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Stephen Nelson |
The implementing regulations of the PRC Enterprise Income Tax Law (the regulations) finally were promulgated on December 11 2007 and entered into effect on January 1 2008 together with the tax law. The PRC State Council has also released a notice dated December 26 2007 (notice) on grandfathering arrangements for foreign-invested enterprises (FIEs) that are entitled to lower tax rates and tax holidays. This article addresses some of the key areas that are addressed by the regulations and the notice.
Grandfathering arrangements
The notice provides that FIEs which are entitled to income tax rate of 15% will be subject to a progressive increase in the applicable income tax rate over a five-year period as follows:
Year |
Income tax rate |
2008 |
18% |
2009 |
20% |
2010 |
22% |
2011 |
24% |
2012 |
25% |
For FIEs that are subject to income tax rate of 24%, the rate will increase immediately to 25%.
The notice also addresses the grandfathering of unutilised tax holidays of FIEs established (with a business licence) before March 16 2007. FIEs which have commenced their tax holidays before 2008 will continue to enjoy the remaining unutilized tax holidays until expiry. For FIEs which have not yet commenced their tax holidays, they will commence in 2008 and may be utilised until expiry.
Lower tax rates and tax holidays available to enterprises established in Western China (notably including Sichuan and, Chongqing Municipals) pursuant to a 2001 tax notice will continue to be in force. These include a 15% income tax rate for enterprises in the encouraged category, and a two-year tax exemption, followed by a three-year 50% tax reduction.
Withholding tax
The general withholding tax rate (for dividends, royalties, interest, rentals and capital gains) is reduced from the basic rate of 20% under the tax law to 10%.
For dividends, the date of a decision to distribute profits by an FIE would appear to be the date the decision on dividend distribution is made pursuant to article 17 of the regulations. Therefore, it appears that any dividend distributions approved by an FIE's board of directors before December 31 2007 still will qualify for existing tax-free treatment, even if the distribution is not made until after January 1 2008. It is possible that the SAT will go further and exempt from withholding tax dividends from all pre-2008 profits; we await a further notice on this point.
Tax incentives
High & new technology enterprises are subject to a lower tax rate at 15% and the regulations set out the qualification criteria, including the legal ownership of core intellectual property.
Agricultural, forestry, animal husbandry and fishery projects are entitled to tax exemptions or 50% tax reduction, depending on the specific nature of the project.
Qualified government-supported public infrastructure projects (including pier and dock, airport, railroad, road, urban public transportation, electricity and water projects) are entitled to a tax holiday of a three-year tax exemption followed by a three-year 50% tax reduction. The tax holiday is also available to qualified environmentally friendly, energy and water conservation projects.
Deductions
Entertainment expenses may be deducted up to 60% of amount incurred, subject to an annual cap of 5% of income of the applicable year.
For advertising expenses, deductions are allowed subject to an annual cap of 15% of annual income of the applicable year. Unutilised advertising expense deductions may be carried forward to future tax years. Management fees, on the other hand, are not deductible.
Reorganisation
Pursuant to a 1997 State Administration of Taxation notice, foreign companies may restructure their China operations at cost on an income tax-free basis. Earlier drafts of the regulations had provisions that eliminated the ability to transfer at cost to non-PRC transferees.
The final version of the regulations no longer contains such provisions. Therefore, as of now, the 1997 restructuring notice should remain in effect. Nevertheless, it is generally anticipated that separate restructuring notices or regulations will be issued to replace the 1997 notice.
Stephen Nelson (stephen.nelson@kingandwood.com.hk), Beijing & Hong Kong
