China, in a lot of cases, would be highlighted as a special example that operates differently from the rest of the world, either due to culture or regulations. Our previous blog posts have addressed main considerations during the registration process. Having the business established is merely the very beginning – the subsequent management in finance, operations, marketing and others are what make or break the deal, which is why tax services in China are so essential.
One of the main aspects to understand and operate with care is regarding the Corporate Income Tax (CIT), which all companies operating within the jurisdiction of PRC will be subjected to.
CIT duties are required to be settled on a quarterly basis, with potential adjustment applicable in the following fiscal year via annual tax filing.
CIT payable amount is generated from the taxable income of the enterprise applied by relevant tax rate.
Taxable Income = Total Annual Profit – (Expenses + Carries Forward Losses)
CIT Payable = Taxable Income * tax rate – Exemption or Deduction (if applicable)
1. Expenses & Carried Forward Losses
The “Carried Forward Losses” in the second equation, in China, could only be carried forward so long as 5 years. And because of the peculiar “fapiao” based tax system in China, all costs/expenses associated with the enterprise could only be deducted with corresponding fapiao in place. (see our previous blog post for more information on fapiao). ( https://mp.weixin.qq.com/s/FWfBzszTPpW6qXpjpGqJ_w)
2. Tax Rate
The tax rate varies for resident enterprises and non-resident enterprises. The former is taxed on their global income with either standard CIT rate (25%) in China, or the opportunity to request using the lower Double Tax Agreement rate (if applicable). All companies registered in China or those have permanent establishment in China will be liable for CIT as Resident Enterprises.
The enterprises that are established under the jurisdiction of any foreign law and have no permanent establishment (see following section for detailed explanation) in China will be deemed to be Non-resident Enterprise, which will only be taxed on the portion of income (with tax rate of 20%) that is sourced from China. When an entity is the tax resident in both PRC and another country/region, provided there is a double tax agreement (DTA) in place, this entity has the opportunity to request to have the (presumably lower) withholding tax rate applied.
3. Exemption
The CIT payable amount could be offset by certain exemptions or deductions specified in the tax law. The items are typically the expenses accumulated for income-producing purpose, including but not limited to:
- Employee salaries/remuneration: the keyword for this category is “reasonable amount”
- Employee welfare expenses: the expenses that do not exceed 14% of the total salaries of all employees is deemed deductible
- Social insurance premiums
- Business entertainment expenses: deemed to be 60% deductible
- Advertising and marketing expenses: up to the amount of 15% of annual sales revenue. The residuals could be carried forward to the following year.
- Research & Development Expenses
- Borrowing costs
- Interest expenses
- Exchange losses
Resident or not? The concept of Permanent Establishment
To continue the conversation on resident enterprise and non-resident enterprise…
Permanent establishment (PE) is a concept in international taxation law to determine whether or not an individual or enterprise should be considered as a tax resident. Bilateral tax treaties generally define a PE depending on whether the firm has a “fixed place of business” within the target country. A few examples of a “fixed place of business” are:
- Place of management
- Branch or office, representative office
- Factory
- Workshop
- A mine, oil, or gas well, quarry or any other place where natural resources are extracted
There are, however, exceptions to the establishments mentioned above:
- Use of a facility solely for the storage, display or delivery of goods or merchandise owned by the corporation
- Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purposes of storage, display or delivery
- Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise
- Maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise (or collecting information) for the enterprise
- Maintenance of a fixed place of business solely for the purpose of carrying on,, for the enterprise, any other preparatory or auxiliary activity
- Maintenance of a fixed place of business solely for any combination of activities listed above
This bilateral tax treaty term, of course, has more nuanced-criteria than what was explained above. If you require a discussion on your specific case, feel free to contact our team anytime. The importance of understanding PE is to determine the tax resident status. If tax resident status is established, they will be subject to the tax liability in the corresponding country/region. In contrary, if they are deemed to be non-residents, they will only be taxed on the portion of income that is sourced from China.
Non-resident Enterprises – Withholding CIT
Non-resident enterprises that derive income (dividend derived from equity investments, royalty, interests and other income deemed taxable by tax bureau) from China will be subjected to withholding tax, which the entity in China will act as the withholding agent for the tax bureau. The CIT withholding tax rate is determined by multiply standard CIT rate (25%) by the deemed profit rate (15% – 50%). Therefore, it is at the discretion of the tax bureau to finalize the withholding rate.
CIT withholding rate = 25% * deemed profit rate
Preferential tax rates…
For Small firms and micro businesses
The criteria of being categorized as a small/micro business are as following:
- Company’s annual taxable income does not exceed RMB 3,000,000.
- Company’s employee is not more than 300 heads.
- Company’s total assets are below RMB 50,000,000.
Once qualified as small/micro business, they are eligible for the preferential CIT rate depending on their circumstances:
1. Profit less than RMB 1 million – CIT rate of 2.5% (reduced from 5%）;
2. Profit falls between RMB 1 million to RMB 3 million – CIT rate of 10%;
3. Company profit above RMB 3 million –CIT rate of 25%.
The expiry date of the small/micro business preferential rate is 31st December 2021. With regards to further extension on this policy, announcement has yet to be made. Considering the current pandemic circumstances, further extension on this policy would not be surprising.
Other preferential rates
- High-tech company enjoy a 15% CIT rate.
- 10% CIT rate is applicable to firms in integrated circuits design and software industries, with the exemption on the first 5 years.
- Free Trade Ports of Free Trade zones enjoys reduced CIT rate, depending on the specific policies applicable to the zones.
Filing Schedule of Corporate Income Tax
Quarterly filing and payment are the minimum requirement for all companies, while monthly filing is performed by large enterprises. The typical deadline of tax prepayments is 15 days prior to the end of the month or the quarter, though it might be adjusted in the case of public holidays. With a tri-parte agreement in place, the tax amount will be drawn directly from the associated corporate account. It is common that the tax liability in the legal sense to differ from the tax liability in the accounting record. The annual tax filling (completed before end of May in the subsequent year) provides an opportunity for the enterprise to recognize the differences and settle it either through refund or supplementary payment.
On a sidenote…
A note worth taking is that the income derived from individual proprietary firm and partnership will be regarded as personal income. Therefore, they are not under the jurisdiction of CIT.
Conclusion
Accounting/finance wellbeing is the bottom line of a business, which either provides space and resource for other components to function or put a strain on them. Therefore, thorough understanding and effectively management on a company’s finance is paramount. It is advisable for all companies with revenue affiliation with China to carefully asses the tax situation to mitigate compliance risk and maximize tax benefits. If you have any tax related or general Chinese business-related queries, please contact STAR for consultations anytime at: Nancy@www.star-acc.com.
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