New Corporate Income Tax Law 2008

“The Detailed Implementation Rules of Corporate Income Tax Law (CIT Law)” [State Council Order No.512]

On 6 th December 2007, the State Council released State Council Order No.512, providing the Detailed Implementation Rules (DIR) in accordance with the new CIT Law which was issued on 16 th March 2007. We summarized the significant changes as below.

1. Tax Resident Concept
   The new CIT law introduced the concept of tax resident. An enterprise will be deemed as tax resident provided its effective management is located in China, regardless of where the enterprise is actually established. The DIR explained that the effective management refers to, in substance, the place where there is exercise of overall management and control of the production and business operations, personnel, accounting, properties, etc. of a foreign company.
   
2. Preferential Tax Treatment
   - High/ new technology enterprise/ project
   
   

   Items	Preferential Tax Treatment
   Lower tax rate for high/new technology enterprise	Reduced CIT rate of 15% is applicable.
   Qualified technology transfer exemption for tax resident	The first RMB 5 million income from technology transfer on a yearly basis is exempt from tax; whilst the exceeding amount can enjoy half reduction.
   Qualifi ed R&D expenses super deduction	50% of actual qualified R&D expenses are allowed for super deduction when they do not form an intangible asset; or 150% of the cost is allowed to be amortized when they form an intangible asset.
   Tax credit on venture capital investment	70% of venture capital equity investment in un-listed high/new technology SMEs can be deducted against taxable income after the holiday period has reached 2 years. Any portion that is not utilized in that year may be carried forward and deductible in the following years.
   Accelerated depreciation for certain fixed assets	Minimum of useful lives can be as low as 60% of normal useful lives. Double declining balance method or sum-of-years-digits method are allowed to adopt.

   
   Stated in the DIR, a High/New Technology Enterprise refers to the enterprise which meets all the following criterion:
   
   1. Owner of core proprietary intellectual properties;
   2. Products or services fall within the definition of High/New Technology Encouraged by the Chinese Government, which is to be further defined by the Science and Technology Commission, Ministry of Finance, and State Administration of Taxation and approved by the State of Council;
   3. Actual R&D expenses accounts for no less than certain percentage of annual income;
   4. Annual revenue generated from high-technology products (or services) accounts for no less than certain percentage of total income;
   5. Technical employees account for no less than certain percentage of total employees;
   6. Other criteria are stated in the Administrative Measures for the Assessment of the High/New Technology Enterprise.
      
      Further administration rules will be issued soon by the relevant authorities.
      
   - Qualified small scale and thin profit enterprise
   

   Lower tax rate of 20% is applicable.

   The deeming criterion of qualified small scale and thin profit enterprises are as follows:
   1. For industrial enterprises
      1. Annual taxable income <= RMB 0.3 million;
      2. Number of employees <= 100; and
      3. Total assets <= RMB 30 million.
   2. For other enterprises
   • Annual taxable income <= RMB 0.3 million;
   • Number of employees <= 80; and
   • Total assets <= RMB 10 million.

   - Public infrastructure project
   3 years tax exemption and 3 years half reduction commencing from the first year of production/operation.

   Such projects are referred in The Catalogue For Preferential CIT of Public Infrastructure Project; including port, airport, railway, road, urban traffic, electric power, water conservancy, etc.

- Qualified environment protection, energy and water conservation projects
3 years tax exemption and 3 years half reduction commencing from the first year production/ operation.

10% of investment in specific equipments may be offset against its income tax payable for the current year. Any excess amount may be carried forward and deductible in the following 5 tax years.

Detailed criterion and ranges for the qualification will be released by related government authorities.

- Enterprise utilizing comprehensive resources as its primary raw materials
Contained in the Catalogue For Comprehensive Utilization of Resources Qualified For CIT Preferential Treatment and producing non-restricted products are qualify to calculate taxable revenue at 90% of actual revenue.

- Non-profit-making Organizations
Full exemption is allowed for non profit-making organizations; with exception on such organizations’ income derived from profit-making activities.

- Agricultural, forestry, farming, fishery
Tax exemption or reduction applies on qualified income.

3. Grandfathering Rules
   The new CIT law allows unused tax holidays to be carried forward to 2008 and beyond until expiry, whilst the gradual increase of the tax rate from 15% or 24% to 25% will overlay with any unused tax holidays. However, the new DIR still remains silent on how the new tax rate will be phased in for existing foreign invested entities (FIEs), which enjoy currently 5 year tax holiday. We expect that the detailed grandfathering rules will take the form of a separate circular to be issued soon.
4. Withholding Tax for FIEs
   The DIR provides a tax rate of 10% for dividends, interest, royalties, rental income capital gains or other income derived from sources in China by non-tax resident other than permanent establishment. Tax will be exempted for interest income derived from preferential loan provided by international financial institutions to China tax resident or the Chinese government.
   
   The DIR specifies the recognizing date of each item:
   
   

   Dividends	The date in which the investee makes a resolution to make profit distribution
   Interest	Due dates as agreed with the debtor in the contracts
   Rental income	Due dates as agreed with the lessee in the contracts

   
   
5. Tax-Deductible Expenses for FIEs
   
   

   Expenses	Under Existing CITs Law	Under New CITs Law
   Employee training expenses	1.5% of the deductible employees’ remuneration.	2.5% of the employees’ gross salaries and wages; Amounts in excess of the allowable deduction can be carried forward to future years
   Entertainment expenses	0.5% for first RMB 15 million of net sales; 0.3% for the exceeding amount; 1% for the first RMB 5 million of turnover; 0.5% for the exceeding amount.	60% of actual expenses; A further cap of 0.5% of current year turnover
   Advertising and business promotion expenses	No limitation	Capped at 15% of current year turnover; Amount in excess of the allowable deduction can be carried forward to future years
   Donation to certain public welfare	No limitation	Capped at 12% of gross profit
   Fixed assets	10% of residual value Minimum 5 years depreciation for electronic equipments and transportation equipments other than trains and vessels	Reasonably estimated residual value Minimum depreciation period for: Aircrafts :10 years Transportation equipments other than aircrafts, trains and vessels: 4 years Electronic equipments: 3 years
   Pre-operation expenses	Deferral period of at least 5 years	Deferral period of at least 3 years
   Improvement expense forRenovation on leased fixed assets	Deferral period of at least 5 years	Deferral period according to the terms stated in contracts.

   
   
6. Anti-tax-avoidance Measures
   - The tax authority may adjust taxable income due to non-compliance with arm’s length principle in related transactions. The following methods may be adopted for the adjustment purposes:
   
   • Comparable uncontrolled price method
   • Resale price method
   • Cost plus method
   • Transactional net margin method
   • Profit split method
   • Other methods
     
   The tax authority reserves the rights to make such adjustments within 10 years from the tax year during which related transactions occur.
   
   - When tax authority carries out investigations on a particular transaction, other enterprises are obliged to provide sufficient information. Here, other enterprises refer to those which are comparable to the enterprise under investigation, in terms of the substance and the form of production and business operations.
   
   - In the case when an enterprise parks its offshore profit in tax havens, such enterprise that controlled by a China tax resident will be subject to China CITs Law, provided the effective tax rate impose on that enterprise is 50% or lower than the China tax rate. The meaning of “controlled” is stipulated in the DIR:
   
   1. A China tax resident, or Chinese individual directly or indirectly, individually own more than 10% of a foreign enterprise’s voting shares, and jointly own more than 50% of that foreign enterprise’s shares; or
      
   2. The percentage of ownership of shares that does not meet with the criterion prescribed in No. 1, but an effective control is exercised over the foreign enterprise by virtue of shares, capital, business operations, purchases and sales, etc.
   - If tax authority adjusts the taxable income for the current or previous years, interest rates of such overdue tax payment are:
   
   1. RMB benchmark interest rates for the loans of the corresponding year if the enterprise provides all relevant documents; or
   2. RMB benchmark interest rates for the loans plus 5% of the corresponding year for other cases.