During the period of greatest COVID-19 disruption in 2020, the Chinese tax authorities took a lighter touch on tax enforcement so as not to put additional pressures on businesses, as indeed was the case in many countries. Now, with the recovery of the economy, tax enforcement efforts are also recovering their full vigour, with particular focus areas being employee share schemes and technology enterprises.
New tax reporting requirements for ESOP arrangements
In China, companies implementing a new Employee Share Ownership Plan (ESOP) and looking to access individual income tax (IIT) deferral incentives for their staff must make certain filings.
There is a full tax reporting in the case of public companies and a so-called ‘recordal’ filing in the case of private companies. With ESOPs seeing ever greater use and an increasing focus on IIT compliance by the tax authorities, these reporting and recordal requirements are now being enhanced in Circular Shui Zong Ke Zheng Fa  No. 69. The enhanced filing requirements supplement those already prescribed in the existing Circulars Caishui No. 35 (2005) and Caishui No. 101 (2016).
The authorities will now receive more comprehensive information on how the various entities, including employer, ESOP platform, investee entities, are inter-related. The ESOP arrangements of Chinese companies with inverted structures used for overseas listing, so-called ‘variable interest entity’ (VIE) structures, will also be caught by the new reporting.
Apart from enhancing enforcement, it is understood that China tax policymakers are looking to leverage the information they gather from the new reporting to evaluate whether, and in what manner, to extend the existing preferential IIT treatment for ESOPs. This is due to expire on December 31 2021. Enterprises are advised to monitor for developments in this space.
Scrutiny on HNTE status tightened
China’s flagship corporate income tax (CIT) incentive is the 15% reduced CIT rate provided to high-and-new technology enterprises (HNTEs). This compares with the standard CIT rate of 25%.
Enterprises will often claim this in combination with the super deduction for research and development (R&D) expenses. Further enhancements were made in STA Announcement No. 28 of September 2021. Enterprises are allowed to claim the super deduction of R&D expenses incurred in the first three quarters of 2021 under the provisional CIT filing for the third quarter or the month of September (to be completed in October). Previously, R&D expenses super deduction could only be claimed in the annual CIT filing after the year end.
While the Chinese government provides generous tax incentives to HNTEs, recognition and review of HNTE status are becoming ever more stringent. On-site checks have been made in several cities such as Beijing, Qingdao, Haikou, Suzhou, Guangzhou, and Zhuhai. As disclosed on several official websites, 97 enterprises in Beijing, 220 enterprises in Jiangsu province, and 21 enterprises in Guangdong province have been disqualified from their HNTE status in 2021.
From September 15 2021 to October 25 2021, the national leading office for HNTE recognition and administration (i.e. Torch High Technology Industry Development Centre of Ministry of Science & Technology) conducted a nationwide inspection on the recognition and administration of HNTE by 36 local offices.
The inspection focused on whether the HNTE recognition and supervision performed by the local offices was in line with the existing rules and regulations, as well as the implementation of the relevant preferential tax treatment. We expect to see local offices, which in the past may have adopted a more flexible and tolerant approach to awarding HNTE status, take a more rigorous approach going forward.
Given this, enterprises should review the basis on which they secured their HNTE status to ensure this is robust and avoid the risk of the associated tax incentives being clawed back.
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