China’s corporate income tax implementation further clarified

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Mar. 14 – China’s Corporate Income Tax Law, effective from January 1, has been a work in progress for quite some time. As the tax law itself is more principle-based rather than rules-based, the government has relied on publishing various implementation rules and circulars to clarify how the law is to be implemented. Three important tax circulars were issued in February which will significantly impact foreign invested enterprises (FIEs) in China. These circulars further clarify several significant areas of the new tax regime including tax incentives for high-technology industries and grandfathering treatments.

Tax incentives for high-tech industries
Circular 1 (Caishui [2008] No. 1) further clarifies tax incentives available to certain industries in the new tax law. It provides tax incentives to software production companies, IC production companies and security investment funds. These tax incentives mirror the incentives granted under the old tax regime. Preferential tax treatment will also continue to apply to IC production and assembly companies and software production companies newly established in the western region of China. Circular 1 also states that tax holidays for software production companies and IC production companies will start from the first profit-making year.

Grandfathering further clarified
Circular 21 (Caishuai [2008] No. 21), issued February 4, clarifies how the half-rate reduction during an unutilized tax holiday period should be calculated during the grandfathering period for qualifying FIEs. Circular 21 states that the half-rate reduction during the unutilized tax holiday period should be calculated based on the gradually increased tax rates of 18, 20, 22 and 24 percents for the years 2008, 2009, 2010, 2011 respectively, and 25 percent from 2012 forward. That means the net rates will be 9, 10, 11, 12, and 12.5 percents, depending on the year in which the half-rate reduction applies. For FIEs that were subject to a 24 or 33 percent tax rate under the old tax regime, the half-rate reduction during the unutilized tax holiday period should be calculated based on 25 percent, making the net rate 12.5 percent.

Circular 23 Guoshuifa [2008] No. 23, released on February 23, further clarifies aspects of the grandfathering treatments of previously enjoyed tax incentives. To qualify for reinvestment tax refunds, FIEs mast have completed all reinvestment steps and obtained the dated business license of the new business license on or before the end of 2007. Additionally, the reinvestment is not allowed in cases where the reinvestment funding was taken out of the prepayment of 2007 profits, indicating that the 2007 profits are not eligible for reinvestment tax refund.

For contracts involving interest or royalties that were entered into before 2008, met the criteria for withholding tax under the old tax regime, and had been already approved by the tax authorities, the withholding tax exemption will continue to apply until the expiration of the original contract. This will not apply to any extension, expansion or supplementary contract of the original contract.

And finally, FIEs eligible for grandfathering treatments of unutilized tax holidays will still need to observe the original requirements stipulated under the old tax law, chief among these would be business scope and operation period. If an FIE fails to fulfill the original requirements, the tax exempted or reduced period during the tax holiday, including the part falling after 200, would be drawn back.