China enhances preferential income tax policies to encourage entrepreneurship and innovation

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1 China enhances preferential income tax policies to encourage entrepreneurship and innovation Issue No.CTIN Oct 2016 Recently, Caishui [2016] No. 101 (Circular 101) was jointly issued by the Ministry of Finance (MOF) and the State Administration of Taxation (SAT). Following that, the SAT issued another two documents SAT Announcement [2016] No. 62 (Announcement 62) and Shuizonghan [2016] No. 496 (Circular 496), respectively addressing the collection administrative matters and implementation of Circular 101. Background In recent years, stock incentive plans have become a popular tool to retain talent. The tax policies for stock incentive plans have accordingly started to attract considerable attention from the business community. At China s 20th National People s Congress (NPC, the parliament) held in March this year, China s Premier Li Keqiang advocated for unleashing the power of entrepreneurship and innovation, and urged policy makers to enhance preferential tax policies on stock or stock option plans to further encourage entrepreneurship and innovations. Recently, the release of Caishui [2016] No. 101 (Circular 101), a document jointly issued by the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) presented a response to this aforementioned proposal. Following that, the SAT issued another two documents SAT Announcement [2016] No. 62 (Announcement 62) and Shuizonghan [2016] No. 496 (Circular 496), respectively addressing collection administrative matters and implementation of Circular 101. Circular 101 provides more options for the preferential income tax treatment of stock incentive plans and investments with technologies as capital contribution (Technology Contribution). The key articles of Circular 101 include: China Tax & Investment News 1

2 On Corporate Income Tax (CIT) Additional option on preferential CIT treatment for corporates investors investing in PRC resident enterprises with technologies On Individual Income Tax (IIT) Additional options regarding preferential IIT treatment for individual investors investing in PRC resident enterprises with technologies IIT deferral treatment on qualifying income derived from stock options, equity options, restricted stocks and equity incentives of non-listed companies Extended IIT filing deadlines for income derived from stock options, restricted stocks and equity incentives of publicly listed companies In this issue of China Tax & Investment News, we focus on related CIT policies. A separate PAS Alert focusing on IIT policy analysis and observations was issued on 30 September. Key point No. 1 - Additional tax incentive: Income tax deferral treatment for Technology Contribution According to the prevailing Circular 116 (Caishui [2014] No.116, issued on 31 December 2014, a circular providing CIT treatment on non-monetary asset investment 1 ), corporate investors were allowed: to pay CIT by installments throughout a period of up to five years for the income derived from nonmonetary assets and from investments in resident enterprises with non-monetary assets as capital contribution; and to adopt special tax treatment as stipulated in Caishui [2009] No. 59 if relevant criteria for the special tax treatment are satisfied New policies provided in Circular 101 In addition to the five-year installment plan provided under Circular 116, Circular 101 offers another option on preferential treatment by introducing a new CIT deferral on Technology Contribution. Instead of paying CIT at the time when such investments are made, cooperate investors investing in PRC resident enterprises with technology may choose to delay CIT until the relevant shares are disposed, provided that: the consideration is 100% comprised of stocks/equity; and relevant record filing compliance is fulfilled with relevant tax authorities The taxable income is the balance between share transfer consideration and the original value of technologies plus related taxes and levies. There is no elaboration on how the original value of technology be calculated, unless further rule will be issued, taxpayers may calculate the same according to accounting principles. Although Circular 101 does not specify, it is logical to construe that a corporate investor should either choose a five-year installment tax payment plan or the CIT deferral treatment, instead of applying both incentives on a single investment. However, Announcement 62 has limited the CIT deferral treatment only to those enterprises that are filing CIT based on actual profits; in other words, enterprises that are paying CIT based on deemed profits could not select the deferral method. In addition, according to Circular 101, regardless of its corporate investor CIT treatment, the investee enterprise is allowed to adopt the appraised value of technologies in its account and amortize and deduct accordingly for CIT purposes, but Announcement 62 also emphasizes that the in-charge tax authority is empowered to make adjustments if they find the appraised value unreasonable. Note: 1. According to Circular 116, a non-monetary asset refers to assets apart from monetary assets like cash, bank deposits, receivables, notes receivable and held-to-maturity debt investments. China Tax & Investment News 2

3 The applicable scope of technologies Circular 101 specifies that the applicable scope of technologies include patented technology (including national defense patent), computer software copyright, exclusive right of integrated circuits design, right of new species of plants or biological pharmaceuticals, as well as other technologies recognized by the Ministry of Science and Technology, the MOF and the SAT. Such tax deferral treatment also applies to individual investors investing in resident enterprises with technology. Key point No. 2 - Extended preferential IIT treatments for stock incentive plans Circular 101 does not provide any new policies with regard to CIT treatment for stock incentive plans, but it has obviously extended the relevant preferential IIT treatments. To facilitate the readers understanding, we hereby provide a quick review of the prevailing CIT policies related to stock incentive plans, i.e., policies provided under SAT Announcement [2012] No.18 (Announcement 18, issued in May 2012). According to Announcement 18, for stock incentive plans established by listed resident companies based on relevant administrative measures, the related costs/expenses incurred by the resident listed companies, which are the consideration in exchange for the services provided by the stock incentive planqualified personnel, shall be recognized based on the fair stock price and quantity of the shares granted to the stock incentive plan-qualified personnel at the time of grant. Two different CIT treatments of such stock incentive plans are provided in Announcement 18 as shown below: Scenario 1 where the stock incentive plan-qualified personnel can exercise affirmative action immediately upon any stock incentive plan being implemented: The stock incentive plan costs/expenses should be treated as deductible salaries and wages for CIT purposes at the year of affirmative action being exercised. The deductible salaries and wages should be calculated as the result of fair market value of stock on the date of the exercise beginning, minus the actual costs incurred by the SIP-qualified personnel multiplied by the number of shares exercised. Scenario 2 where the stock incentive plan-qualified personnel can only exercise affirmative action after reaching a certain number of service years or upon meeting certain criteria (i.e., a vesting period): The stock incentive plans costs/expenses calculated and accrued by the listed companies for the vesting period shall not be deducted for CIT purposes. Instead, such costs/expenses can only be CIT-deductible in the year when the stock incentive plan becomes vested. The listed companies shall follow the same way as above to calculate the deductible costs/expenses for CIT purposes. As mentioned, Circular 101 does not provide new policies on CIT treatment for stock incentive plans. However, Circular 101 has further extended the preferential IIT treatments related to stock incentive plans, i.e., IIT deferral for qualifying income derived from stock options, equity options, restricted stocks and equity incentives of non-listed companies. Moreover, Circular 101 allows extended IIT filing deadlines for income derived from stock options, restricted stocks and equity incentives of publicly listed companies. Please refer to our PAS Alert for details on the relevant IIT analysis. Key point No. 3 - Documentation filing requirements and the effective date The above preferential policies are expected to help enterprises improve their cash flow due to the extra tax liability arising from technology contributions. However, it is important to note that enterprises applying tax deferral treatment shall perform record filing with in-charge tax authorities within a prescribed timeframe. Announcement 62 stipulates that when an enterprise selects a tax deferral it must fill in the Information form related to income tax deferral on technology contribution within the first provisional filing following the completion of investment (i.e., technology contribution). Since Announcement 62 did not further elaborate the first provisional filing follows the completion of investment, it is highly recommended that enterprises with relevant plans to proactively communicate with in-charge tax authorities earlier to further understand their interpretation and to confirm the applicable due date based on respective circumstances and facts. CIT policies prescribed in Circular 101 took effect on 1 September They also retroactively apply to stock incentive plans provided by enterprises established in Zhongguancun Science Park (Beijing) which were incurred in the period between 1 January 2016 and 31 August 2016 with tax unsettled. China Tax & Investment News 3

4 Action items The promulgation of Circular 101 is definitely welcomed by business communities as it brought over additional favorable tax treatment for business investment activities and stock incentive plans. It allows CIT deferral in addition to installment tax payment for profits derived from capital contribution of technological assets, which certainly will improve cash flow and possibly the operating flexibility and promote the development of entrepreneurship as well as innovation. Although Announcement 62 has introduced certain collection administrative measures, Circular 496 has further emphasized administration posts. This administration should generally include the proper handling of information and periodic analyses. It should also deepen cooperation and communication between and local and state tax authorities. It is therefore not unreasonable to expect more refined regulations being introduced, so we recommend enterprises pay closer attention to any developments as they arise. Corporate executives are encouraged to study the relevant documents and consider the following actions, if appropriate: Assess whether relevant investment and stock incentive plans which have been carried out or are scheduled to be carried out can qualify for tax policies provided under Circular 101 For plans that have been put on hold, taxpayers may reconsider such plans and reassess according to business needs (given more flexibility is now available) Consult with professional and/or relevant tax authorities to understand documentation and filing requirements Contact with in-charge tax authorities to seek tax authorities positions on unsettled cases that are still under review. When assessing whether related plans should be implemented, a total consideration should be given from business, legal and tax perspectives. Particularly on tax, considerations should not only be given to income tax but also to other taxes (e.g. turnover tax). These newly released circulars reflect the PRC government s determination to develop a more flexible and favorable environment to boost entrepreneurships and innovations. Companies are advised to review their investment structure and plan to take advantage of regulations promulgated so far. For IIT analysis of the same matters, please refer to our PAS Alert. In case of doubt, consulting tax professionals for further assistance is highly recommended. China Tax & Investment News 4

5 Contact us For more information, please contact your usual EY contact or one of the following of EY s China tax leaders. Office Tax Leaders Martin Ngai (Beijing) martin.ngai@cn.ey.com Fisher Tian (Tianjin) fisher.tian@cn.ey.com Samuel Yan (Dalian/Shenyang) samuel.yan@cn.ey.com Lucy Wang (Qingdao) lucy-c.wang@cn.ey.com Joanne Su (Xi an) joanne.su@cn.ey.com Vickie Tan (Shanghai) vickie.tan@cn.ey.com Raymond Zhu (Wuhan) raymond.zhu@cn.ey.com Audrie Xia (Suzhou) audrie.xia@cn.ey.com Andrew Chen (Nanjing) andrew-jp.chen@cn.ey.com Patricia Xia (Hangzhou) patricia.xia@cn.ey.com Chuan Shi (Chengdu) chuan.shi@cn.ey.com Clement Yuen (Shenzhen) clement.yuen@cn.ey.com Rio Chan (Guangzhou/Changsha) rio.chan@cn.ey.com Jean Li (Xiamen) jean-n.li@cn.ey.com Tracy Ho (Hong Kong) tracy.ho@hk.ey.com Heidi Liu (Taipei) heidi.liu@tw.ey.com Service Line Tax Leaders Andrew Choy (International Tax & Transfer Pricing) andrew.choy@cn.ey.com Paul Wen (People Advisory Services) paul.wen@hk.ey.com Kenneth Leung (Indirect Tax) kenneth.leung@cn.ey.com Becky Lai (Tax Policy) becky.lai@hk.ey.com David Chan (Transaction Tax) david.chan@hk.ey.com Samuel Yan (Global Compliance & Reporting) samuel.yan@cn.ey.com Sector Leaders Henry Chan (Financial Services) henry.chan@cn.ey.com Alan Lan (Energy & Resources) alan.lan@cn.ey.com Martin Ngai (Technology, Media, Telecommunications) martin.ngai@cn.ey.com Vickie Tan (Life Science) vickie.tan@cn.ey.com Gary Chan (Real Estate) gary.chan@cn.ey.com Audrie Xia (Consumer Products) audrie.xia@cn.ey.com Walter Tong (Automotive & Transportation) walter.tong@cn.ey.com Raymond Zhu (Government& Public Sector) raymond.zhu@cn.ey.com Greater China Tax Leader Henry Chan henry.chan@cn.ey.com Author China Tax Center Jane Hui jane.hui@hk.ey.com China Tax & Investment News 5

6 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com Ernst & Young (China) Advisory Limited. All Rights Reserved. APAC No ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/china