Corporate taxation in China
Currently, domestic enterprises and foreign enterprises (FE) and foreign investment enterprises (FIE) are governed by two different sets of enterprise income tax legislation, thereby profoundly affecting the way enterprises consider investment decisions. However, with WTO accession, China is mandated to dismantle some of the preferential taxation policies adopted in relation to foreign enterprises to attract FDI.
FIEs include Chinese-foreign equity joint ventures, Chinese-foreign contractual joint ventures and wholly foreign-owned enterprises established in China. FEs include foreign companies, enterprises and other economic organizations which have establishments in China and are engaged in production or business operations or which, although without establishments in China, have income from sources within China. Establishments refer to management offices, business organizations, representative offices, factories, places where natural resources are exploited, places where contracted projects of construction, installation, assembly and exploration are carried out, places where labour services are provided and business agents. FIEs are subject to income tax on their worldwide income whereas the FEs are generally liable to income tax in respect of their China-sourced income.
Income tax on resident enterprises
Generally the national income tax on FIEs and FEs with establishments is levied at 30 per cent while local income tax is 3 per cent on the net taxable profit. FIEs are eligible for various tax holidays and other tax reductions and exemptions under the tax law, depending on their locations and nature of operations.
The following are the preferential income tax rates for income derived from production and non-production operations carried on by FIEs and FEs located in various special tax regimes:
- Income from production or non-production businesses obtained by FIEs and FEs with establishments located in Special Economic Zones (SEZ) in Shenzhen, Zhuhai, Shantou, Xiamen and Hainan is subject to tax at 1 5 per cent.
- Income from production businesses obtained by FIEs located in the designated Economic and Technological Development Zones (ETDZ) is also subject to tax at 1 5 per cent.
- Income obtained by FIEs located in Coastal Economic Open Zones (CEOZ) and in the old urban districts of cities where the SEZs or ETDZs are located, and are engaged in production operations, is subject to tax at 24 per cent.
- Income obtained by FIEs located in Coastal Economic Open Zones and in the old urban districts of cities where the SEZs and ETDZs are located, and are engaged in the following projects, is subject to tax at 1 5 per cent:
(a) technology- intensive or knowledge- intensive projects;
(b) projects with a long investment return period with foreign investment of not less than
US $30 million; and
(c) energy, communications or port development projects.
- Income obtained by FIEs located in Shanghai Pudong New Area and engaged in productive operations, energy and transportation construction projects is subject to tax at 1 5 per cent.
- Enterprises located in certain free trade zones and export processing zones and in certain Western and Central areas may also be subject to a 1 5 per cent reduced income tax rate.
- In order to induce reinvestment of profits by foreign investors, a 40 per cent tax refund is granted to the foreign investor that reinvests its share of distributed profits in the same or a new FIE for a period of more than five years. Profits reinvested by the foreign investor in the same or in a new export-orientated enterprise or technologically advanced enterprise for a period of more than five years may be granted a 1 00 per cent tax refund.
- On repatriation of after-tax profits, no income tax is levied. In addition, dividend income received by FIEs in China is also tax exempt but any relevant loss or expenses incurred are non-deductible.
- For FIEs engaged in encouraged projects that purchase China-made equipment within the total investment or FIEs purchasing China-made equipment beyond the total investment but for the purpose of technological upgrading or for producing hightechnology products, 40 per cent of the costs of the domestic equipment may be used as a credit to offset the increment in the enterprise income tax liability in the year of equipment purchase as compared with that of the previous year.
- If the expenditure on technology development of an FIE increases by 1 0 per cent or more over that of the previous year, the taxable income of that FIE for the current year, with the approval from the tax authority, will be offset by 50 per cent of the actual amount of the spending on technology development.
- Newly established software production enterprises will be eligible for two years of exemption and three years of 50 per cent reduction of Enterprise Income Tax (EIT) from the first year they make profits.
Tax holidays and incentives
In addition to the preferential tax rates mentioned above, FIEs are entitled to the following and incentives:
- Production FIEs scheduled to operate for a period of more than 10 years will be entitled to two years’ tax exemption and three years’ 50 per cent income tax rate reduction commencing from the first profit-making year.
- After the expiry of the tax exemption and reduction period, a production FIE exporting 70 percent or more of the value of its production output in a year may pay income tax at a 50 per cent reduction rate for that year subject to a minimum rate of 10 per cent.
- After the expiry of the tax exemption and reduction period, a ‘technologically advanced FIE’ may pay income tax at a 50 per cent reduction for a further three years subject, again, to a minimum rate of 10 per cent. The ‘technologically advanced’ status requires special certification from the local government.
- Preferential tax exemption in a given year will have EIT levied at the reduced rate of 10 per cent. FIEs in the Central and Western areas and under the encouraged category of the Investment Guidelines will enjoy an extension of the normal tax holiday for three years. That is, on top of the normal tax holiday of two years’ exemption and three years 50 per cent reduction of EIT, the reduced EIT rate of 15 per cent will be applicable for another three years after this five-year normal tax holiday. An extended 15 per cent reduced EIT rate will be available provided that the projects fall within the key encouraged projects category and satisfy other conditions.
Business tax is applicable to enterprises in the service, transport and other non-production industries as well as the transfer of intangible assets or immovable properties. Business tax rates range from 3 per cent to 20 per cent, depending on the category of the business concerned. Consumption tax is levied on the production, in China, of 11 categories of goods including cigarettes, alcohol, cosmetics, jewellery, gasoline and motor vehicles. Importation of taxable goods is also subject to consumption tax but export is exempt.
Turnover tax paid, except for value-added tax, is deductible for foreign enterprise income tax purposes, because both business tax and consumption tax are considered as costs to the business or enterprise concerned. Value-added tax, however, is a tax which is borne by the end-user of taxable products and services and would not be deductible for income tax purposes. Local income tax is levied at three per cent of net taxable profit. Exemption or reduction in local income tax may be granted to FIEs located in SEZs, ETDZs and the old urban districts of cities where an SEZ is located, at the discretion of the local tax authorities.
Effective 1 January 1994 a turnover tax system consisting of value-added tax, consumption tax and business tax was introduced by the Chinese authorities. Value-added tax, consumption tax and business tax are indirect taxes charged on the gross turnover of businesses and enterprises operating in China. Under the turnover tax system, FIEs will pay either value-added tax or business tax, depending on the nature of their businesses. Value-added tax is levied on the sales of tangible goods, provision of processing, repairs and replacement services and the importation of goods within PRC. The general value-added tax rate is 17 per cent on products and imports and a lower rate of 13 per cent is levied on certain specific products, mostly necessities. Export sales are exempted under VAT rules and an exporter who incurs input VAT on purchase or manufacture of goods should be able to claim a refund from the tax authorities.
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