 (August 2008) Capital Gains from the Alienation of Shares of a Company Mainly Consisted of Immovable Property Example Answer
The 3 years rule would apply as the Second Protocol had become effective at the time of alienation. According to the year-end accounts for 2005 to 2007, the assets of Company B were not at any time comprised mainly of immovable property (40% only in all 3 years). Therefore, not subject to tax under Article 13(4).
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October 2011
DIPN No. 44 (August 2008) Capital Gains from the Alienation of Shares of a Company Mainly Consisted of Immovable Property Example Capital Gains
If instead, Mr. Wong had in the previous example sold the shares of Company B on 1 May 2008 and made a profit. Question
Would the gains received by Mr. Wong from the alienation of shares be subject to tax in the Mainland under Article 13(4)?
DIPN No. 44 (August 2008) Capital Gains from the Alienation of Shares of a Company Mainly Consisted of Immovable Property Example Answer
The Second Protocol was not yet effective at the time of alienation. Therefore, all accounts of Company B during which Mr. Wong held any shares in the company would be scrutinized.
According to the year-end accounts of 2004, the assets of Company B has once comprised mainly of immovable property (60%). The gains on alienation received by Mr. Wong would therefore be subject to tax in the Mainland under Article 13(4).
In short, the capital gains derived by a Hong Kong resident from the alienation of shares in a Mainland company may be taxed on the Mainland, if this company once owned at least 50% of immovable properties within three years prior to the alienation transaction. Investors can now estimate their tax liabilities with increased certainty as the second protocol has specified "three years" as the reference period in the implementation of the articles of the arrangement.
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October 2011
DIPN No. 44 (August 2008) Capital Gains from the Alienation of Shares of a Company Not Less than 25% of the Entire Shareholding
Paragraph 5 of Article 13 Gains derived from the alienation of shares, other than those referred to in paragraph 4 of Article 13, of not less than 25% of the entire shareholding of a company which is a resident of One Side, may be taxed in that Side What shares the 25% was referring to in this paragraph?
DIPN No. 44 (August 2008) Capital Gains from the Alienation of Shares of a Company Not Less than 25% of the Entire Shareholding Paragraph 5 of Article 13 Hong Kongs view : The 25% rule referred to the shares that are the subject of the alienation the shares that were sold The Mainlands view : Put emphasis on the phrase shares of not less than 25% of the entire shareholding of a company; i.e. refers to the shares held
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October 2011
Paragraph 5 of Article 13 Both Sides has now agreed that the 25% applied to the shares held by the alienator Under the Second Protocol, both Sides agreed to set a time frame of 12 months for the purposes of deciding whether the alienator has once held at least 25% of the shareholding
Example Capital Gains On 1 April 2006, a HK resident, Mr. Cheung acquired 35% of the entire shareholding of a Mainland company, Company C. He sold the shares on the following occasions and made a profit : On 1 May 2007, 20% shares of Company C; On 23 June 2008, 15% shares of Company C. Question Would Mr. Cheungs gains derived from the alienation of shares be subject to tax in the Mainland?
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October 2011
Example Answer Paragraphs 1 to 4 of Article 13 would not apply. However, Mr. Cheungs gains received from the alienation on 1 May 2007 would still be subject to tax in the Mainland as he once owned 25% or more of the entire shareholding of Company C. The position would be different for the sale on 23 June 2008. The Second Protocol would have come into effect and the new 12 months rule would apply. As Mr. Cheung only had a participation of less than 25% of the capital of Company C during the 12 months prior to the alienation, his gain would not be subject to tax in the Mainland.
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October 2011
The capital gains derived by a Hong Kong resident from the alienation of shares, irrespective of the number of shares involved, in a Mainland company may be taxed on the Mainland, if within 12 months prior to the alienation transaction the vendor once owned not less than 25% of the entire shareholding of this Mainland company. Investors can now estimate their tax liabilities with increased certainty as the second protocol has specified and "12 months" as the reference period in the implementation of the articles of the arrangement.
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October 2011
Guoshuifa [2009] No. 124 - Administrative Measures on Tax Treaty Relief Claims by Non-Residents in the PRC
Prior to Circular 124, under normal circumstances, the Mainland would accept the Identity Card, Re-entry Permit, Certificate of Incorporation, and certified extract of the Business Registration particulars issued by Hong Kong as evidence in determining the resident status of a Hong Kong resident. Only when the Mainland tax authority is not able to ascertain the resident status would it issue a referral letter to the applicant for obtaining a certificate of resident status from the IRD (see Form IR 1313A on the IRDs website). According to Circular 124 which was introduced on 24 August 2009 (with effect from 1 October 2009), non-tax residents of China who wish to enjoy a treaty benefit on their China-sourced income under a DTA have to go through either an Approval-application procedure (for passive income dividends, interest, royalties and capital gains) or Record-filing procedure (for active income business profits of a permanent establishment, service fees and personal employment income) (e.g. for claiming treaty protection) in specified forms.
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October 2011
Guoshuifa [2009] No. 124 - Administrative Measures on Tax Treaty Relief Claims by Non-Residents in the PRC (contd)
For assessing whether the non-resident should be regarded as the beneficial owner of the income, the information required to be disclosed with respect to claiming preferential tax rates on payments made from the PRC includes:
1.
2. 3. 4.
5.
6. 7.
details of shareholders of the non-resident company who holds at least 10% of the shares in the company who are not from the PRC or the relevant nonresident jurisdiction; tax treatment of the income in the jurisdiction in which the non-resident company is incorporated; copies of property certificates, contracts, agreements, invoices and other ownership certificates relating to the income derived; major operations and businesses of the non-resident company; total amount of gross income of the non-resident company; number of employees in the non-resident company, and details of related party transactions undertaken by the non-resident company with entities outside the PRC and the relevant treaty jurisdiction.
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October 2011
Guoshuihan [2009] No. 601 Interpretation and Determination of Beneficial Owner under Tax Treaties
Circular 601, issued on 27 October 2009, provides clearer guidance on how to determine whether a non-resident applicant qualifies as the beneficial owner of PRC sourced income for the purposes of obtaining treaty relief. Circular 601 specifies that the beneficial owner should carry out substantial business activities and own or have control over the income, rights or assets which give rise to such income. Specifically, agents and conduit companies will not be regarded as the beneficial owner of such income. [A conduit company is elaborated in Circular 601 as a company that is established for the purposes of avoiding / reducing tax or shifting / parking profits. Such a company is registered in a country with the mere intention of putting in place the necessary legal form but it does not carry on substantive business activities such as manufacturing, trading or management, etc.] PRC tax authorities will adopt a substance over form approach in determining whether a non-resident should be regarded as the beneficial owner of the income.
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October 2011
Guoshuihan [2009] No. 601 Interpretation and Determination of Beneficial Owner under Tax Treaties (contd)
Who is beneficial owner in Circular 601? Beneficial owner is a person that has the ownership and control over the income or the rights or assets that generates such income. Beneficial owner can be an individual, corporation or other organization. A beneficial owner shall generally engage in substantive business activities which is further referred to as manufacturing, trading and management activities, etc. under Article 1 of Circular 601. [The latter indicates that the PRC tax authorities can now accept that it is unreasonable and unrealistic to expect all treaty residents (and all non-resident recipient of dividend, royalties and interest) to be manufacturing or trading companies.] Circular 601 is in line with the OECDs Discussion Draft (20 April 2011) and stresses that the beneficial ownership has to have the full right to use and enjoy the income unconstrained by a contractual or legal obligation to pass the payment received to another person. Unlike the OECD Discussion Draft which looks at beneficial ownership as a standalone specific treaty anti-abuse provision, Circular 601 appears to be also using economic substance in assessing beneficial ownership which was not emphasized in the OECDs Discussion Draft.
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The seven unfavourable factors which the PRC tax authorities will consider include whether: The treaty non-resident has an obligation to pay or distribute more than 60% of its income to a resident of a third country (region) within 12 months of receipt; The treaty non-resident does not have or almost does not have any other business activities apart from the holding of assets or rights from which the relevant income is derived; Where the treaty resident is a corporation, its assets, scale of operations and employee/staff are relatively few and not commensurate with the amount of income received; The non-resident has no or almost no controlling rights or disposal rights over the assets or rights from which it derives the income and bears very little or no risks;
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The income earned is either exempt from tax or taxed at a very low effective tax rate in the non-residents jurisdiction; Loans into the PRC are part of a back-to-back arrangement with the offshore lender with very similar amount of principal, interest rate and time of conclusion; and Rights to use copyrights, patents, technology or other intellectual property in the PRC are part of a back-to-back arrangement with the offshore intellectual property provider. Question: How to interpret the seven unfavourable factors in the actual assessing practice of the local-level tax bureaus? What guidance from the SAT?
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October 2011
Guoshuihan [2010] No. 218 Supplementary Notice Regarding the Issuance of Certificates for China Tax Residents
To further facilitate the issuance of China tax resident certificates, on 19 May 2010, the SAT issued Guoshuihan [2010] No. 218 to supplement certain certification related matters. Circular 218 adds for the purpose of enjoying benefits of the tax treaty between China and (name of the other contracting country/jurisdiction) to the current model certificate, to specify the purpose of the certificate. Circular 218 stipulates that the Chinese and English names of the competent tax authority that issues the certificate should be shown on the certificate. The certification should be properly signed by the competent tax director and the official chop should be affixed as well. Circular 218 reveals the support of China on outbound investment strategies for those Chinese enterprises beginning to invest or operate overseas making use of tax treaty provisions for ensuring tax efficiency, e.g. lower withholding tax rates.
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October 2011
Third Protocol to the Arrangement for the Avoidance of Double Taxation with the Mainland
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Following the 2008 consultation outcome, in the 2009/10 Budget Proposal delivered on 25 February 2009, Hong Kongs Financial Secretary, the Honorable Mr. John Tsang, proposed to put forward amendments to the existing provisions in the IRO to accommodate the more liberal OECD standards (i.e., to adopt the 2004 OECD Model Tax Convention) on transparency and exchange of information in response to the international demand and movement in that direction. On 26 June 2009, Inland Revenue (Amendment) (No. 3) Bill 2009 was gazetted, which was subsequently enacted as Inland Revenue (Amendment) Ordinance No.1 of 2010 on 14 January 2010.
Third Protocol to the Arrangement for the Avoidance of Double Taxation with the Mainland (contd)
The Ordinance introduces a new s49(1A) which empowers the Chief Executive of the HKSAR Government to declare any arrangement made with any jurisdiction outside Hong Kong for the purposes of resolving double taxation (i.e. CDTA) in relation to any tax imposed by that jurisdiction to have effect on any taxes under the IRO and the disclosure of information requirements provided under the arrangement should have effect in relation to any tax of that jurisdiction. Since the legislative amendments, Hong Kong has expedited to enter into more CDTAs. Actually eight CDTAs (the sixth to thirteenth DTAs) framed on the 2004 OECD Model Tax Convention signed by HKSAR Government shortly after the Ordinance became effective in Hong Kong. As of February 2011, more new CDTAs were concluded and more old CDTAs were amended to account for the 2004 version of EoI.
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October 2011
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On 27 May 2010, the HKSAR Government signed the Third Protocol (in Chinese only) to the existing 2006 CDTA between the Mainland of China and the HKSAR for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income. The Third Protocol upgrades the exchange of information clause in the 2006 CDTA to the OECD standards to require exchange of information even when there is no domestic tax interest involved.
DIPN 47 Exchange of Information under Comprehensive Double Taxation Agreements (June 2010) was issued. It covers the discussion of legal bases for EoI abroad, safeguards provided under the CDTA, disclosure rules and administrative guidelines on processing of disclosure requests.
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October 2011
Applicability of Exchange of Information EoI
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EoI between two jurisdictions occurs either through a Double Taxation Agreement (DTA) if it exists, or a Tax Information Exchange Agreement (TIEA). China has signed TIEAs with BVI, Bahamas, the Isle of Man, Guernsey, Jersey, Bermuda as well as Argentina etc. SAT views the EoI as an effective weapon in meeting the challenge of economic globalization and cross-border tax avoidance. Focuses of EoI include the following areas: (1) Outbound payment of commission, dividends and royalty fees, (2) Non-salary income derived from China and provided to non-Chinese citizens, and (3) Use of tax havens or low-tax jurisdiction to shift profits to outside China In 2010, via EoI, China tax authorities collected approximately RMB690 million of taxes, surcharges and penalties, representing an increase of 44% over 2009.
Interpretation of the China-Singapore Tax Treaty
On 1 September 2010, the SAT released Guoshuifa [2010] No. 75 (as Departmental Interpretation Notes officially dated 26 July 2010, but released to public in September 2010) - the Interpretation of the Provisions in the Agreement between the Government of the Peoples Republic of China and the Government of the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and its Protocols. Notice 75 provides a set of comprehensive interpretations of the China-Singapore tax treaty. More importantly, Notice 75 prevails over all of the SATs previous interpretations of tax treaties generally and will be applied to all other tax treaties containing provisions that are the same as those in the China-Singapore tax treaty. Hence, Circular 75 will have an impact on Singapore tax residents as well as other treaty residents from jurisdictions with comparable DTAs with China.
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October 2011
Interpretation of the China-Singapore Tax Treaty (contd)

Highlights of Notice 75 Tax residency PE (fixed place of business, place of management; provision of service) Potential impact on secondment of employees to China Business profits Dividend, interest and royalties Capital gains Anti-avoidance rules
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October 2011
Interpretation of the China-Singapore Tax Treaty (contd)
Overseas financial institutions which have invested into China through non-resident holding companies should be aware of the tax impact of Circular 75 on their China-sourced passive income (such as dividends, interest, royalties and capital gains). In this respect, Circular 75 emphasizes the importance of the beneficial ownership requirement for the claiming of tax treaty benefits by non-residents in relation to the receipt of dividends, interest and royalties. The requirements in Circular 75 are similar to those outlined in Guoshuihan [2009] No. 601. Given this, it is important for non-resident holding companies to establish commercial substance in the chosen tax treaty jurisdiction and to demonstrate reasonable business purposes for the chosen structure, in order to enjoy the tax treaty benefits. The issuance of Circular 75 reflects the PRC tax authoritys commitment to strengthening the administration of access to treaty benefits. It also shows the SATs effort in improving the technical knowledge of the PRC local tax authorities to avoid inconsistencies in local interpretations and practices concerning the implementation of DTAs across the country.
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October 2011
Other Related Publications for the Comprehensive DTA

Full Text (English and Chinese) (August 2006) Arrangement between the Mainland of China and the HKSAR for the Avoidance of Double taxation and the Prevention of Fiscal Evasion Certification of Resident Status (December 2006) DIPN No. 44: Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (revised April 2007) and (revised August 2008) Guoshuihan [2007] No. 403, 4 April 2007
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October 2011
Other Related Publications for the Comprehensive DTA
Arrangement between the Mainland of China and the HKSAR for the Avoidance of Double taxation and the Prevention of Fiscal Evasion Business Profits, Income from Immovable Property, Income from Investment, Gains from Alienation of Property (June 2007) Arrangement between the Mainland of China and the HKSAR for the Avoidance of Double taxation and the Prevention of Fiscal Evasion Income from Personal Services (June 2007)
Second Protocol to the Arrangement for the Avoidance of Double Taxation signed with the Mainland (30 January 2008)
http://www.ird.gov.hk/eng/ppr/archives/08013002.htm DIPN No. 44: Arrangement Between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (revised August 2008)
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October 2011
Prescribed Reading
1. Macpherson, A. and Laird, G. , Hong Kong Taxation: Law and Practice, 20101/12 Edition, Hong Kong, The Chinese University Press, 2011 (Chapter 11 International Aspects of Hong Kong Taxation) 2. CCH, Hong Kong Master Tax Guide, 20th Edition (2011/2012), Hong Kong, CCH Hong Kong Limited, 2011 (Chapter 8 Double Taxation Relief) 3. CCH, China Master Tax Guide, 9th Edition (2011/12), Hong Kong, CCH Hong Kong Limited, 2011 (Chapter 11 Double Tax Relief) Links: http://www.ird.gov.hk/eng/ppr/dip.htm (for DIPN No. 32 and 44)) http://www.ird.gov.hk/eng/paf/pam.htm (pamphlets - double taxation)
http://www.ird.gov.hk/eng/ppr/archives/08013002.htm (for 2nd Protocol)


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AF4222 China Tax Framework Lecture No.

1 Overview of China Tax System

AF4222_L1 Overview of China Tax System

Legal and Administrative Framework of China Tax

Tax reform background

Tax collection (data from SAT [www.chinatax.gov.cn])

2005 ($M) 3,086,583.17 1,069,828.57 163,431.36 422,005.23

2006 ($M) 3,763,627.43 1,289,460.33 188,566.94 496,710.62

2007 ($M) 4,944,928.79 1,560,991.01 220,681.90 651,328.24

423,142.48 436,313.29 114,769.32 209,391.36 (337,157.35)

512,888.97 554,587.81 153,481.61 245,232.44 (428,488.54)

658,297.25 772,373.49 195,120.10 318,498.01 (527,328.68)

AF4222_L1 Overview of China Tax System

Tax collection (data from SAT)

100% 31.56% 4.46% 13.17% 12.90% 13.31%

Tax collection (data from MOF [www.mof.gov.cn])

AF4222_L1 Overview of China Tax System

29530.07 9201.6 2196.43

CT&VAT on imports BT CIT

3373.67 4309.2 6820.44

-14.9% +6.4% -13.8%

Tax collection (data from SAT and MOF)

AF4222_L1 Overview of China Tax System

AF4222_L1 Overview of China Tax System

Major Development Trends

AF4222_L1 Overview of China Tax System

Current PRC Tax Regime

AF4222_L1 Overview of China Tax System

Current PRC Tax Regime (Contd)

Current PRC Tax Regime (Contd)

Current PRC Tax Regime (Contd)

AF4222_L1 Overview of China Tax System

Current PRC Tax Regime (Contd)

VI. Agricultural Tax

VII. Custom Duties

AF4222_L1 Overview of China Tax System

Taxes NOT Applicable to FIEs or FEs*

AF4222_L1 Overview of China Tax System

AF4222_L1 Overview of China Tax System

Individual income tax (1.1.1994 Present)

AF4222_L1 Overview of China Tax System

Summarized Position of Expatriates IIT Liability on Wages and Salaries Income

Income paid/borne by establishme nt in China Taxable(2) Taxable(1)

Income paid Income paid by by overseas establishment entity in China

< 90/183 days 90/183 days<x<1 year 1<x<5year >5 years

AF4222_L1 Overview of China Tax System

Allowable Deduction for Wages and Salaries

AF4222_L1 Overview of China Tax System

Allowable Deduction for Wages and Salaries (contd)

AF4222_L1 Overview of China Tax System

Tax Rate 3% 10% 20% 25% 30% 35% 45%

AF4222_L1 Overview of China Tax System

Foreign enterprise income tax (1.7.1991 31.12.2007)

Enterprise income tax (1.1.1994 31.12.2007)

AF4222_L1 Overview of China Tax System

Turnover taxes (1.1.1994 Present)

AF4222_L1 Overview of China Tax System

Property and behaviour taxes

Tax liability of individuals

Foreign enterprise income tax (1.7.1991 31.12.2007)

AF4222_L1 Overview of China Tax System

Enterprise income tax (1.1.1994 31.12.2007)

Enterprises liable to corporate income tax