The Chinese government has introduced a range of VC tax
incentives, including a rule which allows 70% of the VC
investment to be offset against the taxable income of the
investing VC enterprise or angel investor.
This incentive can be used where the seed or start-up
capital investment is made in 'science and technology'
enterprises, as defined in the rules. The latest iteration of
this incentive, set out in Circular 55 (issued 2018), applies
on a national basis from January 1 2018 for corporate income
tax (CIT) purposes, and from July 1 2018 for individual income
tax (IIT) purposes.
Building on this, China's Ministry of Finance (MOF) and
State Administration of Taxation (SAT) issued Circular 8 on
January 10 2019, setting out the IIT rules for individual
partners of VC enterprises taking limited partnership form.
This addresses longstanding issues with lack of clarity in
the application of partnership tax rules to VC enterprises.
These recent changes to VC tax rules are being made in parallel
to announcements of further CIT and VAT reductions for small
domestic businesses, the lowering of tax burdens under the new
IIT law, as well as major, across-the-board, VAT rate
reductions announced in the context of the National People's
Congress meetings in early March.
Circular 8 offers two tax calculation options for VC
partnership enterprises (through which investment funds are
operated) when determining the IIT liabilities of their
In situations where a VC partnership elects to tax account
for its investment returns on a fund-by-fund basis, the capital
gains and dividend income of the enterprise are attributed
through to the individual partners.
The annual gains/losses of all projects invested by the
specific VC enterprise are aggregated, with some allowance for
transfer expenses. Tax is withheld on behalf of the partner in
respect of his share of the net gains.
Where applicable, the individual partner may utilise against
these gains the special VC investment incentive to obtain a
deduction of 70% of the amount invested in the transferred
project (which is solely applicable for gains arising from
transfer of equity, with no carry forward of the balance
Dividend income is similarly (separately) aggregated, and
tax is withheld from the portion attributable to each partner.
Other VC enterprise operating expenses are not deducted from
the income attributed through to the partners. The flat 20%
rate, which is the standard IIT rate for investment income, is
Annual enterprise income basis
There are two approaches for income and loss offsets:
1) In situations where a VC partnership
elects to tax account for its investments gains/losses on an
annual enterprise income basis, income derived by an individual
partner through the VC enterprise is calculated as a proportion
of the VC enterprise's total aggregate income.
The total aggregate income is determined by deducting (from
gross income and gains) the allowable costs, expenses and
losses related of the business, allowing for aggregation and
offset of all the different income streams arising to the VC
2) Where the 70% deduction, special VC
investment incentive is applicable, the individual partner may
utilise against their share of the total aggregate income, and
carry forward any unused balance. The taxable net income will
then be subject to IIT at a progressive rate from 5% to
Venture capital taxation
As can be seen, the second approach allows for a better use
of income and loss offsets. Under the first approach, not only
is there no set-off regarding dividend income and equity
losses, but also regarding where a net loss arises from gains
and losses on equity disposals. The individual partner simply
recognises its equity transfer income as zero, and the loss
cannot be carried forward.
The second approach also allows for better use of VC
enterprise expense deductions, as well as better utilisation of
the 70% deduction and standard IIT deductions. The trade-off is
a potentially higher IIT rate. A record filing must be made
with relevant in-charge tax authorities on the treatment chosen
(the default approach is the annual enterprise income method).
Once the election is made, it may not be changed within three
years. Circular 8 applies from January 1 2019 to December 31
Inbound investment landscape
Against the backdrop of China-US trade issues and a slowing
pace of economic growth, the Chinese government has been
actively making efforts to retain and attract more foreign
investment to China.
These efforts include accelerating the introduction of the
Foreign Investment Law and making revisions to two industry
catalogues that govern sectoral limitations on foreign
- new Foreign Investment Law: The draft bill
passed in December, with reviews in January by China's
National People Congress (NPC), and a final review in early
March. Once it is finalised, it will replace the existing
legislation governing foreign investment in China. Highlights
include harmonisation of the rules governing foreign and
domestically invested enterprises, new rules to prohibit
'forced' technology transfers, and institution in law of the
rules governing sectoral limitations on foreign investment in
China (the national treatment + 'negative list' approach);
- Amendment to industry catalogues: These
catalogues designate whether economic sectors are open or
closed to foreign investment, and whether the latter is
encouraged. The latest (February) draft revisions to the
Catalogue of Encouraged Industries for Foreign Investments
(and Catalogue of Priority Industries for Foreign Investments
in Central and Western China) additionally list 53 and 43
encouraged sectors, respectively. The goal of the revision is
to encourage more foreign investments in fields such as
modern agriculture, advanced manufacturing, hi-tech, and
modern service sectors.
Khoonming Ho (email@example.com) and Lewis Lu (firstname.lastname@example.org)
Tel: +86 (10) 8508 7082 and +86 (21) 2212 3421