China-Britain Business Council - Market Intelligence - Tax, Law & Banking

There are many taxes levied in China. The taxes that are of most relevance to foreign businesses are those levied on Foreign Investment Enterprises ("FIEs") and Foreign Enterprises ("FEs"). These are:
• enterprise income tax
• business tax
• value-added tax
• consumption tax
• urban real estate tax
• stamp duty
• deed tax
• land value-added tax
• vehicle and vessel purchase tax
• vehicle and vessel use tax
• resources tax

Foreign businesses also have to have regard to individual income tax: click to view.

ENTERPRISE INCOME TAX (“EIT”)
Enterprise Income Tax applies to FIEs with income which they derive from production and business operations and other income, and to FEs with income derived from production and business operations and other income in China.

Taxable income
FIEs are subject to EIT on their worldwide income sourced in and outside the PRC. But a foreign tax credit is allowed for income tax paid in other countries with respect to foreign-sourced income derived by the overseas subsidiaries and/or branches of an FIE. The foreign tax credit is limited to the EIT payable on the same amount of income, so you can’t get tax credits in this way!

FEs are subject to EIT only with respect to income sourced from the PRC. The taxation of an FE also depends on whether it has a "permanent establishment" in China. FEs with permanent establishments in the PRC would be subject to EIT on all income sourced from the PRC, while FEs without permanent establishments in the PRC are subject to a withholding tax on such income as certain dividends, interest receipts, rentals received, royalties, capital gains and other passive income sourced from China.

Tax rates
FIEs and FEs are generally subject to EIT at a standard rate of 33% (which amounts to a national tax rate of 30% plus a local tax rate of 3%) on the taxable income. Up until March 2007, foreign-invested enterprises in certain special zones could benefit from lower rates (either 24 per cent or 15 per cent).

As from 1st January 2008, the rate of tax paid by foreign-invested enterprises and Chinese companies will be 25 per cent (although it is not yet clear how the income tax rate will be increased over the five-year transitional period from 15 per cent to 25 per cent). Note that there are still some exceptions and exclusions, as follows:

1) Provisions for small low-profit and hi-tech enterprises
The new law applies a preferential rate of 20 percent to eligible small low-profit enterprises and a preferential rate of 15 percent to hi-tech enterprises receiving priority support from the State.

2) Tax incentive policies
Current preferential policies relating to the regular tax reduction and exemption for production foreign-funded enterprises (i.e. two-year exemption and subsequent three-year 50 per cent reduction of standard tax rate) as well as the 50 per cent tax reduction for export-oriented foreign-funded enterprises will be abolished. However, tax preferential treatment will still be available to venture investment enterprises and to enterprises investing in projects involving environmental protection, agricultural development, water conservation, production safety, high-tech development and public welfare undertakings.

Certain tax breaks will also be granted to new hi-tech enterprises in special economic zones and ‘encouraged enterprises’ located in less-developed western areas of the country.

For those FIEs who will lose their current tax holidays under the new law, they will have to consider raising the high/new-tech content of their products and production technology, as well as purchasing capital goods for enhancing environmental protection, water and energy conservation, and production safety in order to try to qualify for the new tax incentives.

3) 'Grandfathering’ treatment
There will be a transitional period for FIE's currently enjoying preferential tax treatment:

- FIEs subject to a reduced income tax rate and established before the promulgation of the new Tax Law will be subject to a gradually increasing transitional income tax rate over five years after the new Tax Law becomes effective.

- Production FIEs entitled to enjoy the ‘two plus three year’ tax holiday (two years tax free and a further three years at 50 per cent) under the current income tax laws may continue to enjoy remaining incentives in accordance with the requirements and period specified by the current income tax laws.

- For those FIEs which have not yet begun their ‘tax holiday’, the period will commence from the effective date of the new law (i.e. January 1st 2008).

Withholding tax
The withholding tax rate applying to interest receipts, rentals received, royalties, capital gains and other passive income derived by FEs (with no PEs) in China is 10%. While most dividends are currently exempt from PRC tax, some dividends are subject to a withholding EIT at a rate of 20%.

Tax treaties
China has double tax treaties with a number of jurisdictions that seek to avoid taxation of the same income in more than one jurisdiction. In other words, any tax paid in one contracting state with respect to an income shall be allowed as a credit against the tax on that income payable in the other contracting state. Generally, double tax treaties cover any income tax (including both enterprise income tax and individual income tax), but not turnover taxes (eg business tax, value-added tax, etc) that may be payable.

Currently, China has entered into double tax treaties with 88 countries, including the UK.

OTHER TAXES

Business tax (“BT”)
Business Tax is levied on enterprises and individuals that provide labour services, transfer intangible assets or sell immovable property in China. BT is generally levied at the rate of 3% or 5% depending on the type of taxable activities performed by the enterprises or individuals in China:

(i) BT is levied at 5% on income earned from the transfer of intangible assets, sales of immovable property in China, or the provision of services related to the financial and insurance industries, agency, the hotel industry, food and beverage industries, tourism industry, warehousing industry, leasing industry, advertising industry and other non-vatable services industries;

(ii) BT is levied at the rate of 3% on income arising from the provision of services related to the transport industry, construction industry, post and telecommunications industries, culture and sports; and

(iii) BT is levied at the rate of 5% to 20% on income earned from the provision of services related to entertainment business.

Value-added tax
VAT is imposed on enterprises and individuals that sell goods, provide processing or repair and replacement services or import goods into China. The standard VAT rate for goods sold or imported by the taxpayers (except for certain goods which are subject to VAT at 13%) and processing or repair and replacement services provided by the taxpayers is 17%.

In calculating the net VAT liabilities, note that the amount of VAT on purchases for the current period ("Input VAT") can be offset against the amount of VAT on sales ("Output VAT") for the relevant period. The formula for calculating the net VAT is as follows:

Net VAT payable = output VAT - input VAT

In addition, input VAT paid on importation/local purchase of materials for the production of exported goods can be fully or partially refunded in accordance with the prevailing export VAT refund policy. The refund rate may vary from 5% to 17% depending on the type of goods exported from China.

Consumption tax ( “CT”)
Consumption Tax is imposed on enterprises and individuals that produce, entrust third parties with processing or import consumer goods specified in the relevant rules and regulations on consumption tax in China. Some of the examples of those consumer goods include tobacco, alcoholic beverages, cosmetics, petrol, cars, etc. CT is calculated at a fixed rate according to the price or at a fixed amount according to the quantity.

Urban real estate tax ("URET")
Urban Real Estate Tax is payable by the individual or corporate owners of the properties situated in China. URET is calculated on the original value of the property or, if the property is leased out, the rental income of the property.

If URET is calculated on the original value of the property, a statutory deduction of 10% to 30% of the original value will be allowed. URET will then be levied at the rate of 1.2% of the net value. The specific rate of deduction shall be determined by the local government and may vary from city to city.

If the property is for rent, URET can be calculated on the rental income at 18%.

The above rates apply only to FEs and FIEs which are established in China.

Stamp duty
Stamp Duty is levied on enterprises and individuals that conclude or receive any of the following documents:

(i) documents issued for a purchase and sale transaction, process contracting, property leasing, commodity transportation, storage and custody of goods, loans, property insurance, technology contracts, engineering project reconnaissance and design contracts, construction and installation project contracts and other documents of a contractual nature;

(ii) documents involved in the transfer of property by purchase, sale, inheritance, gift, exchange or division;

(iii) documentation of rights or licenses; and

(iv) other documents declared to be taxable by the tax authorities.

Stamp duty is calculated at a fixed rate according to the contract amounts (ranging from 0.005% to 0.1% depending on the nature of the taxable documents) or at a fixed amount per document. Specific exemption may be available to certain types of contracts or documents.

Tax withholding obligations
Any entity or individual that pays income on which IIT is payable must act as a withholding agent. If a withholding agent fails to withhold or collect tax as required, tax authorities will pursue with the taxpayer the tax that should have been withheld or collected, as well as the corresponding interest, penalties and/or surcharges. At the same time, a penalty will also be imposed on the withholding agent in this regard.

INDIVIDUAL INCOME TAX ("IIT")
Individual Income Tax is imposed on all individuals (including local PRC and foreign nationals) residing in or earning income from the PRC. This comes under a law called the Individual Income Tax Law of the People's Republic of China (the "IIT Law") and the Detailed Rules for the Implementation of the Individual Income Tax Law of the People's Republic of China (the "Detailed Implementing Rules").

Taxation of individuals working in China
An individual who is domiciled in China is subject to IIT on all of his worldwide income regardless of type (ie wages and salaries, capital gains, dividends, interest, rent, etc). The Detailed Implementing Rules define the term "wages and salaries" to include cash awards, bonuses, allowances, subsidies and other compensations received by an individual for the tenure of employment.

An individual who is not domiciled in China is subject to IIT on "PRC-sourced income" mainly depending on how long the individual stays in the PRC. For the purpose of determining the individual's tax liability, only the days on which the individual was actually present in China are counted. The day on which the individual leaves, enters, enters and leaves, or makes multiple entries shall be counted as a whole day for this purpose.

Notwithstanding this, certain types of PRC-sourced income (such as dividends, interest or rent) are subject to IIT irrespective of whether the individual spends any time in China during a calendar year.

Taxable income
An individual who is not domiciled in China, i.e., foreign nationals residing in China for not more than five "full" consecutive years (a foreign individual who is based in the PRC but spends more than (i) 30 days on a single trip or (ii) 90 days in the aggregate outside the PRC during any calendar year will not be considered to have spent one "full" year in PRC for tax purposes) is generally subject to IIT on "PRC-sourced income". The term "PRC-sourced income" is defined to include "income from personal services provided inside the PRC because of the tenure of office, employment, the performance of a contract, etc".

In addition, the following items, among others, derived by foreign nationals working in China are "temporarily exempted from IIT":

(i) reasonable allowances for housing, meals and laundry services received in a noncash form or on a reimbursement basis;

(ii) reasonable one-off relocation costs on a reimbursement basis;

(iii) reasonable allowances for business trips both inside and outside the PRC;

(iv) allowances for the expatriate's language training, and children's education in China, provided the costs are supported by valid invoices and approved as reasonable by PRC tax authorities; and (v) home leave pay for the expatriate, whereby the expenses are restricted to the expatriate's travel expenses and shall not exceed two trips to return to his/her home (including the residence of his/her spouse or parents) during a single calendar year.

Tax rates
IIT is charged at a progressive rate from 5% to 45%. Foreign nationals with PRC-sourced income can now deduct Yn4,800 (the standard deduction being Yn1,600 and the extra deduction amounting to Yn3,200) each month against his/her monthly income effective from 1st January 2006.

Since 1st January 2000, the withholding requirement has also applied to wages and salary payments made by the parent or affiliated company outside of China to expatriate employees of the entity in China. Accordingly, the entity in China is obligated to withhold taxes on wages and salary payments made to the PRC and expatriate employees by either (i) the parent or affiliated company outside of China; or (ii) the entity in China.

Written by DLA Piper Beijing Office International Tax Team. Contact: Tel: +86 10 6561 1788, Email: jingzhou.tao@dlapiper.com