ASSIGMENT OF IP RIGHTS

Non-resident foreign investor receiving income for the Assignment of IP rights in the PRC will be subject to the following type of taxes: -

Type of tax Rate

Income tax 20% on gross sum paid and payable
Business tax 5% on gross sum paid and payable
Stamp tax 0.03% on gross sum paid and payable
Foreign companies and nationals must register their IP rights in accordance with the PRC law in order that these rights are legally protected inside the PRC. Note that under the PRC Trade Mark Law and the PRC Patent Law, agreements for the granting of IP license or the transfer of IP rights shall be registered with the PRC State IP authorities for record filing purposes and notify the public by putting up a public notice in the designated official publications. Otherwise, the agreements are not valid.

Agreements for the transfer of patent application rights or patent rights from PRC legal persons or individuals to foreign nationals and companies must obtain government vetting and approval. Otherwise, the transfer is unlawful.

The 10% withholding income tax shall apply to resident payers located in the Special Economic Zones, coastal Economic Technology Development Zones, and coastal open areas. 20% withholding tax rate shall apply to resident payers in other areas, and residents of a non-PRC treaty country.

Type of tax Rate

Income tax 20% on rental income
Business tax 5% on rental income
City property tax 18% on rental income

The resident tenant has an obligation to withhold taxes upon the payment of rental to the foreign owner. On the other hand, the foreign owner can appoint a domestic tax agent to act for it. The tax agent will apply for a temporary tax registration on behalf of its principle, and obtain the tax invoices at the tax office upon payment of taxes.

Both the foreign owner and the domestic tenant shall also pay stamp tax respectively at a rate of 0.1% on the rental amount. In addition, the tenancy agreement shall be registered at the local administrative organs. Thirdly, the landlord shall ensure that it has got a lease certificate for the rented property.

TRANSFER OF PROPERTY
Non-resident foreign investor receiving consideration for the transfer of landed property located in the PRC will be subject to the following type of taxes: -

Type of tax Rate

Income tax 20% on consideration
Business tax 5% on consideration
Stamp duty 0.05% on consideration
Land value appreciation tax 30% – 60% depending upon the appreciated value
Land value appreciation tax is levied on 4 different brackets of the appreciated value, which is arrived at by reference to the selling price minus the direct cost and the statutory deductions including business and stamp taxes. The income tax rate will be reduced to 10% if the owner is a resident of a PRC treaty country.

The buyer, on the other hand, has to pay a deed tax at the rate of 3% on total consideration irrespective of whether he is a resident or a non-resident.

According to the PRC Income Tax Law for Foreign Investment Enterprise and Foreign Enterprise, its Implementation Regulations, ministerial regulations and rules issued by the State Administration of Taxation, an RO that carries on business activities within the PRC is subject to tax on income derived from sources in the PRC irrespective of whether they are paid by any sources inside the PRC.

In the absence of complete and accurate information relating to the RO’s PRC-source income, the PRC tax authority normally adopts the cost plus method to ascertain the taxable income for practical reasons.

The major category of tax includes business tax and income tax. Business Tax is imposed at a rate of 5% on the total gross amount of monthly overheads incurred by the RO. The business tax is filed at monthly interval. Corporate Income tax is imposed at a rate of 33% on the deemed income. The deemed income is assessed at a rate of 10% on the total gross amount of overheads incurred by the RO during the relevant period. The RO must file income tax at a quarterly interval. For example, if the monthly overhead is RMB80,000, the business tax and income tax will be calculated as follows:-

Gross amount = RMB80,000 / (1-10%-5%) = RMB94,118
Business tax = RMB94118 * 5%
Income tax = RMB 94,118 * 10% (deemed profit) * 33%
The income tax rate of 33% including 3% local income tax will be reduced to 15% if the RO is located within the special economic zones or other designated areas.

The State Administration of Taxation (SAT) lists the following types of taxable activities that a representative office may perform: -

Acting as a merchandise trade agent;
Consulting services relating to business, legal, tax and accounting;
Services performed for a resident fellow subsidiaries of the same non-resident holding company;
Acting as advertising agents;
Providing services relating to visa handling, fee collecting, ticketing, tour operator, and hotel accommodation for non-resident tourist companies;
Consulting services given on behalf of non-resident financial institutions;
Providing services within the business scope of a transport company;
Other taxable activities the RO performs for the clients.
The following activities are not subject to income tax and business tax:-

Resident representative offices performing services of market research, providing business information, liaison, consulting for the non-resident head offices on a free of charge basis;
Resident representative offices taking instructions from resident companies to act for them as agent, and the agency activities are mainly performed outside the PRC.

Business Activities
In defining the business activities, the State Administration of Taxation, the State Administration of Industry and Commerce, and the Ministry of Foreign Trade and Economic Cooperation (The MOFTEC is now called the Ministry of Commerce) have different provisions. The SAT prescribes what constitutes a taxable activity while the SAIC stipulates that the RO should be engaged in non-direct business activities, subject to provisions in the international agreement. (Specifically, the restrictions on income-earning business activities undertaken by RO’s in respect of legal, accounting, taxation, and management consulting are lifted in the WTO agreements China has acceded to.) The MOFTC also provides that the RO’s may only be engaged in non-direct business activities in respect of business liaison, product introduction, market research, and technical exchange on behalf of their heading office.

To determine whether certain activities are taxable, one has to consider the income tax rules rather than the types of activities an RO is allowed to do as stated in the scope of activities in the business licence . If the RO performs those non-direct activities for the client of its non-resident head office or other non-resident foreign companies on a fee basis, then the income derived from those activities is taxable under the PRC income tax rules .

The representative offices that do not carry on business activities or the RO’s that carry on non-taxable activities, can submit applications to the tax authority for the granting of a tax exemption certificate.

The table below may help analyze the issue:

Taxation on Employees
The RO has the legal obligation to deduct from its payroll the income tax and pay them to the local tax office. In addition, the RO and the staff have to bear certain social security contributions respectively including pension fund, hospitalization, unemployment, injury, and birth planning insurances. Please see the Individual Income Tax that follows on the income tax issue for foreign nationals and employees from Hong Kong , Macau and Taiwan .

The PRC Enterprise Income Tax Law (referred to as the “EIT Law” hereafter) and the Implementation Regulations of the PRC Enterprise Income Tax Law (referred to as the Implementation Regulations hereafter) will take effect on January 1, 2008. In accordance with Article 57 of the EIT Law, the State Council gives notice on the issues of grandfathering preferential policies under the EIT Law as below:

1. Provisions relating to grandfathering tax preferential treatment for enterprises of which the incorporation have been approved before the promulgation of the EIT law

The tax preferential policies that enterprises have been enjoying in accordance with the old income tax law, regulations and the documents announced under the legal authority of the State Council shall be grandfathered and implemented in the following way:

As from 1st January 2008, the enterprises that have enjoyed preferential tax rates shall be taxed at rates to be increased from the current rate to the full rate under the EIT law within a period of 5 years. Among others, the enterprises that have been taxed at 15% currently shall be taxed at 18% in 2008, 20% in 2009, 22% in 2002, 24% in 2011 and 25% in 2012; the enterprises that have been taxed at 24% under the old income tax law shall be taxed at 25% as from 2008.

As from 1st January 2008, the enterprises that have been granted “two plus three” and “five plus five” tax concessions shall continue to enjoy the tax concessions until the expiry day in accordance with the tax preferences under the old income tax law, regulations and relevant provisions. Where the tax preferences have not been granted due to the fact that the enterprises have not made any profits, the tax preferential period shall commence as from 2008.

The enterprises, to which the tax preferential policies apply during the transitional period, refer to those enterprises that have obtained the business registrations at the local office of State Administration of Industry and Commerce before 16th March 2007. The scope and items to which the grandfathering preferential policies apply are set out in the “List of Grandfathering Preferential Policies for the Implementation of the PRC EIT Law (See attached list)”.

2. Continuing the tax preferential policies in the grand development of China’s Western region

The tax preferential policies for the grand development of the Western regions shall be continued in accordance with the “Notice of the Issues on Tax Preferential Policies for the Grand Development of Western Regions by the Ministry of Finance, the State Administration of Taxation and the General Administration of Customs” jointly issued under document Cai Shui (2001) 202 by the Ministry of Finance, the State Administration of Taxation and the General Administration of Customs in accordance with the spirit of the State Council documents that implement the grand development of the Western regions.

3. Other Provisions on the Implementation of Grandfathering Tax Preferential Policies for enterprises

The enterprises to which the grandfathering income tax preferential policies apply shall compute the taxable income in accordance with the rules of the EIT Law and the Implementation Regulations, and compute the tax preferences in accordance with part one under this notice.

The enterprises can choose the more favorable preferential policies where the there exist any intersections between the grandfathering preferential policies and the preferential policies as provided under the new EIT Law and Implementation Regulations, except that the enterprises shall not receive duplicate preferences. After the enterprise has made the choice, no change is allowed.

It has been a 13-year journey from the preliminary work in 1994 to the passing of thePRC Enterprise Income Tax Law (referred to as “the EIT Law” hereafter) on 16th March 2007, which marked the completion of the unification of two tax systems for  domestically funded and foreign funded enterprises in China. It is a system innovation in the process of building socialism and a harmonized society within the country. To reap the benefits of the new tax system depends very much on its implementation in an effective manner. A few days ago, the State Council announced the long-awaited  Implementation Regulations of the PRC EIT Law (referred to as “the Implementation Regulations” hereafter), which is to come into play with the implementation of the  EIT Law.

To enable the taxpayers and the tax administrators to better understand and  follow the spirit inside the Implementation Regulations, the reporter interviewed theofficials in charge of the State Administration of Taxation on certain questions about  the Implementation Regulations. The officials in charge made the remarks that the drafting of the Implementation  Regulations followed the principles of legality, practicality, global convergence,conservatism, and easy operability. The drafts have brought the existing tax policyinto the contents of the Implementation Regulations and demonstrated the continuity  of the tax policies, without stepping outside the scope of the EIT Law. The Implementation Regulations give details to the EIT Law taking into account the economic activities and the latest development of the economic systems, and this hasdemonstrated the scientific properties of the current policies. In addition, the drafting  committee borrowed the prevailing international income tax policies and learned from  the experiences of international tax reforms. The Implementation Regulations have  embodied international custom and shows the forward-lookingness of the tax policies.According to the officials in charge, the Implementation Regulations contain 8 chapters with 133 clauses, mainly giving details to the provisions in the EIT Law. The  officials in charge gave detailed elaborations on certain key policies and designs in  the EIT Law.

The definition of actual management organization is to protect tax sovereignty.

To share the international experiences, the EIT Law expressly lays down the legal person income tax system, adopting the defined concept of resident and non-resident   enterprises.

The key to define the taxpayer under the legal person income tax system is the  criteria for resident enterprises and non-resident enterprises. The EIT Law uses the  place of incorporation and actual management organization as the criteria todetermine the resident and non-resident enterprises. It is easier to understand and  apprehend place of incorporation but it is difficult to understand the criteria for placeof actual management. How is the place of actual management determined in theImplementation Regulations and what are the relevant considerations?

The officials in charge made the remarks that from the experiences of international practices in recent decades, the place of actual management is in general the place where the enterprise carries on its daily production and business activities. From a legal perspective, it also includes the place where important business decisions are made. From an administrative perspective, the tax law only lays down the principle or

does not lay down anything, leaving the detailed rules to be developed from decided tax cases. To protect tax sovereignty and the willful tax evasion, the Implementation Regulations have expanded the scope for place of actual management and provide that it is the place where the enterprise exercises actual and overall management and control over its production, staff, books of accounts and assets. That helps the issue of administrative decisions later with reference to the actual situations of the enterprises, better protect the tax sovereignty of our country. Detailed criteria can be developed by issuing ministerial rules from the practices in tax collections and administrations.

Budgeted fiscal appropriation is non-taxable income

The EIT Law introduces the concept of non-taxable income. Fiscal appropriation is one of the three items of non-taxable income. What about the various types of subsidies enterprises receive from local governments at the provincial levels or below? How is it provided under the Implementation Regulations?

The officials in charge remarked that the fiscal appropriation, defined as non-taxable income under the Implementation Regulations, is the funds appropriated to the institutions, social bodies and organizations administered under the budget of the local governments, with the exceptions that the State Council, the Ministry of Finance and the State Administration of Taxation provide otherwise. That in general excludes the subsidies and the rebates of local taxes that the enterprise receives from various local governments, and narrows down the scope for fiscal appropriations as an item of nontaxable income. The main considerations for these are (i) the various types of subsidies that the enterprise receives not only include exemption and reduction of turnover taxes, but also include special subsidies for the enterprises to carry on designated activities, both resulting in the increase in net assets and economic benefits flowing in, thus the imposition of income tax being lawful; (ii) the imposition of income tax on the enterprises that receive subsidies from local governments strength the dministration of tax exemption and reduction since the local governments offer various types of tax exemption and reduction in disguise in luring inbound investments, resulting in the erosion of the tax base at the national level; and (iii) the existing legal rules on accounting for government subsidies classify government subsidies as non-operating revenue. That tax rules should be consistent with the accounting rules on government subsidies.

Deduction of reasonable wages and salaries before tax

The EIT Law unifies the deduction of actual payments for various items of expenses,and provides that enterprises can claim deductions of actual and reasonable cost and expense before tax. The Implementation Regulations make specific provisions for the items to be deducted and the criteria for deduction before taxes.

According to the officials, in respect of deduction of wages and salaries, the Implementation Regulations provide that actual and reasonable wages and salaries can be deducted from income. It means that scrapping the limited deduction of wages and salaries for domestically funded enterprises in the past years relieve them of the tax burden. The amount of deducted wages and salaries must be reasonable. Obviously unreasonable amount is not deductible. To the employees in general, the remunerations that the enterprise pays should be considered to be reasonable. There

may be exceptions. Where the shareholders and their close relatives work as the employees in the company, the payment of excessive wages and salaries is thedistribution of dividends in disguise. Alternatively the wages and salaries of the management working for the state owned enterprises are raised in breach of the rules of the departments for the supervision and administration of state owned assets. All

these complicated cases relating to wages and salaries will erode the tax base of the enterprise income tax. To strengthen the administration over tax bases, the Implementation Regulations add the qualification “reasonable” to wages and salaries.The official revealed that the State Administration of Taxation shall issue the 5 “Administrative Measures for the Deduction of Wages” to clarify what is considered

to be “reasonable” wages and salaries in the Implementation Regulations.

60% of the incurred business entertainment expenses are deductible, not exceeding 0.5% on the sales (business) turnover for current year

The Implementation Regulations provide that 60% of the business entertainment expenses incurred in connection with production and business activities shall be deductible from income, but the maximum amount shall not exceed 0.5% of the sales (business) turnover for the current year. What are the policy considerations lying behind this rule?

The official said that the amount of business entertainment expenses is a mix of corporate entertainment and personal consumption. Among them, the personal consumption falls under non-business expenses that should not be deducted before tax. Therefore, there is a requirement to limit the amount of business entertainment to a certain percentage. However, it is difficult to distinguish between business entertainment and personal consumption. The international practice is to arbitrarily set

a relative percentage between the two. In Italy 30% of the business entertainment expenses is deductible before tax. In Canada, the amount is 80%. In the US and New Zealand, the amount is 50%. Taking into consideration of international practices and the existing practice of limiting the deduction of business entertainment to a percentage of the sales amount, we combine the two practices as per experts’ recommendations on the adoption of a strict policy: business entertainment is subject to a 60% deduction and not exceeding 0.5% of the sales amount (business turnover) for the current year.

Limiting the deduction of advising expenses to 15% on sales revenue, and remaining amount being carried over for deduction in future years

The Implementation Regulations consider the combined amount of advertising expenses and business promotion expenses, and provide that the amount of deductible advertising and promotion expenses shall not exceed 15% of the sales amount (business turnover), except for the provisions of the Ministry of Finance and the State Administration of Taxation to the contrary. The amount exceeding the prescribed 15%

can be carried over to future tax years for deduction.

The officials in charge explained that advertising expenses that possess the properties of one-off payment of a large sum and benefit the enterprise for a long period of time should be regarded as a capitalized payment and cannot be deducted in whole in the current tax year. Business promotion has similar properties and should be subject to limits on deduction. The Implementation Regulations permit the deduction of advertising and promotion expenses up to 15% of the sales amount (business turnover), and that the portion in excess of the 15% can be carried over to future tax

years for deduction. The administration has given due consideration to the advertising and business promotion expenses in some industry sectors that require specific

measures to be adopted. In the light of expert opinions and views from relevant departments, the qualification “except for the provisions of the Ministry of Finance and the State Administration of Taxation to the contrary” has been included in the Implementation Regulations with a view to making ministerial rules on the deduction of advertising and business promotion expenses for different industry sectors, in accordance with the provision for the delegation of rule making power in the EIT Law.

Indirect credit helps Chinese enterprises “go abroad”

In accordance with the EIT Law, the corporate income tax the resident enterprises bear indirectly on the dividend and bonus issues from equity investment outside China is eligible for indirect credit. The Implementation Regulations provide that the resident enterprise should hold 20% controlling interest in the equity of the foreign company. What are the policy considerations on this?

The officials said that the PRC EIT law retains the direct credit for tax paid on dividends and bonus issues at the shareholder level and it also introduces the indirect credit for tax on profits earned at the company level out of which the dividends and bonus issued are paid. The adoption of direct and indirect credits gives a helping hand to Chinese resident enterprises going international and increases their competitiveness

in international market. From the perspective of international practices, indirect credit are given on condition that resident enterprises should have actual equity investments in foreign companies. In accordance with the tax laws in the US, Canada, the UK, Australia, and Mexico, resident enterprises holding 10% or more voting rights in the equity investment in foreign companies are eligible for indirect credit. The tax law

requires the equity interest in foreign companies to be 25% for Japanese and Spain investors. It is the first time the PRC EIT law adopts the indirect credit method. The Implementation Regulations provide that the equity interest in foreign companies is 20% for resident enterprises to receive the indirect credit.

New and high technology enterprises by industry sectors

In the light of the requirement for national economic and social development,successful international experiences and the requirement for simple tax system, broad tax bases, low tax rates, and stringent tax collections and administration, the PRC EIT Law adjusts and integrates the tax preferential policies for both domestically and foreign funded enterprises, and gives effect to changes in two dimensions: the tax

policy changes from region-specific preferences to industry-specific preferences,which is to be supplemented by regional tax preferences; the form of tax preferential treatment changes from direct tax exemption and reduction to direct tax exemption and reduction, which is to be combined with reduction in tax bases for indirect taxes.The Implementation Regulations make clarifications on the scope, the conditions, and

the recognition criteria for tax preferential treatments as laid down in the EIT Law.

The officials in charge said that there are three important issues in the recognition of new and hi-tech enterprises. The first is the scope of new and hi-technology enterprises. The Implementation Regulations change the classification of new and high technology by products to classification of the new and high technology by sectors. The Implementation Regulations provide that the products (services) of new and hi-tech enterprises should fall under the scope of <the new and hi-technology industry sectors that receive prior supports from the State> so that it can avoid the problems that product listing and coverage under existing policies are too narrow and that the existing policy is not forward looking. The second issue is the recognition criteria. The Implementation Regulations provide those criteria in principle: the amount of research and development as a percentage to sales; the sales revenue of new and hi-tech products (or services) as a percentage of total revenue; the ratio of employees who possess technical qualifications to the total number of employees in

the company, and other conditions to be met. The Ministry of Science and

Technology, the Ministry of Finance, and the State Administration of Taxation shall formulate policies on this and give the detailed benchmarks with the flexibility to make adjustments for later development.

The third issue is the core proprietary IP rights. The Implementation Regulations lay down the primary requirement for getting recognized as new and high technology enterprises is the ownership in “proprietary IP rights”. In view of the fact that there is no official definition of “proprietary IP rights”, the inclusion of trademark rights, exterior design, copyright that may not have bearing on the core technological

competitiveness of the enterprise into the “proprietary IP rights” will make the scope too wide. The Implementation Regulations finally adopt the “core proprietary IP rights” as one of the criteria for getting recognized to be new and hi-tech enterprises. It is relatively easy to operate and has pointed out the direction for technological innovation. The key point is the IP rights that the enterprise owns and that give core

technical support to the main products and services of the enterprise.

Annual taxable income of small and low profit-making enterprise not exceeding

RMB300,000

The Implementation Regulations give the amount of annual taxable income, the number of employees and the amount of total assets as the benchmark for small profit-making enterprises. Specifically for production enterprises, the annual taxable income shall not exceed RMB300,000, total number of employees shall not exceed 100, and the total asset amount shall not exceed RMB 30 million; for non-production enterprises, the annual taxable income shall not exceed RMB300,000, the number of employees shall not exceed 80, and the total amount of assets shall not exceed RMB 10 million. The scope of the tax concession is larger and the magnitude of tax concession is higher than that as given under the old tax law for domestically funded enterprises.

The officials said that the dividing line that the annual taxable income is RMB300,000 drawn under the Implementation Regulations results from careful testing. About 40% of the enterprises shall be taxed at 20% given that this benchmark is adopted.

The business profits that non-profit making organizations earn are taxable

The PRC EIT Law provides that the income of qualified non-profit making

organizations is exempted from tax. Article 85 of the Implementation Regulations provides that the income of the qualified non-profit making organizations excludes the income derived from profit-making activities of the non-profit making organization. Why is it?

The officials in charge said countries all over the world make a distinction between profit-making and non-profit making activities and give tax preference to non-profit making activities. The relevant legal rules in China provide that non-profit making organizations cannot carry out profit-making activities. To regulate these organizations and plug the loophole that may arise from the profit making activities

carried out by these tax-exempt organizations, the Implementation Regulations expressly provide that the income derived from the profit-making activities would not be exempted from tax. Where some non-profit making organizations derive income from profit-making activities and use them in whole for charitable events, that should

be primarily encouraged under the national policies. Therefore, the Implementation Regulations include the qualification “except for the provision of the Ministry of Finance and the State Administration of Taxation to the contrary”.

Dividend and bonus issue derived from investment over 12 months being exempted from tax

The PRC EIT Law provides that dividends, bonus issues and income from equity investment are tax-exempt income if they are distributed by resident enterprises that satisfy prescribed conditions. What are differences between the conditions to be met by the resident enterprises and the provisions on the taxation of dividends and bonus issues in the old tax law for domestically funded enterprises? What are the policy

considerations?

The officials in charge said that the exemption of income tax on dividend and bonus issues that are distributed among resident enterprises is to eliminate double taxation. Under the old tax regulations for domestically funded enterprises, the distribution of dividends from an enterprise that pays tax at a lower rate to an enterprise that pays tax at a higher rate attracts additional taxes for the high-tax enterprise on the rate

differences. In order to make the tax preferential treatment available to enterprises created in the development of the Western region, the new and high technology enterprises, and the small and low profit-making enterprises, the new EIT Law scraps the practice of imposing additional tax on the rate difference and exempts the income tax on dividend and bonus issues that are distributed by unlisted companies and listed companies, of which the ownership in the investment in the listed companies is over

12 months. To encourage direct investment in production and business activities, the stock speculations in the secondary capital market that is characterized by short-term ownership (less than 12 months) without the primary objective of receiving dividends and bonus issues should not become targets for tax preferential treatments.

The tax exemption and reduction commencing in the year the first sales transaction is reported

The Implementation Regulations provide that enterprises deriving income from the investment in projects of public basic infrastructure that receive primary support from the state shall enjoy tax preferential treatment in the form of “three years’ tax exemption and three years’ tax reduction”, commencing from the tax year in which the first sales transaction for the project is reported. The old tax law for foreign

invested enterprises provided that the year for tax exemption and reduction commences from the first profit-making year. The EIT Law has changed the previous practice from the first profit-making year to the year the first sales transaction occurs. What is the reason for this?

The officials in charge said that the old tax law for foreign invested enterprises adopted the first profit-making year as the year in which the tax exemption and reduction period commenced. That would in practice encourage the postponement of the first profit-making year to avoid paying taxes and made the tax collection and administration a difficult job. The Implementation Regulations adopt a new method under which the tax exemption and reduction commence from the year in which the first sales transaction is recorded. On one hand, this policy change can avoid the

practices by the foreign invested enterprises of putting off the first profit-making year to later years. On the other hand, this policy change can address the issue that the investment scale is big with long period of construction. It is more realistic to the situation under which the domestically funded enterprises receive tax preferences from the date of incorporation. It also encourages the enterprises to shorten the construction period, make the project profitable at the earliest possible moment and improve the return on investment.

Tax adjustment to strengthen the anti-tax avoidance measures

To comply with the relevant provisions on special tax adjustments in the EIT Law and learn from international experiences, the Implementation Regulations expressly lay down provisions for the related parties or associated enterprises in the transactions

with related parties, the adjustment methods for related party transactions, the principle of arm’s length transactions, advanced pricing agreements, the obligations for providing information, collecting taxes as per prescribed profit margins, preventing the use of controlled foreign corporations, prevention on thin capitalization,

general anti-tax avoidance, and the imposition of additional interest on overdue taxes.

The officials in charge said that these provisions strengthen the measures to combat tax avoidance, help prevent and stop acts of tax avoidance and safeguard the interests of the nation. He specially emphasized that after tax adjustments taking effects, the taxpayer, in addition to the payment of additional tax, is liable to a penalty interest that is computed with reference to the bank’s lending rate plus 5% in the period for which additional tax is collected. Where the taxpayer can submit the information to

the tax authority on time, it can be exempted from the payment of additional interest on tax.

Separate rules to be made for filing consolidated tax returns

The EIT Law follows model of the income tax on legal persons. Organizations that are not legal persons should file income tax returns that forms part of the consolidated tax turn for the head office. The filing of consolidated tax returns by head offices would relocate the tax revenues between different regions in the country. Both the taxpayers and local governments are very much concerned about this issue. The Implementation Regulations only lay down one provision in principle. What are the

policy considerations for this?

The officials in charge told us that in accordance with the EIT Law, business organizations that are not legal persons should file tax returns to the tax bureau in the city where the head office is located. That will cause relocation of tax revenue among different regions in the country, and should be dealt with in a reasonable way. We have performed many studies in order to solve the problem of relocation of tax revenues among different regions in a reasonable and proper way and balance the

interests among them after the implementation of the EIT Law and the

Implementation Regulations. The detailed measures shall be formulated by the Ministry of Finance and the State Administration of Taxation, and submitted to the State Council for approval before taking effect. Therefore, the Implementation Regulations only state the principles in general.

Parent and subsidiary companies no longer file group tax returns

The EIT Law provides that except for the provisions by the State Council to the contrary, enterprises should not file group income tax returns. However, the Implementation Regulations do not make relevant provisions for group of companies to file tax returns on a group basis. How will this problem be solved in future?

The official in charge said that as from 1994, the State Council has given approval to 120 large groups of corporations/enterprises to file group tax returns on a trial basis. The policy objective at that period of time is to relieve the enterprises of tax burden and support the development for the groups of enterprises because the operating results of the parent and individual subsidiaries did not present the true information

and it is difficult to distinguish between the enterprises that are operated in accordance with commercial principle and the enterprises that form part of the governmental organizations. With the implementation of the EIT Law, the parent and subsidiary corporations that are legal persons shall file tax returns and pay tax separately. Where there is a requirement to file group tax returns, the State Council shall make separate regulations. Implementation Regulations need not deal with this again since the EIT Law has already made the provisions and delegated the authority on this.

In view of such situation, the introduction of VAT transformation reform will perform the important function of boosting the development of the enterprises, improving the competitiveness of the Chinese enterprise and the capability to cope with risks, and overcoming the adverse influences on China economy brought about by the international financial crises. According to estimates, the reform will cause fiscal revenue to drop by over RMB120 billion, and is the single largest tax cut in the history of the PRC. It is believed that the reform policy will have a positive impact on the sustained steady and relatively fast development of our country’s economy.

The VAT reform plan was tabled during the third plenary session of the 16th Central Committee of the Communist Party of China (the CPC), and the reform must be completed during the period of the 11th five-year plan in China. Since 1st July 2004, the experimental trials have been completed in the North East and Central part of China. The experimental trials were successful and have achieved the expected target. The 2008 State Council Work Report officially kicked off the reform plan for VAT system transformation. In the same year the 11th Session of the National People’s Congress examined and approved the report of the fiscal budget committee of the 11th Session of the NPC, which provides that the reform shall commence in 2009. The State Council decides to commence the transformation reform and perfect the VAT system of our country in order to meet the requirement of scientific
development of the tax system, finally perfect the VAT system and create the condition for the enactment of the VAT law by the NPC Standing Committee in five years’ time.

Value Added Tax (VAT)

Legal authority
Decision of the Standing Committee of the National People’s Congress on the Application of VAT, Consumption Tax, and Business Tax Tentative Regulations to foreign investment enterprises and foreign enterprises passed and announced on 29th December 1993

The PRC VAT Tentative Regulations, promulgated by the State Council on December 13, 1993 effective from January 1, 1994

Detailed Implementation Rules of the PRC VAT Tentative Regulation, issued by the Ministry of Finance on December 25, 1993 effective from January 1, 1994

The PRC VAT Tentative Regulations, promulgated by the State Council on November 10, 2008 effective from January 1, 2009 (Chinese)

Scope of activities subject to VAT: -
Sale of goods within the Mainland China by business units or individuals;

Import of goods into the Mainland China by business units or individuals;

Provision of taxable service relating to processing, repairing and replacement within the Mainland China by business units or individuals.

Parties to the business transactions subject to VAT

Deemed sales
The taxpayer delivers goods to third party for re-sale on its behalf;

The agent who sells goods for its principle receives the goods;

Transfer of goods between head office and branch, or between branches;

Investor contributes self-made goods, or goods processed under contract, or goods purchased as capital injection to a newly incorporated entity;

Distribution of self-made goods to shareholders, or staff as benefits in kind;
Application of self-made goods to non-taxable items;

Donation of self-made goods, or goods subcontracted, or goods purchased to other party.

Exempted taxable activities
Agricultural producer sells own-made produce;

Manufacturers imports goods to be used in the manufacture of export products.

Type of VAT taxpayers
(1)  General taxpayer
General taxpayer, after completing prescribed recognition procedures, can purchase VAT special invoices from the tax bureau and issue them to buyers. Buyers who are also general taxpayers can obtain VAT input credit that is deductible from VAT output taxable amount.

(2)  Small-scale taxpayer.
Small-scale taxpayers are those engaged in production of goods or provision of taxable labor services, and whose annual sale amount subject to VAT is RMB 1 million or less; and the taxpayers engaged in wholesale or retail of goods with an annual taxable sales amount of RMB 1.8 million or less.
Small-scale taxpayers are not entitled to issue VAT special invoices. Instead, they can only use ordinary invoices, also purchased from the tax bureau. Small-scale taxpayers are subject to a lower VAT tax rate at 6%, without the right to deduct input VAT credit from the VAT output taxable amount.

Small-scale taxpayer can apply to be recognized as general taxpayer subject to examination and approval by the supervising national tax bureau at the county level or above.

VAT amount
The VAT amount for domestic sales and purchases of goods and taxable services is as follows: -
VAT amount = VAT taxable amount X 17%, and
VAT taxable amount = VAT output amount – VAT input amount;
Or VAT amount = VAT sales amount X 17% – VAT purchase amount X 17%
Note that only general taxpayers are eligible for VAT input credit (deduction).
The VAT sales amount is computed as below: -
VAT sales amount = sales before adjustment + deemed sales – exempted sales

The VAT amount for the buyer who imports goods is arrived at as per formula below.

VAT amount = (CIF value + import duty + consumption tax) X 17%

Zero-rated VAT and export rebates
Enterprises subject to zero-rated VAT are entitled to export rebate on VAT paid for input materials in the manufacture of export goods. To be eligible for export rebate, the enterprise must satisfy two conditions:

(1) The enterprise must be a general VAT taxpayer and
(2) It must have obtained a VAT rebate certificate granted by the tax bureau.

Use of VAT and ordinary invoices

VAT Special Invoices
The purchase, issue, use and custody of VAT invoices by the taxpayer are subject to stringent regulations under “the PRC Invoices Administration Method” and “the Provisions for the Use of VAT Special Invoices” as promulgated by the State Council. VAT Special Invoices are tax credit certificates. Only registered VAT taxpayer can purchase and issue VAT invoices under prescribed circumstances. Willful violation such as unlawful purchase and sale of VAT Special Invoices will invite administrative or criminal consequences.
VAT tax items and rates

Note:

(1) In order to do business with a buyer who is a general VAT taxpayer, the small-scale taxpayer may request the tax office to issue VAT special invoice on its behalf. The small-scale taxpayer pays the 17% VAT at the tax office.

(2) VAT is only payable at the wholesale chain, between the manufacturer and the wholesaler, or between manufacturers. Retailers selling goods directly to the final consumer are not to issue VAT special invoices. Instead, state ordinary invoices inclusive of taxes at 4% to 6% are used.

General VAT Accounting Treatment

Factory A sells some vehicle tyres to Company B for RMB5,000. Rubber costs RMB4,000 in domestic market. Both selling price and cost are exclusive of VAT. Assuming that VAT rate is 17% and consumption tax (CT) rate is 8%. The accounting treatment is as follows:

Gross Profit = sales – costs – CT
=5,000 – 4,000 – 400
= 600

VAT payable = 850-680
= 170

CT payable = 400

Special VAT Accounting Treatment

Example 1

Accounting for VAT-exempt goods

A food making FIE buys RMB 20,000 agricultural produce from farmers. Agricultural produce is VAT-exempt. The factory is entitled to have a 10% notional input VAT: 20,000 * 10% = 2,000

Example 2

Deemed sale: non-cash capital contribution

Company A transfers raw materials (RM) to Company B at cost as capital contribution. Cost of RM is 2 million. Fair value of the RM for VAT computation is 2.2 million. VAT rate is 17%. What’s accounting treatment for Companies A & B ?

In A’s book

* Adopting fair value to compute VAT.

Example 3

Deemed sale: distribution of own made goods

A shoe-making factory gives a pair of shoes to each of its employee for own use, costing RMB5,000. Selling price is RMB5,500.

* VAT charged to staff benefits is not recorded as input VAT. VAT is computed on selling price.

Example 4

Accounting for purchase of fixed assets

An FIE buys a piece of equipment and pays VAT of RMB510,000. Equipment costs 3 million.

*Fixed assets are non-taxable items.

Example 5

Accounting for purchase of fixed assets

1 year later, the same equipment is sold. Assume that net book value is 2.7 million. What is the VAT treatment if the asset is sold for 2.5 million, or if sold for 3.1 million?

It will attract a 4%* VAT if sold at above original cost. No VAT liability if sold below cost.

*4% is rendered by half.

Example 6

Use of purchased goods for non-taxable item

A company pays RMB1.2 million for some construction raw materials, paying VAT RMB204,000. The RM is first delivered to the warehouse, but later is put to use in the construction of its own warehouse.

Upon receipt

Example 7

Accounting for non-currency transactions

Inventory is exchanged for a piece of equipment. Assuming that both the fair value of the fixed asset and inventory are RMB1 million.

Exchange of inventory for fixed asset

*The book value of the asset given up is adopted as the value of the asset received under the Chinese accounting rules.

VAT Planning

Case 1 – sales promotion

Sales margin for product is 40%, selling price =RMB100, cost is RMB60. Seller, a general VAT taxpayer, is considering following sale promotion options:

(A) Selling product at 30% discount.
(B) Giving goods valued at 30 for free to those buying over 100 (costing18 inclusive of VAT).
(C) Offering 30 cash rebate for those who buy over 100.
Which option is more cost effective to the seller?

A) 30% discount

VAT
VAT payable = 70 / (1 + 17%) x 17% – 60 / (1 + 17%) x 17% = 1.45

Corporate income tax (CIT)
Profit = 70 / (1 + 17%) – 60 / (1 + 17%) = 8.55
CIT = 8.55 x 33% = 2.82 (Yuan)
After-tax profit = 8.55 – 2.82 = 5.73 (Yuan)

B ) gift valued at 30

VAT payable for 100 sales
= 100 / (1 + 17%) x 17% – 60 / (1 + 17%) x 17% = 5.81

Deemed sale for gift:
VAT = 30 / (1 + 17%) x 17% – 18 / (1 + 17%) x 17% = 1.74
Total VAT payable = 5.81 + 1.74 = 7.55

Profit
= 100 / (1 + 17%) – 60 / (1 + 17%) – 18 / (1+17%) – 7.5 (tax on casual income)
= 11.31

Corporate income tax
= (100 / (1 + 17%) – 60 / (1 + 17%))x 33% = 11.28 (Gift and tax paid on behalf not deductible against income)

After-tax profit
= 11.31 – 11.28 = 0.03

C) 30 cash rebate

VAT
VAT payable = 100 / (1 + 17%) x 17% – 60 / (1 + 17%) x 17% = 5.81

Customer is required to pay Individual income tax. Withholding tax is 7.5. 30/(1-20%) x 20% = 7.5.

Corporate income tax
Profit = 100 / (1 + 17%) – 60 / (1 + 17%) – 30 – 7.5 = -3.31
CIT = (100 / (1 + 17%) – 60 / (1 + 17%) ) x 33% = 11.28
After-tax profit (loss) = -3.31 – 11.28 = -14.59

A Comparison of tax effectiveness on sales promotion

Case 2 – Tax planning

Sale company vs. Commission agent

Company A and Company B are under common ownership. A is going to enter a wholesale distribution agreement with B. Option 1: B acts as A’s commission agent. Option 2: B buys from A

Option 1
Product selling price is RMB1,000.
For every item sold, Company B receives a commission of RMB200.

VAT for A: 1000*17%=170, for B (800 – 800)* 17% = 0. (Company B)

Business Tax (BT): B has to pay a BT of RMB10. (10 = 200*5%)

Total taxes = 170 + 10 =180

Option 2
VAT A: 800*17%=136

VAT B: (1,000-800)*17%=34

Total tax = 136 + 34 = 170, with no Business Tax. Saving is RMB10.

A’s saving A = 170-136=34, B’s additional tax payment is 10-34 = -24.