PRC Enterprise Income Tax Guide

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Jocelyn Webb
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1 Legislation China Enterprise Income Tax Law (EITL) 企業所得稅法 enacted 16 Mar 2007, effective 1 Jan China Enterprise Income Tax Implementation Rules (EITIR) 企業所得稅法實施條例 enacted 6 Dec 2007, effective 1 Jan Tax Resident Enterprise 居民企業 An enterprise established within the territory of China pursuant to Chinese laws or an enterprise established within the territory of another country whose actual management and control is located in China. TREs are subjected to EIT for income sourced within and outside China. Non Tax Resident Enterprise 非居民企業 An enterprise established under the laws of a foreign country (or tax region) and whose actual management or control is located outside China but which has an establishment or place in China, or that does not have an establishment or place in China but derives income from sources within China. Non TREs that has set up establishment in China are subjected to EIT on: i) China sourced income derived from such an establishment AND ii) income arising outside China that is effectively connected with such as establishment. Non TREs without establishments in China or with establishments in China but whose income is not effectively connected with the establishment are subjected to EIT on a withholding basis. Tax Rates Standard Rate = 25% Low Rate = 20% (Qualified small and minimal profit enterprises engaged in a non-restricted / non-prohibited industry) High and new technology enterprises = 15% Page 1 of 14, Updated 18-Feb-14

2 Withholding Rate = 10% unless specifically prescribed by relevant tax treaties. Tax Year 1 st Jan to 31 st Dec of each year. Net Taxable Income - TRE EIT is chargeable on an annual basis on net taxable income. Gross Income x Non-taxable (x) Tax-exempt (x) Deductible expenses (x) Losses C/F (x) Net Taxable Income x Gross Income - TRE Taxable Income: Revenue from sale of goods Revenue from provision of labor services Gross proceeds from transfer of property Dividend income & distributions with respect to equity interests Interest income Rental income Royalty income Donations income Other income (not included in above categories) Non Taxable Income Government funding Official receipts and administrative charges collected in accordance with relevant laws and included under a governmental budget system Other non-taxable income as stipulated by the State Council Income Recognition Normally income recognition is on accrual basis with following exceptions Sale of goods payable by installments, can recognize by dates of payment as stipulated in contract; Large projects with duration of over 12 months, recognize based on % of completion basis or upon work completed within each tax year. Deemed Sales Deemed sales occur when: Non-monetary assets are exchanged by enterprises e.g. products/ services provided as donations, settlements, sponsorships, advertisements, samples, employees welfare or profit distributions Page 2 of 14, Updated 18-Feb-14

3 Enterprises transfer assets to another party for marketing, entertainment, distribution of bonus or benefits to employees Deeded sales income for own produced assets is based on selling price of the same asset in the same period; for purchased assets, based on purchase price. Deemed Profit An enterprise may be required to have its taxable profit estimated with reference to same or similar industries in cases where: Accounting books have not been set up in accordance with laws and regulations; Unauthorized damage to accounting books or refusal to provide tax payment information; Accounting entries are messy or costing information, receipt of income or proof of expenditure incomplete and difficult to verify; Repeated failure to file tax returns within prescribed time periods; Tax calculation basis filed obviously lower without proper reasons. Taxable Income Non TRE with Establishments in China Taxable Income comprises: Income sourced within China Income sourced outside of China that is effectively connected with its establishment in China Effectively connected income refers to income earned by establishments of TRE within the territory of China that own share rights or creditor rights through which income is earned or own/control/manage properties through income is earned. Non TREs with establishments are required to setup accounting books in accordance with the Tax Collection and Administration Law and other relevant laws and regulations and maintain adequate accounting books and records and accurately calculate the taxable income being commensurate with the functions and risks undertaken by the establishment plus declare and pay EIT on an actual basis. Failure to comply with stipulated accounting record or tax declaration requirements entitles PRC tax authorities to access the Non TRE under alternative deeming provisions: Deemed profit = gross revenues x deemed profit rate; OR Deemed profit = cost and expenses + deemed profit margin Deemed Profit margin: Total costs x 15%-30% for construction, design and consulting services Total costs x 30%-50% for provision of management services Page 3 of 14, Updated 18-Feb-14

4 Taxable Income Non TRE without Establishments in China Taxable income is only from Income sourced within China and comprises: Dividends from private and listed enterprises and other distributions with respect to equity interests, interests, rent and royalty taxable on their full amounts; Gains on transfers of assets taxable on the excess of the proceeds over net value of the assets transferred. Deductible Expenses Major categories of deductible expenses against gross income: Costs of sales, costs of services and other expenditures in the course of manufacturing and other business operating activities; Expenses of selling, general, administrative and financial nature incurred in the course of manufacturing and other business operating activities; Taxes & surcharges; Losses from stock-counts, damages, disposals of fixed assets and inventories, transfer of properties, bad debts, disasters and force majeure events incurred in the course of manufacturing and other business operating activities. Wages & Salaries Reasonable wages & salaries paid are deductible: Base wage, bonus, allowance, subsidies, OT and other expenses related to employment Reasonableness determination: Sound staff compensation policy is established; Compensation consistent with benchmark level of industry and geographical region; Compensation granted within a certain period is stable; adjustment to compensation is consistent; Enterprise withholds IIT in accordance with regulations Arrangement for compensation is not for the purpose of tax evasion, Employee Welfare Expenses Deductible up to limit of 14% of enterprise s deductible wages and salaries. Unrelieved amounts cannot be carried forward. Labor Union Dues Deductible up to limit of 2% of enterprise s deductible wages and salaries. Page 4 of 14, Updated 18-Feb-14

5 Employees Education Expenses (Trade Union Education Fund) Deductible up to limit of 2.5% of enterprise s deductible wages and salaries in that tax year, excess can be carried forward (8% for technological-advanced service enterprises). Training expenses incurred by software manufacturing enterprises are allowed to be deducted on an actual basis. Insurance Premiums & Funds Contributions Contributions to insurance and planning funds deductible if made in accordance with relevant regulations: Contribution Employee Employer 1 Pension 8% 20% 2 Medical Insurance 2% 7-12% 3 Work-related Injury Insurance % 4 Unemployment Insurance 1-2% 1-2% 5 Maternity Insurance - Vary 6 Housing Fund % % Loan Interest Payments Interest Deductibility Loans to 3 rd parties Interest on fixed assets and intangible assets construction, purchase production prior to asset use Related party loans Financial Institutions Deductible Non-Financial Institutions Deductible up to financial institutions rates Add to original value of assets and depreciate over expected useful life Deductible up to limit of standard debt equity investment ratios unless proven arms-length borrowing Minimum Registered Capital of Foreign Investment Enterprises Total Investment Amount US$ 3m or less US$ 3-10m US$ 10-30m Over US$ 3-10m Minimum Registered Capital 70% of total investment Higher of US$ 2.1m or 50% of total investment Higher of US$ 5m or 40% of total investment Higher of US$ 12m or 33.3% of total investment Page 5 of 14, Updated 18-Feb-14

6 Entertainment / Advertising / Promotional Expenses Expenses Entertainment A&P Deduction Deductible to the extent of 60% of total incurred but up to 0.5% of operating revenue of the tax year Deductible up to 15% of business revenue of current tax year with excess to be c/f to following tax years. No deduction for payment to related parties. Exchange Loss Exchange losses incurred in currency transactions, incurred during conversion of foreign currency assets and liabilities at the end of tax year using year-end middle spot rates are deductible. Leasing Costs Operating leases rental payments are deductible. Rental payments under finance leases should be capitalized and depreciated. Management Fees Management fees paid between enterprises are not deductible. Management fees paid by Chinese establishment or place of business of a foreign enterprise to its head office in connection with production or business operations may be deductible if deduction claim is supported by documents from HO certifying the scope of the expenses involved, total amount, basis and method of allocation. Asset Losses Asset losses deductible for EIT purpose shall be incurred in production or operation activities and associated with taxable income generating process e.g. stock-count loss; bad debt; damage; theft of fixed asset and inventory, loss from natural disasters etc. Assets = assets owned by or under operational control of taxpayer for operation and management, including monetary and non-monetary assets. Bad Debt Deduction Conditions for claim Debtor is declared bankrupt, or closed, dissolved or has its business license revoked/cancelled AND its property insufficient to pay off receivable balance; Page 6 of 14, Updated 18-Feb-14

7 Debtor is deceased / declared missing / dead AND its property insufficient to pay off receivable balance; Debt is outstanding for over 3 years with verified evidence that demonstrate debtor is unable to pay; Creditor has no recourse against debtor by effect of a debtrestructuring agreement; Debt is unrecoverable as a result of natural disasters, wars and other force majeure; Other conditions set by financial or tax departments under State Council. AR balance outstanding for over 3 years which has been treated as bad debt for accounting purpose can be claimed deduction with an explanation letter and a special report. Evidence Internal External Supporting Documents Accounting vouchers, stock-taking records, business contracts for enterprises with a sound accounting and internal control system Legal documents produced by judicial / administrative authorities or technical verification divisions e.g. bankruptcy / liquidation announcements Donations Deductible for qualified donations to public interest social organizations or People s Government and their department above county level - up to 12% of donor enterprise s annual profit. Public Interest Social Organizations: Legally incorporated with legal person status; With mission of development for public interest, not for profit; All assets and associated earnings and appreciation belong to legal person; Profits and operating surplus mainly used in activities that support established purposes of the organization; Upon termination, remaining assets do not belong to any individual or the profit-making organization; Not engaged in any activities irrelevant to the purpose upon establishment; With complete financial accounting system. R&D Expenses Deductible up to 150% of R&D expense incurred during the development of new technologies, new products or new production techniques. If R&D expenses are capitalized as intangible assets, 150% of actual costs are allowable for amortization purpose. Page 7 of 14, Updated 18-Feb-14

8 Venture Capital Enterprises When a VC enterprise invests in the shareholdings of small/medium high and new technology enterprises for more than 2 years 70% of the investment amount may be deducted against the taxable income of the VC enterprise when the two year holding is accomplished. Losses Tax losses may be carried forward to set-off against taxable profits of next 5 years. No carry-back of losses. Losses from overseas subsidiaries cannot be combined with enterprise s domestic profit. Non-deductible Items Specific non-deductible items: Dividend payments; EIT payments; Surcharge on late payments; Fines, penalties and losses incurred through confiscation of property; Unqualified donations; Sponsorship fees; Unapproved provisions; Other expenditures not incurred for earning taxable income. Depreciation Depreciation shall be computed using the straight-line method based on the original value of the fixed asset less its estimated residual value over the period of its useful life. After 1 Jan 2008, enterprises can revise the residual value of fixed assets and calculate depreciation based on undepreciated value of the fixed assets. Minimum Depreciation Period / Useful Life Houses & Buildings Airplanes, trains, ships, machinery, equipment used in manufacturing Apparatuses, tools, furnishings used in manufacturing & business operations Transportation vehicles Electronic equipment 20 years 10 years 5 years 4 years 3 years Depreciation Period Depreciation shall commence in the month following month of first use and cease in the month following month asset is ceased to be used. Page 8 of 14, Updated 18-Feb-14

9 Fixed Assets Valuation Purchased fixed asset Purchase price Taxes & expenses paid Expenditures incurred to put asset into use Self-constructed fixed asset Asset under finance lease Asset acquired through donation, investment, exchange or debt restructuring Expenditures incurred prior to completion Total payments per leasing contract Expenditures incurred to conclude leasing contract Fair market value Taxes and expenses paid Accelerated Depreciation Depreciation may be accelerated by i) shorter depreciation period or ii) higher depreciation rates for following reasons: Assets affected by accelerated development of nest generation of products due to advancements in technology; Assets in constant exposure to high vibration and high corrosion. Reduced depreciation period cannot be less than 60% of minimum depreciation period. Intangible Assets Amortization Intangible assets are non-monetary long term assets without physical substances, which are held by an enterprise for use in the manufacturing of goods or provision of services, including goodwill, patents, trade-marks, copy-rights, land use rights etc. Purchased intangible asset Self-developed intangible asset Asset acquired through donation, investment, exchange or debt restructuring Purchase price Taxes & expenses paid Expenditures incurred to put asset into use Expenditures incurred in the development process from start of capitalization to completion Fair market value Taxes and expenses paid Amortization period shall not be less than 10 years. Expenditures for purchasing goodwill are deductible when the entire business of an enterprise is sold or the enterprise is liquidated. Page 9 of 14, Updated 18-Feb-14

10 Intangibles that cannot be amortized include: Self-developed intangible assets where the cost has already been deducted in calculating taxable income; Self-created goodwill; Intangible assets irrelevant to business activities; Inventory Valuation Enterprise can select from FIFO 先入先發, Weighted Average 加權舌均 and specific valuation 個別計價 but cannot change valuation arbitrarily once selected. Tax Registration 稅務登記 Taxpayers should submit an application for tax registration to local tax authorities within 30 days from obtaining a business license 營業執照 or 30 days from commencement of tax payment obligations, whichever is earlier. Tax registration should be completed at the place of production or business operations, or at the place where taxpayer has tax payment obligations. If taxpayer relocates to another tax municipality, it should complete deregistration formalities with the original tax authorities before applying for tax registration with the tax authorities at the new location. Supporting documents to accompany tax registration form: Enterprise or business name; Name & details of business owner or legal representative; Business license; Business address; Type of ownership; Method of accounting; Form of production / business operations; Scope of business Bank account details; Finance leader (chief accountant) and phone number Tax Deregistration Tax deregistration may be required due to dissolution, bankruptcy, taxpayer relocation and revocation of business license for taxpayer. Tax deregistration requires a taxpayer to settle all tax in arrears, overdue tax surcharge and other outstanding penalties with the tax authorities. Tax Registration Certificate 稅務登記証 Tax registration certificate is required for following business activities: Opening bank account; Page 10 of 14, Updated 18-Feb-14

11 Applying for tax reduction, exemption, refund; Extension of tax filing or payment deadline; Buying VAT invoices; Applying for certificate of tax administration for out of town business activities; Closing / suspending business operations A taxpayer who opens a new bank account must report the bank account number to the tax authorities within 15 days. Accounting Books and Record Keeping Taxpayers should establish accounting books within 15 days of issuance of business license or commencement of tax payment obligations. General ledgers; Detailed accounts; Journals and other auxiliary accounting records Taxpayers should submit documentation on their finance and accounting systems or procedures to tax authorities within 15 days from obtaining tax registration certificate. Computerized Accounting Systems Before implementing a computerized accounting system, a taxpayer should file records of the accounting software, user manual and other relevant materials with the tax authorities. The complete set of computer-generated accounting records in hard copy is regarded as accounting books. Language, Currency and Record-keeping Requirements Foreign investment enterprises may keep accounts in both Chinese language and a foreign language. Either RMB or foreign currency may be used for preparation of accounts but tax computation must be in RMB. All accounting books, vouchers, statements, tax payment certificates and other relevant tax records must be kept for at least 10 years. Provisional Tax Return and Tax Payment Enterprise must file a provisional EIT Return within 15 days after the end of each month or quarter (month or quarter determined by tax authority) and make provisional tax payment accordingly. Filing is necessary regardless of the enterprise making profits or losses. Page 11 of 14, Updated 18-Feb-14

12 Annual Tax Return and Tax Payment Enterprise must submit final EIT return and settle the final tax payment within 5 months of end of each tax year. EIT return submission must be accompanied by financial statements. Monthly/quarterly provisional tax paid in advance can be offset against the annual tax payment. Overpayment shall be refunded. Overdue Tax Surcharge Reason Surcharge Failure to pay tax within prescribed time limit 0.05% of overdue payment calculated daily with effect from the date of obligation to pay. Tax adjustments from tax authorities resulting in higher taxable income Interest calculated on a daily basis from 1 st Jun following the attributable tax year through to date of payment based on basic PBOC RMB Lending Rate + 5%. If taxpayer provides relevant information to facilitate correct calculation of tax liability, tax authority may waive the 5%. Page 12 of 14, Updated 18-Feb-14

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Our team of experienced finance professionals is led by three directors each with in-depth expertise in commerce and industry, auditing and taxation. andrewng@tcng-cpa.

13 T.C. NG & Company CPA Limited 伍子材會計師事務所有限公司 Founded in 1964, we are a long established and leading professional accountancy practice in Hong Kong. We provide quality auditing, taxation and business consulting advices to local and multi-national corporations. Our team of experienced finance professionals is led by three directors each with in-depth expertise in commerce and industry, auditing and taxation. andrewng@tcng-cpa.com Andrew Ng CPA Practicing, FCA, MHKSI, BA Director (T.C. NG & Company CPA Limited) Founder (TCN Consulting Services Limited) Andrew, a UK educated and qualified Chartered Accountant, has over 20 years experience in financial management, business process reengineering and IPOs, Andrew has assisted clients in statutory audits and delivered improvements to organizational finance functions and business operations, delivered turnaround bottom line improvements. Prior to returning to this family firm, Andrew had held senior finance positions with A.S. Watson & Co., Coca Cola Corporation and Cadbury Schweppes Plc. edwinchiu@tcng-cpa.com Edwin Chiu CPA Practicing, FCCA, ACA Director (T.C. NG & Company CPA Limited) Edwin joined the firm in Edwin serves clients in HK listed companies, real estate development, manufacturing, trading, technology, engineering, publishing. Edwin also acts as auditor for a number of charitable foundations and NGOs, including but not limited to the Women s Welfare Club; Causeway Bay Kai Fong Welfare Association; Children Catastrophic Disease Foundation, AJR Charitable Foundation and Braincare. He is also member of a School Management Committee of a government primary school and the honorary treasurer of the Hong Kong Anti-Cancer Society. eddieman@tcng-cpa.com Eddie Man CPA Practicing, FCA, MSc Director (T.C. NG & Company CPA Limited) Eddie, a UK educated and qualified Chartered Accountant, joined the firm in After graduating with a Master Degree in Finance in University of Lancaster in UK, Eddie worked for a big 4 firm in London for four years before returning to HK. Eddie has broad experience in auditing, taxation, liquidations and has been actively involved in tax investigation and tax planning engagements. Page 13 of 14, Updated 18-Feb-14

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Indirect (Offshore) Shares Transfer (Circular 698)

Indirect (Offshore) Shares Transfer (Circular 698) Legislation Guoshuihan 2009 Circular 698 issued on Dec 2009. Introduction Prior to the issue of Circular 698, it is common practice for foreign investors to use Special Purpose Vehicles SPV as an intermediate