Changes to tax in China

Australia and China enjoy a strong and growing bilateral relationship. Two-way trade with China increased in 2009, reaching $AU83 billion. With a population of 1.33 billion, representing 19.5% of the world’s population, China appears to be a good place for companies looking for global opportunities - it allows businesses to benefit from its cheap labour and rental costs. However, there are a number of critical success factors that if not monitored properly, can cause major issues for Australian businesses.  There have been many changes to China’s taxation system over the past few years and businesses need to attend to these properly.  There have been substantial changes in Enterprise Income Tax (EIT), Value Added Tax (VAT) and Business Tax (BT) in the past few years.

Guidance and circulars have been issued in the form of Implementation Rules for the changes. These rules bring clarity, but still there are uncertainties. What is certain is that this new law will fundamentally change the way business is done in Mainland China.

Enterprise Income Tax (EIT)

The new EIT was enacted on 16 March 2007 to unify the income tax levied on domestic and foreign enterprises. Some of the critical changes in EIT can be summarised as follows:

• A "resident enterprise" is now defined as an enterprise either established under the law of China or effectively managed in China.  Before this change, only companies registered in China would be regarded as tax resident enterprises and therefore subject to Chinese tax on worldwide income basis
• The corporate income tax rate is set at 25%, a reduction from 33% for Chinese companies. 
• Losses are only available for carry forward for five years
• A 10 percent withholding tax is provided for on interest, dividends, rent, royalties, and other passive income derived by a non-resident enterprise from China
• Limitations are provided for on the deduction of certain expenses, in particular entertainment expenses (limited to 60% of the actual expenses up to 0.5% of business revenue) and advertising expenses (limited to 15% of business revenue). In addition, management fees paid between enterprises are disallowed
• The deduction or amortisation of purchased goodwill is now disallowed
• A reduced 15% tax rate is introduced for high and new technology enterprises. Tax exemptions are granted, or a 50% reduction in tax rate is allowed, for qualifying investments in the agricultural, forestry, animal husbandry, and fishery industries. A three-year tax exemption is provided, and a three-year 50% reduction in the tax rates is allowed, for qualifying investments in infrastructure facilities industries, environmental protection projects, and energy and water saving projects
• Tax exemptions are granted and reductions allowed for qualified technology transfers
• A 150% tax deduction is allowed for qualified R&D expenses, and also a 200% tax deduction for wages paid to disabled workers
• Venture capital enterprises are now entitled to a 70% extra deduction of the cost of investment in small and medium size new and high technology enterprises, for duration of at least two years
• Controlled foreign corporation rules have been introduced
• Thin capitalisation rules have been introduced
• A general anti-avoidance rule has been introduced
• Transfer pricing filing rules are confirmed by the by the introduction of a number of new forms associated with related party transactions. These forms are specific to each type of transactions and applicable to all taxpayers. They are:
• List of related parties
• Transaction summary
• Transaction: purchasing and sales
• Transaction: services
• Transaction: intangibles
• Transaction: fixed assets
• Transaction: financing
• Overseas investments
• Overseas payments

The EIT Regulations have implemented withholding taxes at 10% on income including dividends, interest, rent, and royalties.  Previously, dividends paid by Foreign Investment Enterprises to foreign shareholders were exempt from withholding tax. With the imposition of a 10% withholding tax rate and the requirement for mandatory transfer pricing documentation, companies may need to reconsider their holding and operating structure in China.

Value Added Tax (VAT)
On 14 November 2008, the People’s Republic of China (PRC) revised the provisional VAT regulations. These are effective from 1 January 2009. The key changes include:

• full VAT credit on fixed assets with no restrictions in terms of geography, industry or value
• abolition of VAT exemption policy for imported equipment
• abolition of VAT refund policy for domestically-manufactured equipment purchased by foreign invested enterprises
• restoration of the VAT rate for mineral products from 13% to 17%

Business Tax (BT)
The new Business Tax (BT) provisional rules expanded the taxing right on service income to include services where either the provider or the recipient of the service is located in the PRC.

Subject to Business Tax?

The above only provides some highlights of the important changes in the tax laws in China.  The Chinese tax authorities have issued a number of updated circulars to clarify various points from the newly implemented regulations. For further information and guidance on investing in China please contact your regular Grant Thornton advisor or the author of this article. 

Author, Dicky Fong, November 2009

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