China’s Taxation System and Fiscal Policy

China’s Taxation System and Fiscal Policy
Instructed by Dr. DU Li Office: Room 418 Office tel: Office hours: Wednesday,15:30-17:00pm

Dr.DU Li,Depertment of Pulbic Economics,Fudan University
TA Name: Ms Zheng Yuwen Cell phone: 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Introduction 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

What’s this course about?
China’s taxation system and fiscal policy Overall tax structure Tax liability of international taxpayers Tax Reform China’s Budget system Intergovern-mental fiscal relationship Fiscal Policy 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Expected Outcomes of Learning the Course
Understand china’s overall tax structure Get familiar with the determination of the tax liability of international taxpayers in china Be able to analyze the causes and effects of the major measures of china’s tax reform 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Expected Outcomes of Learning the Course
Understand china’s budget system and intergovernmental fiscal arrangement Understand major measures of china’s fiscal policy and be able to analyze the effects of them 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Conduct of the Course The main part of each class will be teacher’s instruction. Students are encouraged to actively participate in the class discussion. Homework will be assigned twice and there will be an open-book final exam. Tips: focusing on teacher’s PPT is helpful 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Assessment Class discussion(10%) + Homework(20%) Open-book Exam(70%) Final Score(100%) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reading and references
Liu,Z. & Du, L. (2013). China tax guide 2012 (in Chinese and English) .China Law Press. Devonshire-Ellis, C., Scott, A., & Woollard, S. (2011). The China tax guide. Springer. Report on the implementation of central and local budgets for 2014 and on draft central and local budgets for 2015,presented by Minister of Finance to CPC China 2030：Building a Modern, Harmonious, and Creative High-Income Society，The World Bank & China’s Development Research Center of the State Council 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Useful Websites China SAT China state statistics Bureau International bureau of fiscal documentation (KPMG) (Ernest Young) (PricewaterhouseCoopers) （Deloitte & Touche） 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Outline Part I Overview of China’s taxation system Part II Income taxes Part III Goods and Service taxes Part IV Other major taxes Part V China’s tax reform Part VI China’s fiscal system and policy 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Part I Overview of China’s taxation system
12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Overview of China’s Taxation System
Tax Statistics Tax-GDP Ratio Taxes Payable Tax Structure Tax Legislation Tax Administration Revenue-sharing System Tax Terminology 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Statistics

The Tax Revenue in China (1978-2014)
Since 1978,China’s tax revenue increased considerably. But that is to some extent due to the increased size of the whole economy. The relative indicator tax-GDP ratio is more meaningful. That ratio increased gradually after the 1994 tax reform to the current level of about 18%. (The jump of tax-GDP ratio in 1985 is due to the 1984 tax reform. Before that time, state-owned enterprises’ profits is the main source of China’s fiscal revenues. During that reform, state-owned enterprise were required to pay enterprise income tax and various other taxes. Even though for SOEs the taxes mainly took the place of previous profits and overall fiscal revenue did not change much , tax revenue did increase dramatically in But the 1984 tax reform did not form a good framework of modern tax system which can meet the requirements of market economy and it did not form a good mechanism for stable tax revenue growth. In particular, the local governments which take the major responsibility of tax collection had spared much effort for the revenue mobilization under the contract-based intergovernmental revenue sharing system. In 1994, Tax-GDP ratio dropped to an unacceptable level of about 10%.So in 1994, China launched another fundamental tax reform and adopted the new tax-sharing system at the same time. China’s current framework of taxation system is mainly the result of that reform. ) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Understand the Evolution of China’s Tax-GDP Ratio after 1978
Before 1984: Even though China launched the overall economic reform, the former extremely simplified tax system remain unchanged. China’s fiscal revenues mainly come from state-owned enterprises’ profits instead of taxes. So the tax-GDP ratio is relatively low. 12:54:56 Dr.DU Li, Department of Public Economics, Fudan University

China began the dramatic tax reform in 1984.The state-owned enterprise were required to pay enterprise income tax and various other taxes, so the tax revenue increase dramatically in 1985. But under the contract-based intergovernmental revenue sharing system, the local governments which take the major responsibility of tax collection had spared much effort for the revenue mobilization, so the Tax-GDP ratio dropped to an unacceptable level of about 10% in 1994. Contract-based intergovernmental revenue sharing system means, for each provincial level local government, the the arrangement for revenue sharing with the central government shall be determined by kind of contract made between them. Usually the contract determines the fixed level of fiscal revenue that the local government can keep or shall handover to the central government. In order to keep more or handover less in next round of contracting, the local governments tend to collect less tax revenue than they can in the current period. 12:54:56 Dr.DU Li, Department of Public Economics, Fudan University

1994-present In 1994, China launched another fundamental tax reform and adopted the new tax-sharing system to improve the tax revenue mobilization. After that, the tax-GDP ratio resumed the upward growing . China’s current framework of taxation system is mainly the result of 1994 tax reform. Under the new tax-sharing system, the central and local governments share the revenue from major taxes according to specified percentages. So in order to keep more tax revenue, local governments shall try to collect more. 12:54:56 Dr.DU Li, Department of Public Economics, Fudan University

Tax-GDP Ratio of Some OECD Countries(1972-2013）
This figure shows the tax-GDP ratio of some OECD countries during a long time period. We can see in most countries that indicator has remained stable. The obviously greater fluctuation of tax-GDP ratio in China is mainly the result of dramatic tax reform. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax-GDP Ratio of OECD Countries (2013 provisional)
China’s current tax-GDP ratio is about 18%. Is it high or low? That question is not easy to answer. But we can have some idea by making an international comparison. The tax-GDP ratio of most OECD countries are more than 20%. For most European countries, that indicator is higher than 30% or 40%.So if the tax-GDP ratio is comparable across countries, China’s level of 18% is not high. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

But there is a big gap between tax revenue and overall governmental revenue in China.

China’s Total Governmental Revenue
　 Items 2011 2012 2013 2014 billions of RMB % of GDP General budget (Public finance budget) 22 22.6 22.7 22.1 Government fund budget 8.8 7.2 9.2 8.50 State capital budget 76.5 0.2 97.068 105.84 157.80 Social security fund budget 2054.2 5.5 6.1 5.9 Total governmental revenue 36.5 35.5 38.2 37.0 China’s total governmental revenue consists of four parts. The main part of general budget ( or public finance) revenue is tax revenue which can be indicated in next slide. It is the general budget revenue that provides funds for the general budget expenditure such as general public service, education, national defense, health care, etc.. The main part of governmental fund budget revenue is State-owned land-use rights transfer revenue. In principle, the governmental fund budget revenue can only be used for special purposes and can not cover the general budget expenditure in general public service, education, national defense, etc. The State-owned land-use rights transfer revenue is the most important source of fund for China’s infrastructure construction. The State capital budget and the social security fund budget have been published only in recent years. The main source of the State capital budget revenue is the dividends distributed by the State-owned or State-invested enterprises from their after-tax profits to the state. The main source of the social security fund budget revenue is the social security contribution. Generally speaking, the State capital budget revenue and the social security fund budget revenue are not collected by the fiscal or tax departments, and the revenue cannot be used to cover the general budget expenditure as well. Based on the information above, we can see that even if China’s tax-GDP ratio is not high compared with many other countries, the government actually controls much bigger share of GDP. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Structure of the Public Finance Budget Revenue(2014)

Taxes Payable

Tax Structure in China（2013）
China relies more on indirect taxes than on direct taxes. The three major indirect taxes ( or Goods and Service Taxes) are VAT, Consumption Tax and Business Tax. The two major direct taxes are Enterprise Income Tax and Individual Income Tax. The Enterprise Income Tax in China is equivalent to the Corporate Income Tax in western countries. The most important tax in terms of tax revenue in China is VAT. Property taxes are not well-designed and their contributions to the overall tax revenue are quite small so far. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

(18 taxes) Taxes Payable GSTs Property Taxes Other Taxes
House Property Tax GSTs Taxes Payable Property Taxes Other Taxes Land Appreciation Tax Urban and Township Land Use Tax Farmland Occupation Tax Deed Tax Vehicle Purchase Tax Vehicle and Vessel Tax Value-added Tax Consumption Tax Business Tax Income Taxes Individual Income Tax Enterprise Income Tax Stamp Tax City Maintenance and Construction Tax Resource Tax Tobacco Tax Customs Duty Tonnage Tax (18 taxes) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University 26

(18 taxes) Taxes Payable GSTs Property Taxes Other Taxes
House Property Tax GSTs Taxes Payable Property Taxes Other Taxes Land Appreciation Tax Urban and Township Land Use Tax Farmland Occupation Tax Deed Tax Vehicle Purchase Tax Vehicle and Vessel Tax Value-added Tax Consumption Tax Business Tax Income Taxes Individual Income Tax Enterprise Income Tax Stamp Tax City Maintenance and Construction Tax Resource Tax Tobacco Tax Customs Duty Tonnage Tax (18 taxes) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University 27

Major Taxes Payable for Typical Business Operation
VAT, Business tax Level 1 Gross income Consumption tax GST - Costs, expenses and losses Enterprise income tax Net profits Level 2 Income tax For typical business operation, it is common that three levels of major taxes will be payable. First, the gross income will be subject to GSTs. Different business will be subject to different GST depending on the commodities and services sold or provided. Second, the net profits will be subject to Enterprise Income Tax. Third, the dividends distributed from the after-tax profits will be subject to Individual Income Tax at the shareholder level. Sure, apart form these five most important taxes ,the business operators might be subject to other taxes as well. For instance, if the business involves imports & exports, Customs duty will be payable. If the business is in mining industry, the Resource Tax will be payable. If the business involves farmland occupation or use of state-owned land, the Farmland Occupation Tax or Urban and Township Land Use Tax will be payable. If the enterprise owns commercial house property, the House Property Tax will be payable. And so on. Individual income tax Level 3 Dividends 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

What Kind of GST? Processing,repair and replacement Provision of Services Consumption tax Sale of goods VAT Business tax In China, nearly every business operator will be subject to at least one of the three major GSTs. After the 1994 tax reform, generally speaking, the business of selling goods shall be subject to VAT and the business of providing services shall be subject to Business Tax. But as exceptions, the “processing, repair and replacement” service shall be subject to VAT and the transfer of “intangible property and immovable property” shall be subject to Business Tax. Moreover, for some selected goods, the Consumption Tax will be levied in addition to VAT. Intangible property and immovable property 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Legislation

Domestic Tax Laws Tax laws : National People’s Congress or NPC Standing Committee Individual Income Tax Law Enterprise Income Tax Law Vehicle and Vessel Tax Law Tax Collection and Administration Law Regulations: State Council Provisional regulations of the People’s Republic of China on Value Added Tax Rules, notices, circulars, etc.: Ministry of Finance, State Administration of Taxation, General Administration of Customs Detailed rules for the implementation of VAT Local regulations and rules: local People’s Congress and their standing committees at provincial level China’s domestic tax laws include the “tax laws” published by the NPC or NPC standing committee, the regulations published by the State Council, the rules, notices or circulars published by the Ministry of Finance, the State Administration of Taxation or the General Administration of Customs, and local regulations and rules published by People’s Congress and their standing committees at provincial level. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Treaties China has entered into the Double Taxation Treaties with 100 countries so far (97 treaties effective). For international taxpayers, usually it is these treaties that finally determine their tax burden. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Year In china, the tax year is just the calendar year, 1 January to 31 December 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Interpretation of Tax Laws
The power of interpreting laws and regulations is shared among : NPC MOF or SAT that introduces the regulations courts In practice, tax court cases are rare in China, SAT and MOF have absolute authority to interpret most tax laws. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Rulings Rulings consist of provisions, circulars, replies and letters, and are issued by the MOF or the SAT to local tax authorities. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax administration

Organizational Chart of Tax Administration
STATE COUNCIL PROVINCIAL GOVERNMENTS STATE ADMINISTRATION OF TAXATION (SAT) PROVINCIAL STATE TAX BUREAUS PROVINCIAL LOCAL TAX BUREAUS MUNICIPAL OR REGIONAL GOVERNMENTS MUNICIPAL OR REGIONAL STATE TAX BUREAUS MUNICIPAL OR REGIONAL LOCAL TAX BUREAUS COUNTY GOVERNMENTS COUNTY STATE TAX BUREAUS COUNTY LOCAL TAX BUREAUS In the 1994 tax reform, China’s tax bureaus at local level were divided into state tax bureaus and local tax bureaus. The state tax bureaus are actually offices of SAT and operate under the leadership of SAT, but the local tax bureaus operate under the double leadership of SAT and the local governments at the same level. The state tax bureaus are responsible for the collection of central taxes(Consumption tax and Custom duties) and VAT, local tax bureaus are responsible for the collection of local taxes and IIT. In addition, state tax bureaus are in charge of the collection of EIT for “central enterprises” and “local enterprises” established after 2003,local tax bureaus are in charge of the collection of EIT for “local enterprises ”established before Generally speaking, “central enterprises” means the enterprises owned or controlled by central government and other enterprises are regarded as “local enterprises” in China. Collecting central taxes, VAT and EIT Collecting local taxes, IIT and EIT 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax sharing system Consumption tax: central Custom duties: central VAT：central 75%, local 25% Business Tax： local (But the tax paid by the headquarters of banks, insurance companies and railways goes to central government) IIT and EIT： central 60%,local 40% Other taxes: local 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Administration Taxpayers The entities or individuals liable to payment of taxes 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Administration Tax payers Enterprises State-owned enterprises Collective-owned enterprises Private enterprises Joint equity enterprises Foreign-invested enterprises Sino-foreign joint ventures Sino-foreign cooperatives Wholly foreign owned enterprises Foreign enterprises Partnership and Proprietorship Tax payers Individuals Individual business households Institutional units Administrative units Military units Social group 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Administration Withholding agents The entities or individuals having the obligation of withholding and remit taxes 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Administration Withholding Tax: Dividends received 63 HOLDCO WHT (7) Country A Dividends distributed 70 China OPCO Profit 100 Tax －30 Net Suppose HOLDCO in country A wholly owns OPCO in China. If OPCO distributes dividends (70) to HOLDCO, HOLDCO shall be subject to China’s Enterprise Income Tax of 10%. OPCO shall withhold the tax (7) and remit the tax to the tax department. HOLDCO can only get the after-tax cash dividend(63). In this case, HOLDCO is the taxpayer of the withholding tax, but since it is a foreign enterprise and shall not be required to make the tax registration with China’s tax authority, China’s tax authority can only require OPCO, which is a Chinese enterprise and shall have made the tax registration in China, to pay (withhold) the tax on behalf of HOLDCO. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Administration Tax registration The tax registration is a statutory formality for registering the economic activities of the taxpayers by the tax authority. Taxpayers should make tax registration within 30 days after receiving the business license Tax declaration Tax declaration is a statutory procedure for the taxpayers (withholding agents) to submit written report on their tax-related affairs to the tax authority by law. Account books and vouchers Taxpayers should keep account books and make records and accounting on basis of legal and valid vouchers. legal and valid vouchers: Invoices (receipt of payment obtained for purchase of goods or services) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Special VAT Invoice Tax rate China’s tax administration highly rely on the invoice (“fapiao”) system. Only when the taxpayers acquire valid invoices from the suppliers, can the relevant payments be deducted as costs for the purpose of taxable profits calculation. And after issuing the invoices, the suppliers have to include the revenue in the taxable income to pay income tax. The tax authority keeps strict control over the printing, selling, purchasing, and issuing of the invoices. Tax paid 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Administration Three major ways of tax collection: Collection by self-assessment Collection by verification Periodical collection by fixed amount 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Collection by Self-assessment
The taxpayers submit tax information in accordance with the law and pay tax after the information being examined and verified by the tax authority. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Collection by Verification
The tax authorities determine the tax payers’ tax payable, taxable income or profit rate and collect the tax according to that. This method includes collection based on deemed tax amount, deemed rate of taxable income or deemed revenue. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Periodical Collection by Fixed Amount
Periodical collection by fixed amount is the tax collection method under which the tax authorities determine the taxpayers’ taxable sales value (or quantity) or taxable income for operation in certain place during certain period within certain scope of business and collect tax according to that. This method applies to individual business households whose scale of business is too small to meet the standards for keeping accounts. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Terminology

Some Abbreviations MOF Ministry of Finance SAT State Administration of Taxation SOE State-owned Enterprise NRE Non-resident Enterprise DTT Double Taxation Treaty DTA Double Taxation Arrangement FIE foreign invested enterprise WFOE wholly foreign-owned enterprise EIT Enterprise Income Tax IIT Individual Income Tax VAT Value-added Tax GST Goods & Service Tax 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Some Abbreviations BT Business Tax CFC Controlled Foreign Company PE Permanent Establishment GAAR General Anti-Avoidance Rule WHT Withholding Tax FTC Foreign Tax Credit SPE Special Economic Zone 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Terms Tax base Business tax: gross income(transaction value or turnover value) VAT:value-added EIT&IIT:taxable income(gross income minus “costs,expenses or losses” or “standard deduction”) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Terms Tax rate progressive rate: 3-45% (IIT for wage and salary income) flat rate(proportionate rate)： 25% (EIT) …… unit rate： CNY 1 per litre (consumption tax for petrol) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Rate Schedule applicable to wages and salaries after September 1,2011
Monthly Taxable Income brackets（Yuan) Tax rate % 1 ≤1500 3 2 10 20 4 25 5 30 6 35 7 ＞ 80000 45 0 3% % % % % % % 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Individual income tax Enterprise income tax Part II Income taxes 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Enterprise Income Tax 中华人民共和国企业所得税法，中华人民共和国主席令第63号，中华人民共和国第十届全国人民代表大会第五次会议于2007年3月16日通过，自2008年1月1日起施行。《中华人民共和国企业所得税法实施条例》，2007年12月6日，中华人民共和国国务院令第512号，2007年11月28日国务院第197次常务会议通过，自2008年1月1日起施行。

Enterprise Income Tax From 1 January 2008, a single enterprise income tax regime was introduced to replace the former dual tax system which consisted of an enterprise income tax for Chinese domestic enterprises and a foreign enterprise income tax for FIEs. Enterprise income tax is charged on the worldwide income of resident enterprises at a flat rate of 25%. A rate of 20% applies to low-profit enterprises. Non-residents are taxed in China mainly on income derived from sources in China. Investment income of FIEs is subject to a withholding tax of 10%. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Enterprise Income Tax Determination of the tax liability International aspects Tax incentives Anti-avoidance rules 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Steps to Determine the Liability Of Enterprise Income Tax
Gross taxable income Step 1： Subtract : Exemptions and Deductions Step 2： Net taxable income Apply : Rate schedule Step 3： Gross tax payable Subtract: Credits Step 4： Net tax payable Costs , expenses and losses 12:54:56 59 Dr.DU Li,Depertment of Pulbic Economics,Fudan University 59

Step 1:determining the gross taxable income

Gross Taxable Income In principle, a resident enterprise is subject to income tax on worldwide income. A non-resident enterprise is taxable on income that has its source in China 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Resident Enterprise Residence from 1 January 2008, a resident enterprise is defined as: - an enterprise established in China - an enterprise established under foreign laws, or in a different region (e.g. Hong Kong, Macau), but whose place of effective management is in China. "effective management" means the factual and effective exercise of the entire management and control of the production and business operations, personnel, finance, assets, etc. of an enterprise. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Criteria for effective management
According to “Notice regarding Chinese-controlled foreign companies to be recognized as PRC tax resident companies in accordance with effective management criteria” (Guoshuifa [2009]82)，Companies should meet all the four criteria below to be deemed as effectively managed in China. Not less than half of directors or senior executives with voting rights reside in China Main property, ledgers, corporate seals/meeting minutes of the board of directors and shareholders are kept in China Financial and human resources decision are made by persons located in China, or must be approved by persons or department in China Senior executive officers and senior management responsible for daily business operations are principally located in China Daily business operations Financial and human resources decision Directors or senior executives Property/ Ledgers /Meeting minutes 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Determination of the Source of Income
Income from sale of goods: places of the transactional activities (normally the location of the business operation of the sales enterprises). Income from provision of services: places of the provision of the services. Income from transfer of property: location of the immovable property ; location of enterprise or institution transferring the property in case of movable property ; or location of the invested enterprises in case of transfer of equity. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Dividends, bonuses: location of the enterprises distributing the income. Interest, rentals, royalties: location of the enterprises or establishments, places bearing or paying the income, or by the domicile of the individuals bearing or paying the income. Other income: determined by Ministry of Finance or State Administration of Taxation. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

HOLDCO &Foreign investors
Discussion 12:54:56 China HOLDCO &Foreign investors what are the tax implications for HK Co. A if it is treated as Chinese resident enterprise after 2008? ↓ ↑ CO. A HK ↑ ↓ China OPCO Shareholding↓ dividend↑ Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Items of Gross Taxable Income
income from trade; income from providing services; income from disposal of property; dividends, bonus and other investment income; interest; rental income; royalties; donations; and other income. Profits and capital gains 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Step 2:determining the net taxable income

Deductible Items Costs , expenses and losses manufacturing costs ,sales, administrative and financial expenses Fixed assets and intangible assets expenditures shall be depreciated or amortized. Some items are deductible but subject to limits 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Deductible Items with Limit
Interest expenses Thin capitalization rules require only eligible interests expenses can be deducted before EIT (we will discuss this rule later). Entertainment expenses Sixty percent of entertainment expenses deductible up to 0.5% of annual business revenue. Promotion/advertisement expenses Deductible up to 15% of annual business revenue. Wages and salaries Reasonable wages and salaries deductible. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reasonableness of Salaries and Wages
The enterprise has formulated the relatively formal salaries and wages system. The salaries and wages system established by the enterprise are in accordance with the level of the industry and district it belongs to. The salaries and wages the enterprise distributes in a certain term are relatively fixed, and the adjustment of the salaries and wages are made in order. The enterprise has withheld the individual income tax for the actually distributed salaries and wages; The arrangement in relation to salaries and wages are not for the purpose of lowering tax burden or evading tax. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Basic social security contributions (rates vary across the nation) Old-age insurance: 22% of total salary payment of the enterprise in Shanghai Medical insurance:…12%... in Shanghai Unemployment insurance:…2%... in Shanghai Maternity Insurance:…0.5%... in Shanghai Work injury Insurance:…0.5%... in Shanghai Housing funds : 14% of the salary payment of previous year in Shanghai 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Donations Charitable donations of up to 12% of total annual profits are deductible. Charitable donations are defined as donations made by an enterprise through government agents （such as bureau of civil affairs) or eligible charitable organizations, such as China Red Cross Society，China Charity Federation ，etc . 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Rental expenses expenses related to the leasing of a fixed asset under an operational lease regime may be deducted evenly throughout the lease term; for the same expenses under a financial lease regime, the portion that forms the value of fixed assets may be depreciated. Financial lease effectively allows a firm to finance the purchase of an asset. Typically, a finance leaser will give the lessee control over an asset for a large proportion of the asset's useful life, providing them the benefits and risks of ownership. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Depreciation Depreciation for fixed assets is computed annually on a straight-line basis on the assumption that there will be a reasonable residual salvage value. Monthly depreciation=(original cost-residual salvage vale)/（depreciation period(year)×12） “Fixed assets” refers to “buildings, structures, machines, machinery, means of transportation, and other equipment, appliances and tools used for the purpose of production, provision of services, leasing and management with a useful life of more than 12 months” For the purpose of calculating depreciation, fixed assets are valued at original cost. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Step 3:Applying the rate schedule

Rates From 1 January 2008, the standard rate of Enterprise Income Tax is 25%. The tax rate for a low -profit enterprise is 20%. Withholding rate for income of a foreign enterprise from the sale of shares held in a Chinese entity or dividend received from a Chinese entity is 10%. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Standards for Low-profit Enterprise
Type of industry Annual taxable income Number of employees Total assets manufacturing <300,000 <100 <￥10,000,000 Non-manufacturing <80 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: a Foreign Enterprise Receive Dividend from a Chinese Entity
（WHT 10%） Bco Equity investment Aco China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: a Foreign Enterprise Receive Capital Gain From the Sale of Shares Held in a Chinese Entity Cco shares Bco Transfer of Shares （WHT 10%） Equity investment Aco Aco in the US invests in Bco in China. If Aco transfers the shares of Bco to Cco and get capital gains, it shall be subject to 10% Chinese withholding tax for the capital gains earned. China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Step 4: Determining the tax credit
In China,enterprise may be eligible for foreign tax credit and investment tax credit.But right now, I will skip this point. I will discuss the investment tax credit in the tax incentive part and discuss the FTC in the international aspect part. But you should bear in mind that ,in order to get the final tax payable for EIT, some enterprises may enjoy kind of deduction from the tax payable calculated just by applying the tax rate to taxable net income. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Dr.DU Li,Depertment of Public Economics,Fudan University
Tax Credit Enterprises may be eligible for: Foreign Tax Credit to be discussed later investment tax credit 12:54:56 Dr.DU Li,Depertment of Public Economics,Fudan University

Enterprise Income Tax Determination of the tax liability International aspects Tax incentives Anti-avoidance rules 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

International aspects
Two Scenarios of Cross-border Transactions: Chinese Resident Enterprises Earning Foreign-source Income Chinese Non-resident Enterprises Earning China-source Income 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

EIT for Chinese Resident Enterprises Earning Foreign-source Income
Since the foreign-source income might be taxed in the host country. China grants the tax credit for foreign tax paid on foreign income to alleviate international double taxation. General rules of foreign tax credit Credit limit with foreign-source income from multiple countries or of multiple items Rules of Credit for foreign taxes paid on dividends

Rules for Foreign Tax Credit
The amount of credit is limited to the amount of Chinese tax otherwise payable on the foreign income. So FTC is the lesser of (a) Foreign taxes paid (b) Foreign income Worldwide income Tax payable for worldwide income X Credit limit 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Rules for Foreign Tax Credit
Foreign source taxable income shall be determined under domestic tax law 5-year carry forward of excess foreign tax paid is allowed 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Foreign Tax vs. China Tax with FTC
If the foreign-source income =100,foreign tax payable shall be 100×20%=20,domestic tax payable shall be 100×25%−100%×20%=5 Top up portion, paid to domestic tax authority Paid to foreign tax authority Credited domestically Tax burden of foreign income determined by the higher of foreign and domestic tax A given amount of foreign-source income shall be subject to foreign tax at the rate of 20% and subject to domestic tax at the rate of 25%. Under China’s FTC system, the foreign tax paid can be fully credited against domestic tax payable since foreign tax rate is lower than domestic. So double taxation can be eliminated. But there will be a top up portion (100×25%-100×20%=5), the taxpayer need to pay additional tax to domestic tax authority for the income earned overseas. Foreign tax 20% China tax 25% 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Foreign Tax vs. China Tax with FTC
Domestic tax payable? Excess foreign tax Paid to foreign tax authority Credited domestically Tax burden of foreign income determined by the higher of foreign and domestic tax In this case, foreign tax rate is higher than domestic tax rate, only part of the foreign tax paid can be credited. But Chinese tax authority actually gives up the tax revenue otherwise should have been collected. So even if there will be a excess foreign tax ,there is no double taxation any more. And the excess foreign tax can be carried forward for 5 years. Foreign tax 30% China tax 25% 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Credit Limit with Foreign-source Income from Multiple Countries or of Multiple Items Alternative credit limitation Overall limitation Country by country limitation Item by item limitation China has adopted per country limitation but not item by item limitation 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

FTC with No Limitation Foreign Income Tax Business Income-Country X 100,000 45,000 Dividends-Country X 20,000 1,000 Business Income-Country Y 50,000 10,000 Interest Income-Country Z 1,500 Total foreign income 180,000 57,500 Domestic Income 200,000 Foreign Income Worldwide Income 380,000 Tax Before Credit (25%) 95,000 Foreign Tax Credit (57,500) Domestic Tax 37,500 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

FTC with Overall Limitation
Foreign Income Tax Business Income-Country X 100,000 45,000 Dividends-Country X 20,000 1,000 Business Income-Country Y 50,000 10,000 Interest Income-Country Z 1,500 Total foreign income 180,000 57,500 Domestic Income 200,000 Foreign Income Total Income 380,000 Tax Before Credit (25%) 95,000 Foreign Tax Credit (95,000x 180,000/380,000=45000) (45,000) Domestic Tax Excess foreign tax 12,500 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

FTC with per Country Limitation
Foreign Maximum FTC Income Tax Limit (25%) Business Income-Country X 100,000 45,000 Dividends-Country X 20,000 1,000 Total-Country X 120,000 46,000 30,000 Business Income-Country Y 50,000 10,000 12,500 Interest Income-Country Z 1,500 2,500 Total foreign income 180,000 57,500 41,500 Domestic Income 200,000 Foreign Income Total Income 380,000 Tax Before Credit (25%) 95,000 Foreign Tax Credit (41,500) Domestic Tax 53,500 Excess foreign tax 16,000 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

FTC with Item by Item Limitation
Foreign Maximum FTC Income Tax Limit Business Income-Country X 100,000 45,000 25,000 Dividends-Country X 20,000 1,000 5,000 Business Income-Country Y 50,000 10,000 12,500 Interest Income-Country Z 1,500 2,500 Total 180,000 57,500 37,500 Domestic Income 200,000 Foreign Income Total Income 380,000 Tax Before Credit (25%) 95,000 Foreign Tax Credit (37,500) Domestic Tax Excess foreign tax 20,000 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Rules of Credit for Foreign Taxes Paid on Dividends
Direct credit Only foreign tax directly paid creditable Indirect credit Foreign tax indirectly paid also creditable China allows direct and indirect foreign tax credit for foreign tax paid on dividends, but to be eligible for indirect credit, the taxpayer shall directly or indirectly control more than 20% of the capital of the overseas subsidiary. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Indirect Foreign Tax Credit
Indirect foreign tax credit means the credit for corporate taxes paid by the foreign subsidiary on its income (“underlying tax”). Underlying tax= Dividend received Subsidiary’s total distributed after-tax profits Credit is granted at the time dividend received by parent company Withholding tax on dividends still qualify for FTC as a direct credit Taxable amount of dividends should include the “underlying tax” Total foreign tax paid by the subsidiary X 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Discussion: FTC for Dividends
12:54:56 Which part creditable:7 or 30+7? How to determine the domestic tax payable? HOLDCO Gross Dividends 70 less WHT (7) Cash Dividends 63 China investment dividend Country A OPCO Profit 100 Tax −30 Net 70 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

International aspects
Two scenarios of cross-border transactions: Chinese resident enterprises earning foreign-source income Chinese non-resident enterprises earning China-source income 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

EIT For Chinese Non-resident Enterprises Earning China-source Income
Tax liability of non-resident enterprise Determination of source of income Determination of the existence of PEs The assessment mode for NREs Withholding tax under tax treaties Tax sparing credit

Tax Liability of Non-resident Enterprises
A non-resident enterprise(NRE) is defined as: an enterprise established under foreign laws whose place of effective management is not in China 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Liability of Non-resident Enterprises
For NREs with establishments in China: Subject to EIT on China-source income and foreign-source income that is effectively connected to the establishment (mainly business profits from sale of goods and provision of services, EIT of 25% ) For NREs without establishments in China: Subject to EIT on China-source income (mainly passive income like dividends, interest, royalties, rental income, capital gains, WHT of 10% ) Double taxation treaties concluded by China provide that a foreign enterprise is subject to Chinese tax on business profits only if the enterprise has a permanent establishment (PE) in China, and only to the extent that profits are attributable to the PE. 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Key Points for Determining the Tax Liability of NREs
Determining the source of income China-source or foreign-source? Determining the status of taxpayer with or without establishments or Pes? Determining the type of taxable income business income, dividends, interest, royalties， rental income or capital gains? Determine mode of assessment WHT, based on actual accounting profits or deemed margin? 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Income from sale of goods: places of the transactional activities (normally the location of the business operation of the sales enterprises). Income from provision of services: places of the provision of the services. Income from transfer of property: location of the immovable property ; location of enterprise or institution transferring the property in case of movable property ; or location of the invested enterprises in case of transfer of equity. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Dividends, bonuses: location of the enterprises distributing the income. Interest, rentals, royalties: location of the enterprises or establishments, places bearing or paying the income, or by the domicile of the individuals bearing or paying the income. Other income: determined by Ministry of Finance or State Administration of Taxation. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

How to Determine Effective Connection?
Country B China Branch Funds C co Country A B CO Interest Suppose Bco is located in country A and is a non-resident enterprise of China. It has set up a branch (establishment) in China. Cco is located in country B and is also a non-resident enterprise of China. If Bco directly lends some funds to Cco and get interests. The interests will be regarded as ordinary foreign-source income according to China’s EITL. But if Bco let the China branch provide the funds to Cco. The interests will be regarded as foreign-source income effectively connected to the establishment in China and subject to China’s EIT. Effective connection: when the branch( that is an establishment) owns the assets that give rise to the interest. foreign-source income: taxable 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Determination of the Existence of Permanent Establishments
PE refers to a fixed place of business through which the business of an enterprise is wholly or partly carried on. A construction site or installation project is regarded as a PE if it continues for more than 6 months Dependent agents is regarded as PE. Employees working in China more than 6 moths is regarded as PE. PE does not include a fixed place of business through which preparatory or auxiliary activities are carried out for the enterprise. 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Determination of the Existence of Permanent Establishments
Typical PEs Branches Rep offices (not carrying out only preparatory or auxiliary activities) Contracted projects (more than 6 months) Dependent agents Employees (more than 6 months) 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Assessment Mode for NREs
For NREs with establishments in China With well-developed accounting system Tax collected on self-assessment basis Without well-developed accounting system Tax collected on deemed basis For NREs without establishments in China Tax withheld by the payers of income 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Basis for the Deemed Taxable Income
Gross revenue: Taxable income = gross revenue ×deemed margin Costs and expenses: Taxable income = [total costs and expenses ÷ (1 – verified margin ) ]× deemed margin Revenue converted from operational expenditures: Taxable income =[ total of operational expenditures ÷ (1 –verified margin – business tax rate) ]× deemed margin 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Dr. Du Li Department of Public Economics,Fudan University
Deemed Margin For enterprises engaging in project contracting, design and consulting services, the margin shall be 15% to 30% For enterprises providing management services, the margin shall be of 30% to 50% For enterprises providing other services or engaging in business other than providing services, the margin shall be not less than 15% 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Discussion Aco China Payment Service provision (design) Country B Bco
2018/9/18 Aco China Payment Service provision (design) Country B Bco Background: Bco , a resident company of Country B, provides the design service to Aco, a resident enterprise in China. Will the income derived by Bco subject to China’s EIT? If so, discuss the relevant tax issues that Bco shall consider. (Hint: what determines the source of income, the type of income, the rate, the assessment mode， etc. ? Dr. Du Li Department of Public Economics,Fudan University

Withholding Tax under Tax Treaties
The rate may be lower than the standard rate. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced WHT Rate for Dividends under Treaties
Country(region) rate Minimum capital Luxembourg, Korea, Ukraine，Armenia，Iceland, Lithuania, Latvia, Estonia, Moldova, Cuba, Ireland, HK, Singapore, Greece, Algeria, Trinidad and Tobago, Finland, Malta, Syria, Czech, Tajikistan, Turkmenistan, Kuwait* 5% 25% Austria 7% Mongolia, Mauritius, Slovenia, Jamaica, Yugoslavia, Sudan, Laos, South Africa, Croatia, Macedonia, Seychelles, Barbados, Amen, Bahrain, Saudi Arabia*, Brunei, Mexico, Ethiopia, Zambia no Venezuela 10% Egypt, Tunis 8% No The United Arab Emirates* Nigeria 7.5% Georgia 50% or €2million 10% or 0.1million * For companies invested by the government, the rate may be reduced to 0. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced WHT Rate for Interest under Treaties
Country(region) rate note Kuwait, 5% no restrictions Venezuela Only applies to banks Singapore, Isreal 7% Only applies to banks and financial institutions Macao In protocol and memorandum Austria In protocol, Only applies to banks and financial institutions HK, Algeria, The United Arab Emirates ,Ethiopia Jamaica, Cuba, Nigeria, Czech 7.5% Tajikistan 8% * For companies invested by the government, the rate may be reduced to 0. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced WHT Rate for Royalties under Treaties
Country(region) rate Cuba, Georgia, Zambia, Ethiopia, Tunis* 5% HK, Romania, Bulgaria* 7% Nigeria 7.5% Egypt, Tajikistan 8% * For companies invested by the government, the rate may be reduced to 0. Applied to specified items Treaties with some countries such as the US, Germany, France, the UK, etc. provide that only 60% or 70% of the royalties shall be included in the tax base. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Dr. Du Li Department of Public Economics,Fudan University
Case: Treaty Shopping HK has double taxation arrangement with China, while Bermuda not. China Aco Cco makes loan to Aco but does not receive the interest directly. Interest received by Bco from Aco can enjoy lower WHT rate because of the DTA entered into by China and HK. So Cco may set up a Bco and let Bco receive the interest directly. HK Bco Interest loan Bermuda Cco 2018/9/18 Dr. Du Li Department of Public Economics,Fudan University

Anti- treaty Shopping But China will deny the application of reduced WHT rate if Bco is not the beneficial owner of the interest. （ Circular [2009] No. 601 ） Announcement [2012] No. 30 provides a safe harbor rule: if an applicant is a listed company or 100% directly or indirectly owned by a listed company located in the same country / region, the applicant shall be qualified as the “beneficial owner”. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Sparing Credit Owing to unilateral tax incentives offered to foreign investors, China has persuaded most of its treaty partners( apart from the United States) to include "tax sparing credit" clauses in the treaties to make the tax incentives beneficial to the investors. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Sparing Credit Tax sparing credit is a credit granted by the residence country for foreign taxes that for some reason were not actually paid but would have been paid under the source country’s normal tax rules. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

FTC with and without Sparing
with sparing without sparing Foreign tax actually paid Foreign tax reduction FTC limit Deemed foreign tax paid Actual FTC 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Enterprise Income Tax Determination of the tax liability International aspects Anti-avoidance rules Tax incentives 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Anti-avoidance Rules 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Anti-Avoidance Rules General anti-avoidance rules (GAAR) Transfer pricing rules Thin capitalization rules Controlled foreign company rules China introduced a series of anti-avoidance rules in the new enterprise income tax law in a special section called special tax adjustment. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

General Anti-avoidance Rules (GAAR)
The tax authority is authorized to make adjustments to arrangements that can result in a reduction of tax payable and are made without any justifiable business reason. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Discussion： Singapore case
Bco in China is wholly owned by Aco in Singapore. Aco in Singapore is wholly owned by Dco in Singapore. Dco transfer the equity of Aco to Cco in China. Will the capital gains earned by Dco subject to China’s Enterprise Income Tax? Dr.DU Li, Department of Public Economics, Fudan University 12:54:56

Discussion： Singapore case
Transfer of Shares of A Cco Dco Bco holding holding Equity investment Aco China Singapore

Transfer Pricing Rules
Enterprises are required to conduct business transactions with their related companies at arm's length. The tax authorities are empowered to make reasonable adjustments if such transactions are not conducted at arm's length and the amount of tax payable in China is reduced as a result. Advance pricing agreements are possible. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Transfer Pricing: Why Can It Reduce the Tax Burden?
Price:? Related Pco Sco Cost:80 Price:140 Unrelated Price:100 Cco A country: CIT rate 40% B country: CIT rate 30% Here Pco and Sco are related parties, the price of transactions between them is called transfer price. Suppose Pco is to sell some goods to Sco. Here fair market price should be 100,since Pco sell the same goods at 100 to unrelated Cco. But if P sells goods to Sco at price of 100,the total tax burden is : (100-80)×40%+( )×30%=8+12=20 If P sells goods to Sco at price of 90,the total tax burden is : (90-80) ×40%+(140-90)×30%=4+15=19 Since Pco and Sco are related parties, they can freely (if there are no anti-avoidance rules) set the price to maximize the after-tax profit of the group as a whole. So P may sell the goods to Sco at 90 to lower the total tax burden. Then A country will suffer loss of tax revenue .That is why transfer pricing rules are adopted. If P sells goods to Sco at price of 100,the total tax burden? If P sells goods to Sco at 90,the total tax burden? 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Criteria for Identifying Related Parties
25% of the total share capital of one enterprise is held directly or indirectly by the other; 25% of the total share capital of both enterprises is held directly or indirectly by a third party; a loan granted by one enterprise to the other constitutes 50% of the total assets of that other enterprise, or one enterprise guarantees 10% of the total debts of the other enterprise; more than half of the board members or directors of one enterprise are appointed by the other enterprise, or one executive board member is appointed by the other enterprise; These are criteria to determine whether or not two enterprises are related according to China’s Enterprise Income Tax Law. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Criteria for Identifying Related Parties
the production of one enterprise is only possible if the intellectual property of the other enterprise is used; raw materials and spare parts necessary for production are supplied or controlled by the other enterprise (including pricing and trading conditions); the sale of products (including pricing and trading conditions) is controlled by the other enterprise; or there is indirect but actual control over production and trade based on other related interests (e.g. family ties). 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Methods of Adjustment for Transfer Pricing of Tangible Property
Traditional method(transaction-based) comparable uncontrolled price method resale-minus method cost-plus method Profit-based method profit-split method net profit method The tax law has prescribed the methods that can be adopted by the tax officials to make adjustments for the deemed transfer pricing. Resale-minus method can be used only when products are not substantially changed by processing. And profits to be earned by the reseller must be determined reasonably. If possible ,the tax authority should choose the first method. That is ,as long as the so-called comparable uncontrolled price can be found, it can be regarded as the fair market price for the related party transactions. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Comparable Uncontrolled Price Method
Arm’s length price determined by the price of similar products set by unrelated parties under similar circumstances Related Aco Bco Unrelated Aco and Bco are related parties. Aco and Dco are unrelated parties. If the transaction made between Aco and Bco and between Cco and Dco are determined to be comparable, the price set by Cco and Dco shall be deemed as the comparable uncontrolled price and then the arm’s length price. Cco Dco Comparable uncontrolled price 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Resale-price Method Arm’s length price determined by subtracting an appropriate margin from the price at which the goods are finally sold to unrelated parties. Related Unrelated Aco Bco Cco Suppose Aco and Bco are related party, Bco and Cco are unrelated party, and Bco resells the goods purchased from Aco to Cco. If the goods are not further processed by Bco, and Bco has not affixed valuable brands to the goods, then the price set by Bco and Cco can be the basis for determining the arm’s length price of the transaction made between Aco and Bco. The arm’s length price shall be the resale price minus a reasonable margin. Resale price -reasonable margin 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Cost-plus Method Arm’s length price determined on basis of the manufacturing and other costs of related sellers. Related Aco Bco If the tax authority cannot find the comparable uncontrolled price for the transaction made between Aco and Bco, and Bco has not resold the goods to a unrelated third party, then the manufacturing costs of Aco can be the basis for determining the arm’s length price for the transaction made between Aco and Bco. The arm’s length price shall be the costs plus a reasonable margin. Costs +reasonable margin 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 1-1 Assume Pco is a corporation in country X.It manufactures chairs in country X at a cost of 40 and sells them to unrelated distributors at 47 each. It also sells nearly identical chairs to Sco,a controlled foreign subsidiary,which resell the chairs to unrelated consumers at 70. How to determine the fair market price? 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 1-1 70 Bco Related Sco Unrelated Pco 47 Unrelated Dco 47 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 1-2 Assume Sco in the previous example only resells the chairs in a foreign market at 70 each and export distributor generally earn commissions of 20% . How to determine the fair market price? 70-70*20%=56 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 1-2 70 Related Bco Sco Unrelated Pco General commission: 20% 70-70*0.2=56 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 1-3 Assume in the previous example we only know the average costs of a chair is 40 and the common practice in chair industry is to obtain a gross profit of 20% of costs. The fair market price? 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 1-3 Related Sco Pco Cost:40 40+40*20%=48 Common gross profit: 20% of costs 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Profit-split Method Under this method, worldwide taxable income of related parties engaging in a common line of business is computed. The taxable income is then allocated among the related parties in proportion to the contribution they are considered to have made in earning the income. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 2 Pco and Sco are related companies engaged in the production and sale of cosmetics.Pco is reponsible for research and production and Sco reponsible for repackage and attaching its valuable brand. Assume Pco ‘ s cost is 300，Sco’s cost is 100,the aggregate sales by Sco to unrelated customers is 600.So the net profit of the group is 200.Meanwhile ,contribution of Pco to the enterprise accounts for 75% of the total net profit. The fair market price for the related transaction? 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 2 repackage and sell brand valuable research and production Price:? Pco Sco Related Cost:300 Cost:100 Price:600 Unrelated Dco Contribution of Pco : 75% of total net profit Profit of the group: =200, Pco’s profit=200×75%=150, fair market price: =450 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Comparable Profit Method
An arm’s length profits on a set of transactions should be established based on range of profits. If the related party’s reported profits on those transactions fall outside that range, the tax authority may make transfer pricing adjustments so that the profits fall within the range. The arm’s length range of profits shall be determined by referring to the ratio of profits to such indicators as gross receipts, total assets or capital of unrelated parties engaged in similar business. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 3 Assume Tco is engaged in business activities similar in complexity and character to the activities of Aco and Bco, which are corporations unrelated to Tco and to one another. Aco and Bco have ratios of profits to gross receipts of 20% and 30% respectively. Tco has gross receipts of How to determine Tco’s fair market profit range? 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Case 3 Unrelated Aco Bco Unrelated Unrelated Tco Ratio of operating profits to gross receipts: Aco:20% Bco:30% Tco’s gross receipts : Fair market profit range: ~ (= × 20%) (= × 30%) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Transfer Pricing Adjustment for Intangibles and Services
Methods are not as well-designed as for the tangible goods. Adjustments are generally based on market rates, or amounts charged by or agreed between unrelated parties, or made using Cost-plus method. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Thin Capitalisation Rules
Thin capitalization rules denies deduction of certain interest expenses Denies interest on excessive amount of debt according to a maximum debt-equity ratio (5:1 or 2:1) 5:1 is for financial companies,2:1 otherwise. Standard ratio is set by the circular Caishui[2008]No.121. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

What is Thin Capitalization?
A company is thinly capitalized if it is mainly funded by debt finance. Debt financing Assets 1,000 loan Capital Total 1,000 Equity financing Assets 1,000 Capital 1,000 In the equity finance scenario, the debt-equity ratio is 0:1000=0. But in the debt finance scenario, the debt-equity ratio is raised to 999:1=999. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Why Thin Capitalization?
Debt financing Interest payment deductible One level of tax Loans can be repaid easily Equity financing Not deductible Possible double taxation on dividends Capital repatriation could be difficult The debt financing can bring lower tax burden and easier transfer of money, so it is frequently used by the investors and causes thin capitalization problem. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Burden under Debt and Equity Financing
Debt Equity Income before tax Interest expense (999*10%) 100 Taxable income EIT 25% 25 Dividends paid 75 WHT on interest, 10% 10 WHT on dividends, 10% 7.5 Total foreign tax paid 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Determination of the Non-deductible Interests
Equity Debt Debt:Equity Total interests(rate:5%) Non-deductible interests Deductible interests I 200 II 100 1：1 5 III 50 150 3：1 7.5 2.5 Scenario III: Non-deductible interests=7.5× [1-(2:1)/(3:1)]=2.5 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Controlled Foreign Corporation ：the Practice for Tax Avoidance
The offshore companies are used to accumulate income and defer distributions to delay payment of home country tax because dividends are usually taxed when received CIT rate: 40% HOLDCO Holdco transfers money to OPCO OPCO CIT rate: 0% OPCO does not pay tax In this case, OPCO is wholly owned by HOLDCO. HOLDCO transfer profits to OPCO through some arrangements. OPCO need not pay tax since it is located in a low-tax jurisdiction. And as long as OPCO doesn’t distribute dividends to HOLDCO, if there is no CFC rule in the home country, HOLDCO need not pay tax to its home country for the profits retained in OPCO. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Controlled Foreign Corporation Rule (“CFC Rule”)
A portion of income from an foreign controlled enterprise must be included in the taxable income of the resident enterprise controlling the first enterprise if the foreign enterprise is established in a jurisdiction where the tax burden is obviously lower than 50% of the standard rate of 25%, i.e. 12.5%, and if the foreign enterprise does not distribute or insufficiently distributes its profits without justifiable operational reasons. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Key Points of CFC Rule CFC are foreign company or China’s non-resident tax payer. CFC are controlled by China’s resident tax payer. CFC are located in low-tax countries If not for CFC rules, the foreign company’s shareholders need not pay tax for the foreign company’s income even though certain share of the foreign company’s income can be attributed to them as long as they do not receive the income as dividend. BUT CFC’s shareholder must pay tax for their share of CFC income . 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

How to Define “Low-tax Countries”?
CIT rate lower than 12.5%. A white list is provided: US.UK.France.Germany,Japan,Italy,Canada,Australia,India,South Africa,New Zealand,Norway 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

How to Identify Company as CFC?
Definition Non-resident Corporations Controlled by domestic shareholders or in which domestic shareholders have a substantial interest or control Control more than 50% of shares held by Chinese shareholders who hold more than 10% votes each. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

How to Define ”Control”?
more than 50% of shares held by Chinese shareholders who hold more than 10% votes each. Aco in BVI Is Aco a CFC? 30% 40% 9% 11% 10% foreign shareholder China shareholders 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

How to Define ”Control”?
more than 50% of shares held by Chinese shareholders who hold more than 10% votes each. Is Bco a CFC? Bco in BVI 40% 40% 9% 5% 6% foreign shareholder China shareholders 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Enterprise Income Tax Determination of the tax liability International aspects Anti-avoidance rules Tax incentives Now let’s discuss the tax incentives provided by the new enterprise income tax law. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax incentives Before the introduction of the new enterprise income tax law, the former domestic enterprise income tax law and the foreign enterprise income tax law both provided various tax incentives. But generally speaking, foreign enterprises and foreign invested enterprises could enjoy more favorable tax incentives. These were just part of the measures taken by Chinese government to attract more FDI. During the early stages of China’s opening-up, China did not have sound infrastructure and investment environment, and foreign investment was allowed in quite limited area and industries. So the favorable tax treatment was kind of compensation for that. But sure, more favorable tax treatment for foreign invested enterprises meant disadvantageous competition conditions for domestic enterprises. It would certainly cause more and more complaints from domestic enterprises. It is also contrary to the tax theory that says tax burden should be fairly distributed among taxpayers and taxation should not cause much distortion of private sector behaviors. So in 2008, China introduced new enterprise income tax law which unified the former two parallel domestic and foreign enterprise income tax system and at the same tax unified the tax incentives applied to domestic and foreign enterprises. So at present, most tax incentives are industry or region –oriented regardless of the nationality of the investors. Provided that an enterprise meet the relevant requirements , it can enjoy the tax incentive no matter what nationality are the investors. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Summary of Different Kinds of Incentives
Tax exemption and reduction (tax holiday) Reduced tax rate Extra deduction Reduced taxable income Investment tax deduction Investment tax credit Accelerated depreciation The tax incentives provided by China’s Enterprise Income Tax Law can be divided into 7 categories. We will use an numerical example to analyze the differences of them. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: without Incentive
Gross income 100 deductions 70 net income 30 Rate() 25% This slide shows the basic process to calculate the EIT tax payable when there is no tax incentive. Tax payable 7.5 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example : Exemption Gross income 100 100 deductions 70 70 net income 30 Rate() 25% 25% If there is tax exemption, then simply the taxable income is zero.And tax payable is zero. Tax exemption is called tax holiday when the exemption is granted only for some time period. Tax payable 7.5 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example : Reduction Gross income 100 100 deductions 70 70 net income 30 30 Rate() 25% 20% Tax reduction usually means tax rate is reduced to a lower level compared with the standard rate or statutory rate. In this case, the rate is reduced to 20%,and tax payable is reduced after that. Tax payable 7.5 6 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example : Extra Deduction
Gross income 100 100 deductions 70 140 net income 30 -40 Rate() 25% 25% Extra deduction is also called additional deduction. That means the deductible amount exceeds the amount of costs and expenses actually paid. In this case, according to taxpayer’s accounting records, if there is no tax incentive, the deduction should be 70. But the tax law may allow the taxpayer to claim higher deduction, say 140,this means the government will subsidise the taxpayer. Tax payable 7.5 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example : Reduced Taxable Income
Gross income 100 70 deductions 70 70 net income 30 Rate() 25% 25% Reduced taxable income means the government allow the taxpayer to claim lower gross income when preparing tax return. Tax payable 7.5 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example : Investment Deduction
Gross income 100 100 deductions 70 70 Investment deduction 5 net income 25 30 25% Rate() 25% This means the government allow additional deduction associated with qualified investmment. Tax payable 7.5 6.25 Assume investment value is 50, and investment deduction rate is 10% 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example : Investment Credit
Assume investment value is 50,and investment credit rate is 10% Gross income 100 100 deductions 70 70 net income 30 30 Rate() 25% 25% This means the taxpayer can claim certain amount of deduction from tax payable associated with qualified investment. In this case ,the credit is 10% of investment. Tax payable 7.5 7.5 5 Investment credit Tax liability 2.5 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

The rules of tax incentives
Now we have finished discussing the forms of tax incentives in China . Maybe you will ask, why the forms of tax incentives seem so complicated. Why not just use tax exemption or reduction? Actually different kinds of tax incentive may have different impacts on the behavior of taxpayers. The government adopt kind of mix of different tax incentives just to better achieve its different objects. In addition, the government must consider the feasibility of the particular rules. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Exemption for Listed Income
The following income of an enterprise is exempt from enterprise income tax: interest on state bonds; dividends, profits and other investment income distributed between qualified resident enterprises; dividends, profits and other investment income received by a foreign enterprises with an establishment or site in China and such income is actually connected with establishment or site ; and income from a qualified non-profit organization. The second and the third items are to avoid double taxation .The fourth item is to encourage and support the development of non-profit organizations . Since non-profit organizations usually do some work which should be the obligation of the government. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Not Actually Connected Dividend
dividends Bco investment Aco Aco ‘s Chinese branch Whether of not income received by a foreign enterprises actually connected with its establishment ? In this case, Aco directly made the investment, the dividend received by Aco is not actually connected with the establishment (the branch). China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Actually Connected Dividend
Bco dividends investment Aco Aco ‘s Chinese branch Whether of not income received by a foreign enterprises actually connected with its establishment ? In this case, Aco made the investment through the establishment (the branch),the dividend received by Aco is actually connected with the establishment (the branch). China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Exemption for Listed Industries
Income derived from the following industries exempt Growing of vegetables, grains, tuber crops, oil plants, beans, cotton, hemps, sugar crops, fruits and nuts Selection and cultivation of new agricultural species Growing of Chinese medicinal herbs Cultivation and growing of forests Rearing of livestock and poultry Harvesting of forestry products Fishing in high seas …… Most of these items are related to agricultural industry. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduction for Listed Industries
Rate reduced by 50% for Income derived from the following projects Growing of flowers, tea plants and other crops used for beverages and spices; Sea and inland water aquaculture 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Exemption/ Reduction for Technology Transfer Income
Within a single tax year, income from technology transfer that does not exceed RMB 5 million shall be exempt from EIT; the portion that exceeds RMB 5 million shall enjoy a 50% reduction 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Three- Year Exemption/Three- Year 50% Reduction for Listed Projects
projects engaged in key public infrastructure supported by the state; qualified projects engaged in environmental protection, energy or water saving 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Two- Year Exemption/Three- Year 50% Reduction for Hi-tech Enterprises In Sezs High-tech enterprises incorporated after January and within the five Special Economic Zones (Shenzhen, Zhuhai, Shantou, Xiamen and Hainan Provinces) and the Shanghai Pudong New District, may enjoy a two-year tax holiday and a reduced EIT rate of 12.5% for the three years following. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Temporary Exemption for Investment Funds
The following income of investment funds temporarily exempt from enterprise income tax: income derived by an investment fund from stock market transactions (including share and bond transactions), dividends, profits, interest on debt certificates and other income; distributions received by investors of investment funds; and price differences earned by funds on share transactions and bonds. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced Rate : 15% for Hi-tech Enterprises
registered in China and owned the core proprietary intellectual property in the last 3 years or granted the only use right in the last 5 years; products (services) fall within the scope of the "High-New Technology Areas Supported by the State"; R&D expenses amount to at least 6% of if the annual sales are less than CNY 50 million, 4% if the annual sales are between CNY 50 and 200 million, and 3% if the annual sales are more than CNY 200 million; sales of high-new technology products (services) must account for 60% of the total turnover of the enterprise; number of technicians involved in research and development activities must comprise more than 10% of the total number of employees and at least 30% of the total employees must possess a university degree; and …… 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced Rate: 15% for Enterprises in Western Region
For enterprises located in the western region with 70% of the business encouraged by the state. Rate reduced to 15% 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced Rate: 10% for Qualified Thin-profit enterprises
If annual taxable income is less than: RMB30,000 from Jan. 1,2010 to Dec. 31,2010 (Circular caishui[2009]133) RMB30,000 from Jan. 1,2011 to Dec. 31,2011 (Circular caishui[2011]4) RMB60,000 from Jan. 1,2012 to Dec. 31,2015 (Circular caishui[2011]117) RMB100,000 from Jan. 1,2014 to Dec. 31,2016 (Circular caishui[2014]34) RMB200,000 from Jan. 1,2015 to Dec. 31,2017 (Circular caishui[2015]34) RMB300,000 from Oct. 1,2015 to Dec. 31,2017 (Circular caishui[2015]99) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Accelerated Depreciation for Listed FAs
Fixed assets for which the depreciation period may be shortened or an accelerated depreciation method may be adopted includes: (1)Fixed assets that are upgraded and replaced frequently due to advancement in technologies; (2)Fixed assets that are exposed to constantly high level of vibration or corrosion (3)Fixed assets for the encouraged industries: pharmaceutical manufacturing special equipment manufacturing transportation equipment manufacturing electronic manufacturing measuring instrument manufacturing information transmission, software and information technology light, textile, machinery and car industries 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Original Specified Depreciation Periods
20 years for buildings and structures; 10 years for aircrafts, trains, vessels, machinery, mechanical equipment and other production equipment; 5 years for appliances, tools and furniture used for production and business operations; 4 years for transportation means other than aircrafts, trains and vessels; and 3 years for electronic equipment. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Accelerated Depreciation for Listed FAs
Shortened depreciation period 60% of the originally specified depreciation period or longer Accelerated depreciation method Double declining balance method Total number of years method One-off deduction The cost of apparatus or equipment purchased by small and low-profit enterprises engaged in the above encouraged industries, provided that the value of such apparatus or equipment does not exceed CNY 1 million and is purchased after 1 January 2015 for the purposes of research and development and business operations. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example for Accelerated Depreciation
Assumptions: original value RMB1000，specified useful life 5 years，estimated salvage value RMB100 Depreciation under straight line method: 1st to 5th year : ( )/5=180 Depreciation under double declining balance method: 1st year: original value×2/useful life =1000×2/5=400 2nd year: (original value - depreciated value) ×2/useful life =( ) ×2/5=240 3rd year: (original value - depreciated value) ×2/useful life =( ) ×2/5=144 4th year and 5th year: (original value - depreciated value –salvage value) /2=( ) /2=58 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example for Accelerated Depreciation
Assumptions: original value RMB1000，specified useful life 5 years，estimated salvage value RMB100 Depreciation under straight line method: 1st to 5th year : ( )/5=180 Depreciation under total number of years method: Total number of years= =15 Depreciable value=original value -salvage value= =900 1st year: 900×5/15=300 2nd year: 900 ×4/15=240 3rd year: 900 ×3/15=180 4th year: 900 ×2/15=120 5th year: 900 ×1/15=60 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Extra Deduction for R&D Expenses
R&D expenses for new technology,new products,new craftsmanship 150% of the expenses deductible 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Reduced Taxable Income for Listed Products
For products manufactured with comprehensive resources : Only 90% of income is included in total income 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax deduction for Qualified VC Investments
VC enterprise investing in a non-listed small to medium-size high/new technology enterprise for more than 2 years : up to 70% of its investment deductible from the taxable income. Unused allowance can be carried over to the following years. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Credit Qualified Equipment Investments
For investments in equipment used for environmental protection, energy efficiency, water conservation and safety of production 10% of investment creditable against tax liability. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

INDIVIDUAL INCOME TAX 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

General features of China’s IIT system

General Features of China’s IIT System
Individual income tax applies to both Chinese residents and non-residents. Gross income is divided into 11 categories and subject to different taxation basis, rates and deduction rules. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

11 Categories of Gross Taxable Income
wages and salaries income of individual business households from production of business operation income from contracting or leasing operation of enterprises or institutions remuneration for personal services remuneration for manuscripts royalties interest, dividends or bonuses income from lease of property income from transfer of property contingent income other income 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

General Tax Exemption Various monetary awards; Subsidies and allowances paid in accordance with uniform state stipulations; Welfare benefits, pensions for the disabled and for survivors and relief payments; Income from certain services rendered by redundant employees, subject to conditions; Lump-sum payment on dismissal of employment, subject to conditions; Family allowances, job discharge fees, retirement wages and supplementary retirement fees paid to cadres and workers in accordance with uniform state stipulations; Income exempted from tax as stipulated in international conventions Interest on government bonds; Other income approved for tax exemption by the MOF. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

General Tax Reduction Income of the handicapped, elderly and members of revolutionary martyrs' families; Heavy losses incurred due to severe natural disasters; and Other tax reductions approved by MOF. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

WHT Rate Under Tax Treaties
For eligible non-resident taxpayers, the withholding tax rate for interests, dividends or royalties may be lower than the standard rate. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Report and Assessment
Most items of income are subject to withholding tax and withholding agents are required to file returns on a monthly basis. Where no withholding is required or there is no withholding agents, a taxpayer must pay the tax and file a monthly return within 15 days after the month of payment. Taxpayers who earn income outside China are obliged to file a tax return within 30 days after the end of each year. Taxpayers whose total taxable income amounts to more than CNY 120,000 a year are required to make a self-assessment and file the tax return after the tax year. Each individual is considered to be a separate taxable person, and there is no aggregation of income or joint taxation of spouses. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Calculation of IIT payable for international taxpayers

Steps for Calculation of IIT Payable
Gross taxable income Step 1： Subtract : Exemptions and Deductions Step 2： Net taxable income Apply : Rate schedule Step 3： Gross tax payable Subtract: Credits Step 4： Net tax payable 12:54:56 204 Dr.DU Li,Depertment of Pulbic Economics,Fudan University 204

Category 1:Wage and Salary Income
Wage and salary income is the main source of IIT revenue. And for international taxpayers, to determine the IIT payable for the income of this category is the most important, because at each step, there are some special and rather complicated rules.

Step I: How to determine the gross taxable income?

Resident vs. non-resident taxpayers
According to China IIT law, resident taxpayers should be subject to China IIT on worldwide income and non-resident taxpayers on China-source income. In order to determine the gross income subject to IIT ,we first need to determine the residence status of the taxpayers. 12:54:56 Dr.DU Li,Depertment of Public Economics,Fudan University

The Definition of Tax Resident
Individuals who have a domicile in China are tax residents in China. “individuals having a domicile” in China means those who maintain a place of residence in China because of their legal residence status, family, or economic ties. And individuals who have lived in China for at least one year are tax residents in China. In computing length of stay, temporary leaves can not be deducted if time for each leave is less than 30 days or the accumulative leave time is less than 90 days, and arrival day and departure day should both be included. (single leave for more than 30 days will not be regarded as temporary leave) In practice, for foreigners, having domicile means having the permanent residence permit. For Chinese citizens, having domicile in China means the person has to come back to China after going abroad for some time period for the purpose of education, visiting, work, etc.. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Computing of the Length of Stay
Case 1: Arrival date: May 7 Departure date: May 9 Length of stay in China ? Case 2: Departure date: June 7 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example British citizen professor Henry will come to China to teach in a university for one year. He plans to leave China twice for business trip and vocation for 15 days and 30 days respectively. Shall Henry be regarded Chinese resident? With each leave less than 30 days and the accumulative leave time less than 90 days, the two leaves will be regarded as temporary absence and the leave time will not be deductible when computing the length of stay in China. Henry will be regarded as a resident taxpayer in China. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Determination of China-source Income
The following income should be regarded as China-source income wherever the payment is made: Income earned by an individual from a position, employment or fulfillment of contract within china; Income derived from the leasing of property for use in china; Income derived from the transfer of buildings, land-use rights or alienation of other property within china; Income derived from royalties on technology used within china; and Interest, dividends and bonuses obtained from companies, enterprises, other economic entities and individuals located in china. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Taxable Income for Individuals without Domicile in China in Practice
1) Non-residents :only China-source income taxable in principle. However, for individuals without domicile who travel in China and derive income from an overseas employer with no permanent establishment in China: tax exempt if they physically stay in China, consecutively or cumulatively, for less than 90 days in a calendar year. 2) For individuals without domicile residing in China for 1-5 years : worldwide income taxable in principle However, upon approval from the tax authorities, the taxation of foreign-source income can be limited to that received from Chinese enterprises, Chinese establishments, Chinese organizations, and Chinese individuals. 3) For individuals without domicile who reside in China for more than 5 consecutive years : worldwide income taxable from the 6th year onward. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Summary of the Taxable Income for Individuals without Domicile in China
Stay duration China-source income Foreign-source income Paid by Chinese entities Paid by foreign entities 0- 90 days taxable exempt days 1-5years > 5years 90days will be changed to183days with treaties. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

“Chinese entities” Chinese enterprises(resident enterprises): Enterprises registered under Chinese law or having effective management in China Chinese establishments Establishments of Chinese non-resident enterprises such as branches, representative offices, etc. Chinese organizations Chinese individuals 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: China-source Income Paid by Chinese Entities
TOM Salary Work IBM IBM ‘s China branch In this case, Tom is sent by IBM to work in the IBM Shanghai branch and gets salary income from the Shanghai branch. The income shall be regarded as sourced in China since Tom get the salary for a position within China. Meanwhile, the salary shall be regarded as paid by Chinese entity. “Branch” is a typical form of establishment of non-resident enterprise. China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: China-source Income Paid by Chinese Entities
TOM Salary Work IBM IBM ‘s China subsidiary In this case, Tom is sent by IBM to work in the IBM Shanghai subsidiary and gets salary income from the Shanghai subsidiary. The income shall be regarded as sourced in China since Tom get the salary for a position within China. Meanwhile, the salary shall be regarded as paid by Chinese entity. The Subsidiary shall be a Chinese resident enterprise. China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: China-source Income Paid by Foreign Entities
TOM Salary Work IBM IBM ‘s Chinese branch In this case, Tom is sent by IBM to work in the IBM Shanghai branch and gets salary income from the IBM head office. The income still shall be regarded as sourced in China since Tom get the salary for a position within China. Sure, the salary shall be regarded as paid by foreign entity. China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: Foreign-source Income Paid by Chinese Entities
Tom Salary Work as employee BOC New York branch BOC In this case, Tom works as employee of Bank of China New York branch and gets part of the salary income from the BOC head office. The salary income still shall be regarded as foreign-source income paid by Chinese entity. China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example: Foreign-source Income Paid by Foreign Entities
Tom Work Salary IBM IBM ‘s Chinese branch In this case, Tom works in the IBM head office and gets salary from the IBM head office. The income shall be regarded as foreign- source income paid by foreign entity. China US 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Step 2: how to determine the Net taxable income?

General Deduction Individuals are allowed a standard deduction of RMB3,500 per month from wages and salaries since Sept. 1, 2011. Social insurance expenses deductible Old-age insurance: 8% of wage and salary Medical insurance:2% of wage and salary Unemployment insurance:1%of wage and salary Public housing fund:12%of last year’s average wage 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Special Deduction The deduction standard increased to CNY 4,800 for the following individuals: Foreign employees who work in foreign invested enterprises or foreign enterprises within china; foreign experts who work upon the invitation of the chinese side in enterprises, institutions, social organizations and state organs within china; individuals who are resident in china and obtain wages and salaries from their post or employment outside china; and other persons determined by the ministry of finance. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Additional Allowances for Foreigners Working in China
For foreigners working in China, certain expenses paid directly or reimbursed by the employer are normally not taxed, including: Costs of housing or accommodation Home trip allowance Relocation or moving costs Local transportation Meal and laundry allowances Language training Children education allowance 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Exemption for Foreign Experts
Eligible foreign experts are exempt from paying individual income tax on their wages and salaries, e.g. foreign experts sent by World Bank ,UN and other eligible international organizations. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Step 3: How to determine the gross tax payable?

The Rate Schedule applicable to wages and salaries
Monthly Taxable Income brackets（Yuan) Tax rate % Quick Deduction 1 ≤1500 3 2 ＞1500 and ≤4,500 10 105 ＞ 4,500 and ≤ 9,000 20 555 4 ＞ 9,000 and ≤ 35,000 25 1005 5 ＞ 35,000 and ≤ 55,000 30 2755 6 ＞ 55,000 and ≤ 80,000 35 5505 7 ＞ 80,000 45 13505 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example Chinese resident Mr. Zhang ‘s monthly salary is 6100 yuan, suppose his monthly deductible social insurance expense is 500 yuan . Then the individual income tax payable shall be computed as: Taxable income = =2100 yuan Tax payable = 2100×10%-105= 105 yuan The quick deduction? By definition, the tax payable should be calculated like this: 1500×3%+600×10% =45+60=105 yuan If we apply the marginal tax rate to the overall taxable income, then tax payable=2100×10%=210 yuan Quick deduction is just the difference: =105 yuan ( 1500×7%) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example John is an American working for a foreign enterprise located in China and earns a salary of 50,000 yuan for the position per month. He plans to stay in China for a whole year in 2011 , he does not earn other income except for the salaries. His income tax payable in September,2011 in China should be computed as follows : Monthly income tax payable = (50000 – 4800 ) x 30% =10805 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Liability for Foreigners Holding Posts Both in China and Overseas
Some foreigners are holding concurrent posts both in China and elsewhere. Since the tax liability for salary income from different sources and paid by different entities varies, kind of apportionment of tax liability shall be made. So these taxpayers are subject to IIT based on the number of physical days in China and the total salary from local employment position and from the parent company overseas. 12:54:56 Dr.DU Li, Department of Public Economics, Fudan University

Recall: Summary of the Tax Liability for Individuals Without Domicile in China
Income Stay duration China-source income Foreign-source income Paid by Chinese entities Paid by foreign entities 0- 90 days taxable exempt days 1-5years > 5years 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University 183days under tax treaties

Length of stay: 0-90days (Note: when computing working days in China, both the arrival and departure day will be counted as half a day.) 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example John is an American working for a US company. He was sent to work in Shanghai branch from May 15 to June 30 in In May, the Shanghai branch paid him RMB And the US headquarter office pays him a salary equivalent to RMB30,000 per month. His income tax payable in May,2012 in China should be computed as follows: Tax payable =[( – 4800) x 30% ] x 16.5/31 x 20000/50000 =…… 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Length of stay: days 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example John is an American working for a US company. He was sent to work in Shanghai branch from May 15 to December 31 in 2012 In May, the Shanghai branch paid him RMB And the US headquarter office pays him a salary equivalent to RMB30,000 per month. His income tax payable in May ,2012 in China should be computed as follows: Tax payable = [( – 4800 ) x 30% ] x 16.5/31 =…… 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Length of stay: 1-5years 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Example John is an American working for a US company. He was sent to work in Shanghai branch from May in 2008 to December 31 in In May 2009,he left China for 16 days for business in HK. The Shanghai branch pays him RMB20000 monthly as salary . And the US Headquarter office pays him a salary equivalent to RMB30,000 per month. His income tax payable in May ,2012 in China should be computed as follows: Tax payable =[( – 4800 ) x 30% ] x[1-16/31 x 30000/50000] =…… 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Length of stay: more than 5years 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Special Rules for Directors and Senior Managers
Length of stay of directors and senior managers should be determined by the term of the post instead of the actual time of presence in China. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

New formula for directors and senior managers introduced Aug. 2007 When length of stay less than 90(183)days

New formula for directors and senior managers introduced Aug. 2007 When length of stay less than 90(183)days-5years

Summary for the Rules after Aug.2007
Non-CEO 0- 90 days days 1-5years > 5years CEO 91days-5years

Step 4: How to determine the net tax payable?

Foreign Tax Credit Tax credit is granted for foreign tax paid on foreign income to alleviate international double taxation. The amount of credit is limited to the amount of Chinese tax otherwise payable on the foreign income. A country-by-country limitation applies, in that the credit for foreign tax paid on income from all sources in one country is limited to the amount of Chinese tax that would have been payable on the income from the same country. Excess foreign tax paid can be carried forward for 5 years. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Category 2 and 3:business income

IIT for Business Income
Business income include: income of individual business households from production or business operation income from contracting or leasing operation of enterprises and institutions 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

IIT for Business income
Deduction Business expenses +standard deduction of RMB3,500 per month Wages or salaries paid to the employees deductible. But salaries paid to the taxpayer himself not deductible. 5-bracket progressive rates Annual taxable income= (gross income– expenses) -3500yuan x 12 Annual income tax payable = Annual taxable income x Applicable rate – Quick deduction Taxable income calculated and taxed on annual basis 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Rate Schedule Applicable to business income
Annual Taxable Income Brackets(Yuan) Tax Rate (%) Quick deduction 1 ≤ 15000 5 2 ＞ and ≤ 30000 10 750 3 ＞ and ≤ 60000 20 3750 4 ＞ and ≤ 30 9750 ＞ 35 14750 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

IIT for Business Income
Mr. Li opens a restaurant. He employs his wife and 6 other employees. He earned 600,000 yuan from business operation in The annual costs and expenses include: Raw materials Wages paid to employees including his wife Mr. Li’s salary Other expenses Total deduction: x 12= The income tax payable in 2012 should be computed as follows: Taxable income = 600, ,000 = 82,000 yuan Income Tax payable =82000x30% = yuan 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Partnership and Partners’ Tax
Partnership (and proprietorship) shall not be subject to EIT. The profits of partnership (and proprietorship) shall be attributed to the investors and subject to IIT or EIT according to the legal status of the investors. The income attributed to individual investors shall be subject to IIT in the same way as business income. Partne 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Partnership and Partners’ Tax
Assume corporate income tax rate is 25% and Individual tax rate of 35%. Partnership earned 1,000,000 in 2013 and distributed 500,000 to be shared among the partners. Compute the following: Partnership tax =? 0 Mr. A’s tax =? 1,000,000×40%×35%–14750 Holdco’s tax =? 1,000,000×60%×25% Holdco Mr. A 60% 40% Partnership Partne Net income 1,000,000 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Discussion: Income Tax for Alternative Business Forms
12:54:56 Discussion: Income Tax for Alternative Business Forms Mr. A plans to run a shop. He can register his business as a one-person company or a proprietorship enterprise. Suppose his annual net profits will be 1 million yuan. Based on Chinese tax rules and other relevant knowledge , please try to make the choice for Mr. A. Individual Individual OPCO Business In order to protect tax base, many countries levy EIT in addition to IIT. This will give rise to double taxation. What is the specific effect in China? How shall the taxpayers respond to that problem? Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Category 4: remuneration for personal services

IIT for Remuneration for Personal Services
“Remuneration for personal services" refers to income received for providing specified services such as : Designing, decorating, installation, drafting, testing, medical treatment, law practice, accounting, consulting, lecturing, news reporting, broadcasting, interpretation, editing, calligraphy and painting, sculpture, cinema, audio recording, video recording, performance, advertising, exhibitions, technical services, intermediary services, agency, brokerage and other services. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Taxed on per payment basis Deduction from the gross income: -CNY 800 for a single payment of less than CNY 4,000 - 20% of the payment for a single payment of CNY 4,000 or more. Rate: flat rate of 20% But due to the additional taxation, the effective tax rate is progressive. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Tax Rate Schedule applicable to “remuneration for personal services”
Taxable income brackets(yuan) Tax rate % Quick deduction 1 ≤ 20000 20 2 ＞ and ≤ 50000 30 2000 3 ＞ 50000 40 7000 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

An actor received 60,000 yuan for a performance. The income tax payable is calculated as follows: Taxable income = 60,000 – 60,000 x 20% = 48,000 yuan Income tax payable = 48,000 x 30 %– 2000= yuan 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Category 5: royalties

IIT for Royalties Taxed on per payment basis Deduction from the gross income: -CNY 800 for a single payment of less than CNY 4,000 - 20% of the payment for a single payment of CNY 4,000 or more. Rate: flat rate of 20% 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

IIT for Royalties A professor transferred one of his patents to a company and received 50,000 yuan. Here the income tax payable is calculated as follows: Taxable income = 50,000 – 50,000 x 20% = 40,000 yuan Individual Income tax payable = x 20% = 8000 yuan 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Category 6: income from lease of property

IIT for Income from Lease of Property
Taxed on monthly basis Deduction from the gross income: CNY 800 for a single payment of less than CNY 4,000 or 20% of the payment for a single payment of CNY 4,000 or more. Taxes incurred Repairing expenses less than CNY 800 per month Rate: flat rate of 20% 10% for house rents after Jan 1,2001 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

IIT for Income from Lease of Property
A Chinese resident rents out one of his houses to a shop and receives a rent of 6500 yuan per month. The taxes incurred are approximately 400 yuan per month. Repairing expenses deductible are 800 yuan per month. The monthly income tax payable can be computed as: Taxable income = ( )x(1-20%) = 4240 yuan Tax payable = 4240 x 10% = 424yuan 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Category 7: income from transfer of property

IIT for Income from Transfer of Property
Taxed on per payment basis Deduction from the gross income: original value of the capital taxes incurred other reasonable expenses incurred Rate: flat rate of 20% 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

The following exemptions are available : Gains on the sale of shares of Chinese listed enterprises; Income of a foreign national from the transfer of b-shares or overseas shares issued by an enterprise within china; and Certain capital gains on houses, subject to conditions, e.g. Gains on disposal of a house self-occupied for at least 5 years. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

A person sells a house with the original value of 200,000 yuan and receives 400,000 yuan for the sale. The tax paid related to the sale and the expenses are about 80,000 yuan. The income tax payable is computed as follows: Taxable income = 400,000 – 200,000– 80,000= 120,000 yuan Income tax payable = 120,000 x 20% = yuan Business Tax and surcharges *5.5%=22000 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Category 8: interest and dividends

IIT for Interest and Dividends
Resident individuals pay income tax at 20% on dividends received from sources within and outside China. Currently, the income tax on dividends distributed by companies listed on a Chinese stock exchange is reduced by 50%, which results in an effective rate of 10%. Interest is generally taxed at a flat rate of 20%. But interest on savings has been temporarily exempt since Oct. 9,2008. Interest on government bonds is exempt. 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Additional exemptions granted to foreigners: Dividends received by B-share (or H-share) holders Dividends received by FIE shareholders 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

Mr. Li received 6000 yuan as dividends from a company listed in Shanghai Stock Exchange. The income tax payable can be calculated as follows : Income tax payable = 6000 x 20% x 50% = 600 yuan 12:54:56 Dr.DU Li,Depertment of Pulbic Economics,Fudan University

CATEGORY 9: REMUNERATION FOR MANUSCRIPTS

IIT for Remuneration for Manuscripts
Taxed on per payment basis Deduction from the gross income: CNY 800 for a single payment of less than CNY 4,000 20% of the payment for a single payment of CNY 4,000 or more. Rate: flat rate of 20%, with 30% reduction, the effective rate is 14%

Category 10: contingent income

IIT for Contingent Income
Taxed on per payment basis Flat rate of 20% No deduction allowed

Category 11: other income

Taxed on per payment basis Flat rate of 20% No deduction allowed
IIT for Other Income Taxed on per payment basis Flat rate of 20% No deduction allowed

China’s Taxation System and Fiscal Policy

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China’s Taxation System and Fiscal Policy

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