by Gregory Sy
On December 6, 2007, the Implementation Rules of the Enterprise Income Tax Law of the PRC were adopted by the Executive Meeting of the State Council, effective January 1, 2008 (the "Rules"), which were issued to supplement the Enterprise Income Tax Law of the PRC (the “Law”) issued in March 2007 and effective January 1, 2008.
Under the Law, the tax system for domestic and foreign-invested enterprises was unified, resulting in a standardized 25% enterprise income tax to be levied on all ‘resident enterprises’. The Rules contain 8 chapters and 133 articles, which ‘fill in the gaps’ left by the relatively shorter Law, the main points of interest which we discuss below.
Treatment of Foreign Invested Enterprises (FIEs)
Under the Income Tax Law of the People’s Republic of China for Enterprises with Foreign Investment and Foreign Enterprises (which will be annulled January 1), foreign invested enterprises were subject to a 33% enterprise income tax rate, though many enjoyed substantial tax reductions and even exemptions.
Under the Law, the rate is modified to 25%, and the Rules state that FIEs which obtained their business license prior to March 16, 2007 (date of promulgation of the Law) and enjoyed FIE-based tax benefits will continue to enjoy such fixed-term benefits and those who were subject to a lower overall tax rate will be grandfathered into the new Law’s 25% rate.
Incentives
While the previous enterprise income tax laws were very much geography-, nationality-, and industry-based, the Law now removes nationality of investor as a factor, and reduces the importance of geography or location of investment (though there are still benefits for investing in Western/less developed regions). Conversely, industry-based incentives are the major focus, with high-tech, agricultural, environmental, and public infrastructure companies enjoying favorable tax treatment under the Law.
Withholding Tax
Article 4 of the Law states that the general withholding tax rate for non-resident enterprises is 20%, though the Rules provide that income sourced from passive investment in China, including dividends, royalties, income from rentals, and capital gains, will be subject to a lower withholding rate of 10%.
Anti- Avoidance
The Law and Rules demonstrate China’s new approach to eliminating or reducing tax avoidance measures. Transactions which are not on an arm’s length basis or arrangements without a bona fide commercial purpose may be subject to the tax authorities’ now broad discretion, in which transactions may be subject to review for a period of 10 years from the transaction date.
Tax Residency
The Law classifies enterprises as ‘resident’ and 'non-resident’, with the former including those organizations whose ‘effective management institutions’ are located in China, though they are established in foreign countries.
The Rules clarify the meaning of 'effective management institution' as any institution which exercises substantive and comprehensive management and control over an enterprise's production, operation, staff, accounting and property, etc'.
To view an English copy of the Rules provided courtesy of Lehman, Lee & Xu's translation team, please click here.
