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The fundamental regulations on China’s corporate income tax (CIT) are the CIT Law and its Implementation Guidelines. The CIT Law was recently amended on December 29, 2018 and the CIT Implementation Guidelines was recently amended on April 23, 2019.

According to China’s Corporate Income Tax Law all enterprises (except sole proprietorships and partnerships), including all organizations that generate income in China, are subject to CIT.

CIT taxpayers

All enterprises (except sole proprietorships and partnerships), including all organizations that generate income in China, are subject to CIT. The CIT Law categorizes enterprises into resident enterprises and non-resident enterprises, which are subject to different tax obligations. 

Entity type

Description

Nationality

Resident Enterprise

An enterprise established in China according to Chinese law (including a WFOE, JV, or FICE).

Chinese company

An enterprise established according to foreign law but whose actual administrative organ is located in China.

Foreign company

Non-resident Enterprise

An enterprise established according to foreign law, whose administrative organ is not located in China, but which has an office or establishment in China.

Foreign company

An enterprise established according to foreign law, which does not have an establishment in China, but has income generated from China.

Foreign company

Calculating CIT payable

CIT payable is calculated using the below formula:

CIT PAYABLE = CIT TAXABLE INCOME x CIT RATE - TAX EXEMPTIONS OR REDUCTIONS BASED ON TAX INCENTIVES

[tips title="Important Tip"]CIT is calculated against the company’s net income in a financial year after deducting reasonable business costs and losses – in other words, it is effectively a tax on profits.[/tips]

CIT in China is settled on an annual basis but is often paid quarterly, with adjustments either refunded or carried forward to the next year. The final calculation is based on a company’s year-end audit.

CIT Rates

  • A 25 percent standard CIT rate is applied to resident enterprises and non-resident enterprises with income-generating establishments in China.
  • A 10 percent withholding rate (temporarily reduced from 20 percent) is applied to China-sourced income not related to a non-resident enterprise’s establishments in China, or China income derived by non-resident enterprises without establishments in China.
  • Small and low-profit enterprises are entitled to a reduced CIT rate of 20 percent.
  • A reduced CIT rate of 15 percent applies to certain type of enterprise such as high-tech enterprises or enterprises registered in special zones such as enterprises engaging in encouraged sectors in Hainan.

CIT taxable income

CIT taxable income is calculated on an accrual basis, meaning that income items are recorded when they are earned and deductions are recorded when expenses are incurred. There are two ways of calculating taxable income: the direct method and the indirect method.

Direct method

The formula for calculating taxable income under the direct method is as follows:

CIT TAXABLE INCOME= GROSS INCOME - NON-TAXABLE INCOME - TAX EXEMPT INCOME - DEDUCTIONS - ALLOWABLE LOSSES CARRIED FROM PREVIOUS TAX YEAR

Gross income refers to income in currency and non-currency forms received by the enterprise from various sources, including income from the sales of goods; provision of services; transfer of property; equity investments, such as dividends and profit distribution; as well as interests, rents, and royalties.

Non-taxable income includes fiscal appropriations (e.g., government subsidies to enterprises), governmental administration charges and government funds lawfully collected and brought under relevant laws, as well as other non-taxable income stipulated by the State Council.

Tax-exempt income includes:

  • Income from interest on government bonds;
  • Dividends, bonuses, and other income from equity investment between qualified resident enterprises;
  • Dividends, bonuses, and other income from equity investment received from a resident enterprise by a non-resident enterprise with an establishment or premises in China, with which the income has an actual connection; and
  • Income of qualified non-profit organizations.

Deductions from gross income include reasonable expenditure incurred in relation to income received by an enterprise, such as costs, expenses, taxes (except CIT and VAT) and losses; charitable donations and gifts within 12 percent of the gross annual profit; reasonable depreciation of fixed assets; amortization of intangible assets; amortization of long-term prepaid expenses; inventory cost; net value of an asset transferred; and other deductions stipulated by laws and regulations.

Caps apply when deducting certain expenses from taxable income, such as follows:

Deduction Cap for Certain Expenses

Expenses

Deduction cap

Employee welfare

≤14% of the total amount of employee salaries and wages

Labor union funds

≤2% of the total amount of employee salaries and wages

Employee education

≤8% of the total amount of employee salaries and wages (the

excess can be carried forward to future years for deduction) *

100% deduction for enterprises in software and integrated circuit industries

Business entertainment relating to production and business operations

≤ 60% of the actual incurred amount; and

≤ 0.5% of the sales revenue of the current year.

Advertising and publicity **

≤15% of the sales revenue of the current year (the excess can be carried forward to future years for deduction)

*Originally, the 8% deduction cap was only available for advanced technology service enterprises. However, starting from January 1, 2018, it was extended to cover all enterprises unless it is stipulated otherwise.

** From January 1, 2021 to before December 31, 2025, for enterprises manufacturing or selling cosmetics, enterprises manufacturing pharmaceuticals, and enterprises manufacturing beverages (excluding alcohol), the deduction cap of advertising fee is 30% of the sales revenue of the current year (the excess can be carried forward to future years for deduction). Advertising fees paid by the tobacco enterprises are not deductible.

Non-deductible expenditures include:

  • Dividends, bonuses, and other income from equity investment paid to investors;
  • Fines for delayed tax payment;
  • Penalties, fines, and confiscated property;
  • Sponsorship expenditures other than charitable donations within 12 percent of the gross annual profit;
  • Non-verified reserves; and
  • Other expenditures unrelated to income.

Indirect method

In practice, the indirect method below is more frequently adopted in the annual declaration of CIT

CIT TAXABLE INCOME = GROSS PROFIT AS SHOWN IN THE ACCOUNTING BOOK ± ADJUSTMENTS FOR TAX PURPOSE ± INCOME/PROFITS TO MAKE UP FOR THE LOSS INCURRED IN THE PREVIOUS YEAR

The “adjustments for tax purpose” refers to the discrepancies between applying China’s Accounting Standards for Business Enterprises (ASBEs) and the CIT Law.

CIT incentives

CIT incentives are available in China to support and encourage the development of businesses of certain types, businesses in certain area, and businesses engaging in certain sectors, including:

  • CIT incentives for small and low-profit enterprises
  • CIT incentives for high-tech enterprises
  • CIT incentives for advanced technology service enterprises
  • CIT deductions on R&D expenditures
  • CIT incentives for hiring disabled employees
  • CIT incentives for hiring retired soldiers
  • Tax reduction for enterprises investing in west China
  • Tax incentives for enterprises engaging in pollution control
  • CIT incentives for enterprises making investments in or operating of public infrastructure projects specially supported by the state
  • CIT incentive for eligible technology transfers
  • CIT incentive for income derived from eligible environmental protection, energy saving, or water conservation projects
  • CIT reduction for enterprises investing in seed-stage or start-up technology enterprises
  • CIT incentive for software enterprises
  • CIT incentives for integrated circuit enterprises
  • CIT reduction for enterprises established in certain development zones

Key Preferential CIT Incentives Checklist

CIT incentives for small and low profit enterprises

CIT incentives for high-tech enterprises

CIT deductions on R&D expenditures

CIT incentives for advanced technology service enterprises (ATSE)

CIT incentives for qualified enterprises making investment to encouraged industries in the west China region

Tax incentives for enterprises engaging in pollution control

CIT incentives for enterprises making investments in or operating of public infrastructure projects specially supported by the state

CIT incentives for enterprises that are established in development zones, such as Hengqin area and Qianhai area in Guangdong Free Trade Zone (FTZ), and Pingtan area in Fujian FTZ, and are engaged in encouraged industries

Tax reduction for enterprises investing in seed-stage or start-up technology enterprises

Tax incentives for software enterprises and integrated circuit enterprises

Income derived from eligible technology transfers

[faq title="FAQ: China’s Latest Corporate Income Tax Update for Six Items" ui="accordion"]

The corporate income tax treatment of which six items have been updated?

China’s tax body recently clarified the corporate income tax assessment applicable on six items, including expenses associated with COVID-19 charitable donations, convertible bonds, and cross-border hybrid investments. Enterprises should note that the new policy will close some prevailing corporate income tax loopholes.

On June 25, 2021, the State Taxation Administration (STA) released the Announcement about Policies for Collecting Corporate Income Tax (STA Announcement [2021] No.17). The Announcement, applicable for tax settlement and payment in the 2021 tax year and future years, clarified the following corporate income tax (CIT) treatment on six items in China:

  • Pre-tax deduction of expenses associated with COVID-19 charitable donations;
  • Tax treatment for the conversion of convertible bonds into equity investments;
  • Tax treatment for cross-border hybrid investments;
  • Tax treatment for assets after the change from “levying upon assessment” to “levying upon audit of accounts”;
  • Tax treatment for enterprise’s collection of cultural relics and artworks assets; and
  • The point of time to recognize the income after receiving government payments.

This article explains the CIT treatment for the six items for the reference of enterprises.

How to deduct expenses associated with COVID-19 charitable donations?

During the pandemic, some enterprises made donations towards COVID-19 relief. To encourage such acts and help businesses make it through the year, the government rolled out support measures (MOF SAT Announcement [2020] No.9), which allow cash and materials donated by enterprises to combat COVID-19 to be fully deducted before calculating corporate income tax (CIT).

However, when corporate taxpayers make non-monetary asset donations, some of them incur transport fares, insurance fares, handling charges, labor costs, and other related costs.

For these costs, the STA Announcement [2021] No.17 clarifies that:

  1. If the expense is included in the amount recorded in the donation voucher issued by the state organs or public welfare social organizations, it can be deducted before CIT as public welfare donation expenditure.
  2. If aforesaid expense is not included in the said amount, it can be deducted before CIT as related corporate expenditure.

To be noted, for general charitable donations, the deduction limit is within 12 percent of the enterprise’s gross annual profit, and the excess part can be carried over to the following three years. In principle, the same expense cannot be repetitively deducted.

What is the tax treatment for conversion of convertible bonds into equity investments?

A convertible bond is a fixed-income corporate debt security that yields interest payments but can be converted into a predetermined number of common stocks or equity shares.

The conversion from bond to stocks can be done at certain times during the bond’s life and is usually at the discretion of the bondholder. A vanilla convertible bond provides the investor with the choice to hold the bond until maturity or convert it to stocks.

The STA Announcement [2021] No.17 clarifies the CIT treatment for conversion of convertible bonds into equity investments:

CIT treatment for holders (purchasing enterprises) of convertible bonds

  1. If a bondholder obtains interest income at an agreed rate during the holding period, the bondholder should declare and pay CIT according to law.
  2. If a bondholder converts the bond into stocks together with the accrued interest receivable, even the accrued interest receivable is not recognized as income on the bondholder’s accounting books, it should be recognized as interest income of the current period by tax authorities and be declared for tax purposes. After conversion, the purchase price of the bond, the accrued interest receivable, and related taxes and fees paid together constitute the cost of the equity investment.

CIT treatment for issuers (issuing enterprises) of convertible bonds

  1. If a bond issuer incurs interest expense of convertible bonds, the cost can be deducted before CIT.
  2. If the bond issuer converts the bond into stocks together with the unpaid interest payable, the unpaid interest payable should be deemed as having been paid to the investor and should be allowed to be deducted before CIT.

In short, for convertible bond issuers, the interest expense, which is part of the company’s financing cost, is allowed to be deducted before tax.

If the bondholder converts the convertible bonds as well as the accrued interest receivable (which is the unpaid interest payable for bond issuers) into stocks, the interest should be deemed as received by the investor and thus for bond issuers, it is allowed for pre-tax deduction.

What is the tax treatment for cross-border hybrid investments?

Hybrid investment refers to investments that have dual characteristics – of equity and debt.

According to the STA Announcement on Issues Relating to Handling of CIT on Hybrid Investments of Enterprises (STA Announcement [2013] No.41), if a hybrid investment meets certain conditions, it can be treated as debt investment (instead of equity investment); thus, the investee enterprise can recognize interest expense and carry out pre-tax deduction.

In a bid to fill tax loopholes omitted in the SAT Announcement [2013] No.41, which was implemented from 2013, the SAT Announcement [2021] No.17 added two restrictive conditions. The added conditions will prohibit hybrid investment from being seen as debt investment under certain situations.

According to the No.17 Announcement, if a hybrid investment meets both of following two conditions, the interest paid by the domestic investee enterprise to the overseas investment enterprise should be regarded as dividend (that is, to be regarded as equity investment instead of debt investment), and cannot be deducted before CIT:

  1. Foreign investment enterprise and domestic investee enterprises are related parties; and
  2. The country (region) where the foreign investment enterprise is located recognizes the investment income as equity investment income and does not levy CIT on it.

What is the tax treatment for assets after the change from “levying upon assessment” to “levying upon audit of accounts”?

In China, there are two methods to collect corporate income tax:

  • Levying CIT based on audit of accounts; or
  • Levying CIT based on assessment.

Most corporate taxpayers are subject to CIT based on the audit of accounts. However, for taxpayers, such as those who are exempt from keeping accounts or those whose accounts are confusing, tax authorities will assess the percentage of their taxable income.

In some cases, taxpayers may eventually transfer from being levied CIT upon assessment to being levied CIT upon audit of accounts.

After the transformation, how to confirm the value of the company’s assets is important as it will affect the owner’s equity as well as depreciation and amortization expenses, which in turn will affect the profit and loss of the enterprise and its taxable income.

To avoid tax evasion, the STA Announcement [2021] No.17 clarifies how to confirm the value of assets for tax collection purpose.

How to confirm the value of the asset

According to the Announcement No.17, if an enterprise can provide an invoice for asset purchase, the tax should be calculated on the basis of the amount stated in the invoice.

In case an asset purchase invoice cannot be provided, the amount recorded in the asset purchase contract (agreement), proof of fund payment, and accounting materials and other documents may be used as the basis for tax collection.

How to deal with the depreciation and amortization of the asset

For an asset that was put into use during the period of levying upon assessment, after the enterprise transfers to levying upon audit of accounts, based on the depreciation and amortization years stipulated in the tax law, after deducting the use years of the asset, the amount of depreciation and amortization of the asset shall continue to be calculated and deducted before tax for the remaining year.

What is the tax treatment for enterprise collection of cultural relics and artworks assets?

Based on the STA Announcement [2021] No.17, cultural relics and works of art purchased by the enterprise and used for collection, display, and preservation and appreciation should be treated as investment assets for tax purposes.

Therefore, during the holding period of cultural relics and artworks assets, accrued depreciation and amortization is not allowed for pre-tax deduction.

When to recognize the income after receiving government payments?

Recognizing the income on the accrual basis

Pursuant to the STA Announcement [2021] No.17, where an enterprise sells goods or provides labor services at market prices and is paid in whole or in part by the financial department of the government, in accordance with a certain proportion of the quantity or amount of the goods sold or labor services provided by the enterprise, the income should be recognized under the principle of accrual basis.

Recognizing the income on the actual basis

Except for the aforesaid circumstances, for all kinds of government financial funds obtained by enterprises, such as financial subsidies, subsidies, tax rebates, and compensation, income should be recognized on cash basis – at the time on which the income is actually obtained.

China Briefing will keep you updated on the most recent tax news. Our parent company, Dezan Shira & Associates, has an experienced team of tax accountants, lawyers, and ex-tax officials who can help your business on a wide spectrum of tax service areas across all major industries. For more information and assistance, please email us at China@dezshira.com.

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