Corporate Income Tax in China

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By the end, you will understand:

CIT for resident enterprises CIT for non-resident enterprises The deemed profit rate

The subject of a permanent establishment Tax incentives Calculation of the taxable income

Within a survey of 10 consulting

companies the German Institute for

Service Quality (DISQ) announced

ECOVIS as the Best Auditor for Medium-

Sized Enterprises in Germany for 2013!

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Client logos Corporate Income Tax

As a foreign business that generates income from Chi-

na, you may be subject to taxes from both your home

country and from China. Firms must be vigilent to min-

imize their tax losses and penaltieis and maximize tax

benefits to operate efficiently.

This primer will start with two different cases for a resi-

dent enterprise and a non-resident enterprise. To apply

the right form of taxation we need to distinguish be-

tween the companies that have a Permanent Estab-

lishment and those that do not. For example, PRC

sourced and foreign sourced income are both taxable

for a foreign company with an effectively connected

Permanent Establishment in China. But only PRC

sourced income is taxable for foreign companies with

no permanent establishment or one without an effec-

tive connection.

Non-resident enterprises

Non-resident enterprises are established under foreign

laws but have either a Permanent Establishment or

place of business within the PRC or generate income

from sources in China.

In general, foreign sourced income is not taxable.

However, if the foreign sourced income is effectively

connected to the Permanent Establishment then it will

be taxable. Here, we might need further explanation

regarding the term “effectively connected”. “Effectively

connected” refers to the company owning equity inter-

est or debt claims that give rise to income or if it owns,

manages and controls property giving rise to income.

Non-permanent establishment

For a company without a permanent establishment

within the PRC only the PRC sourced income is sub-

jected to withholding tax. Passive Income such as divi-

dend, interest, rental income, royalty, capital gain and

other income is subjected to a tax rate of 10% but the

domestic rate may be reduced. For example, if a recip-

ient of interest is a resident of Hong Kong the income

tax rate is reduced to 7%. Tax base is the total turno-

ver that the foreign enterprise generates in China for

the respective project.

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Client logos No expenses related to the services are to be deduct-

ed in this case. The Chinese customer is obliged to

withhold the tax for the foreign company and to trans-

fer it to the appropriate State tax authority.

Non-resident enterprise with a PE

There are several criteria for identifying a Permanent

Establishment.

Firstly, an establishment or place of business in China

can be:

• a management, business establishment or an

office,

• a factory, farm or a place of extraction of nat-

ural resources,

• a place providing services, place where a

project of construction, installation, assembly,

repair, exploration etc. is carried out or

• other establishments or places of business

where production and business operations are

carried out.

However, some activities are not considered a PE in

treaty provisions. For example, the use of facilities

solely for the purpose of storage, display or delivery of

goods or merchandise belonging to the enterprise; the

maintenance of the stock of goods or merchandise be-

longing to the enterprise solely for the purpose of stor-

age, display or delivery or by another enterprise; as

well as the maintenance of a fixed place of business

solely for the purpose of purchasing goods or mer-

chandise, or for advertising or for collecting information

for the enterprise.

Secondly, employees working in China must not ex-

ceed 6 months (180 days) continuously or cumulatively

in any 12 month period.

The last point concerns the appointment of an agent

to conclude contracts and accept orders in China. This

means a person in China acts on behalf of the non-

resident enterprise and has the authority to conclude

contracts in the name of the enterprise. Thus, if the

agent is independent from the enterprise, both legally

and economically, and if he is not engaged in any of

the said enterprises’ other economic activities, the en-

terprise will not be considered as a PE.

How to treat active income

Active Income from the sale of goods, provision of ser-

vices or from the transfer of property is subjected to

the CIT rate of 25% and is derived from an enterprise

with a taxable presence. A taxable presence means

that a particular foreign enterprise has set up a perma-

nent establishment in the PRC. Foreign enterprises

that have a permanent establishment in the PRC shall

be subject to tax on all PRC sourced income.

The calculation is sometimes complicated since non-

resident enterprises cannot declare the taxable income

accurately due to incomplete accounting books or oth-

er reasons.

Tax authorities determine taxable income using the fol-

lowing methods for different situations. Tax authorities

compare the calculated rates with the deemed profit

rates depending on the business type.

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Client logos Type Calculation of the taxable income

Assessment made on total revenue

(Actual revenue, but not costs, can be deducted

through accounting books or other reasonable

ways.)

= to𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒∗𝑑𝑒𝑒𝑚𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 𝑟𝑎𝑡𝑒

Assessment made on costs and expenses

(Costs can be calculated correctly but not the reve-

nues.)

𝑡𝑜𝑡𝑎𝑙 𝑜 𝑡 𝑒 𝑝𝑒𝑛 𝑒

( 𝑑𝑒𝑒𝑚𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡) ∗ 𝑑𝑒𝑒𝑚𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 𝑟𝑎𝑡𝑒

Assessment made on the basis of convert-

ing expenditure into income

(Expenditures can be calculated accurately but not

revenues and costs)

𝑡𝑜𝑡𝑎𝑙 𝑒 𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒

( 𝑑𝑒𝑒𝑚𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 𝑢 𝑖𝑛𝑒 𝑎 𝑎𝑡𝑒) ∗ 𝑑𝑒𝑒𝑚𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 𝑟𝑎𝑡𝑒

Table 1: Overview of the calculation of taxable income

These deemed profit rates are:

Performance of engineering, design or la-

bour service consultation: 15 - 30 %

Provision Management Service: 30 - 50%

Other labour services or operations: no

less than 15%

The tax authorities can apply a higher profit rate if they

have evidence to believe that the actual profit rate sig-

nificantly exceeds the prescribed ranges. It can also

occur if the non-resident enterprises fail to provide true

and valid proof for their expenditure. In this case tax

authorities may deem that all the services provided

take place within China and are therefore liable for

CIT. Regarding the registration, non-residents need to

complete their tax registration with a tax bureau at the

location of the project within 30 days after signing the

contract. Also the CIT filing needs to be done accord-

ing to CIT law and Detailed Implementation Regula-

tions.

Resident enterprises

Resident enterprises are either established under the

laws of the PRC or founded outside but have effective

management in China in the sense of a management

team with overall management control over manufac-

turing and business operations. The place of effective

management is where the main assets are gained, ac-

counting and other books are held, the shareholder

meetings take place and where half of the senior man-

agement staff is located. Resident enterprises have to

pay CIT within and outside of PRC which is slightly dif-

ferent to other countries because China does not dis-

tinguish between ordinary business income and capital

gains. Overseas income derived by resident enterpris-

es shall also be included in the taxable income for CIT

purposes. However, foreign income taxes that have al-

ready been paid be deducted or credited when calcu-

lating CIT.

Resident enterprises are subject to CIT on their global

income. Basically, it is the taxable income which is the

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Client logos gross income minus non-taxable income, tax exempt-

ed income, carried forward losses and other deduc-

tions. All points will be explained further.

Figure 1: Calculation of taxable income

Gross Income includes, but is not limited to,

sales income, service income, asset transfer

income, dividend income, interest income,

rental income, royalty income, donation in-

come and other income of both monetary and

non-monetary nature

Non-taxable income

Income exempt from tax, which includes inter-

est on state debt, income to non-profit organi-

zations and dividend income from a resident

enterprise

Forward carried losses can be carried forward

for a maximum of 5 years.

Other deductions include real and reasonable

expenses related to income generating activi-

ties, for example costs, expenses, taxes, loss-

es and other expenses incurred during the

course of generating income. Deduction of ex-

pense items should be related to the acquiring

income such as salary, staff welfare, educa-

tion, advertising expenses, entertainment ex-

penses and donation to qualified institutions.

The Statutory corporate income tax is 25

percent but there are several tax incen-

tives:

1. High and new Tech Company

The company must have been a resident of China

for over one year and own intellectual property for core

technologies used in their products or must give their

Chinese subsidiaries a global exclusive license for at

least 5 years. Also a sufficient R&D department is a

must and needs qualified personnel. At least 10% -

30% of them must have obtained a bachelor degree or

above. Additionally, the company must focus its activi-

ties on one of these areas:

Electronic information technology

Biological and new pharmaceutical technology

Aviation and aerospace technology

New material technology

High technology service industry

New energy and energy conservation technol-

ogy

Resources and environmental technologies

High and new technology for traditional indus-

tries innovation

The HNTE status is granted by provincial tax authori-

ties for companies located in those provinces. It offers

a tax reduced rate of 15 % and is valid for three years.

It can be renewed every three years.

Gross Income

Non-taxable income

Tax exempted income

Carried forward losses

Other deductions

= Taxable Income

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Figure 2: Tax incentives

2. R&D Expenditures

Another reduction that can be made is for R&D

expenses incurred in the development of new technol-

ogies, products and processes as far as it is not an in-

tangible asset. The super deduction can be an addi-

tional 50% from the R&D expenses. Requirements are

HR personnel costs, costs for the evaluation of R&D

results, clinical trial costs, maintenance testing & repair

costs, samples and models & testing equipment costs.

3. Salary of Disabled personnel cost

An additional 100% of salary expenses paid to

disabled personnel can be deducted from taxable in-

come.

4. Fixed Assets

1. Fixed assets susceptible to fast obsolescence due

to technological progress.

2. Fixed assets that are subjected to strong vibration

and therefore high corrosion throughout the years.

In the case of adapting a shorter-period deprecia-

tion method, the minimum term of deprecation shall not

be less than 60% of the depreciation duration as set

forth in article 60. When using an accelerating depreci-

ation method, fixed assets shall be depreciated using

the double declining balance method or the sum of the

years’ digits method.

5. Small or Low Profit enterprises

In order to fulfil the requirements, an enterprise

must have less than 300,000 RMB in annual taxable

income, less than 10 million RMB in total assets, less

than 80 employees and not be engaged in prohibited

or restricted industries. An exception is provided for

manufacturing companies which may have less than

100 employees and a maximum of 30 million RMB in

total assets. For small or low profit enterprises the tax

rate is 20% but you can get an additional 50% CIT re-

duction if the enterprise has less than 60,000 RMB of

annual taxable income.

Benefits 15% tax rate for high and new technology companies (HNTE)

50% Super deduction of R&D expenditures

100% super deduction of disabled personnel

cost

Possible accelerating deduction pace of fixed

assets 20% for small or low profit Enterprises under certain

restrictions (number of employees, & total assets

Income Subject to tax reduction or exemption

15% tax rate for western regions

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Client logos 6. Income Subject to Tax Reduction or

Exemption

Agriculture, forestry, animal husbandry and

fishery project income are exempt

Infrastructure projects and environmental pro-

tection, energy and water saving investments

are exempt for the first three years, and enjoy

three years of 50% reduction afterwards

Technology transfer income is exempt for up to

5 million RMB annually and a 50% reduction

for any amount which exceeds 5 million RMB.

7. 15% tax rate for Western Regions

Companies in western regions such as Chongqing,

Sichuan, Guizhou, Yunnan, Tibet, Shaanxi, Gansu,

Ningxia, Qinghai, Xinjiang, Inner Mongolia and Guang-

xi can profit from the reduced tax rate.

In order to benefit from all tax reductions and file your

CIT according to the regulations you should consult a

tax advisory. There are also other areas you need to

consider when doing CIT compliance.

We would suggest that you review internally and pre-

pare a CIT Annual Settlement Checklist which should

be reviewed by a tax specialist within the company. If

compliance is given, take action accordingly and con-

sult our tax experts from ECOVIS Beijing.

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