Income Tax Policies and Management Measures concerning Enterprises with Foreign

Income Tax Policies and Management Measures concerning Enterprises with Foreign Investment and Foreign Enterprises

<![if !supportEmptyParas]>  <![endif]>

• Taxpayers

The following enterprises with foreign investment and foreign enterprises are liable to pay income taxes:

1. Enterprises with foreign investment (hereafter referred to as EFIs): legal persons established under the Chinese laws, including Chinese-foreign equity joint ventures and Chinese-foreign contractual joint ventures established inside the Chinese territory by foreign companies, enterprises and other economic organizations together with Chinese companies and enterprises; and enterprises with sole foreign investment.

2.Non-legal-person Chinese-foreign contractual joint ventures: foreign partners in contractual enterprises which do not constitute legal persons.

3.Joint-stock enterprises: joint-stock enterprises emerged from Chinese-foreign equity joint ventures through reorganization, and joint-stock companies jointly sponsored by Chinese enterprises and Chinese-foreign equity joint ventures or foreign investors.

4.Foreign enterprises: non-Chinese legal persons, including foreign companies, enterprises and other economic organizations which have establishments or places in China and engage in production or business operations, and which, though without establishments or places in China, have income from sources within China.   As economic organizations set up by Chinese companies and enterprises abroad are foreign legal persons, their branches inside the Chinese territory are also liable to pay income taxes imposed on EFIs and foreign enterprises.

<![if !supportEmptyParas]>  <![endif]>

• Determination of taxable incomes

1.Scope of taxable incomes

⑴ Incomes from production and business operations

"Income from production and business operations" mentioned in Article 1,paragraph 1 and paragraph 2 of the Tax Laws means income from production and business operations in manufacturing, mining, communications and transportation, construction and installation, agriculture, forestry, animal husbandry, fishery, water conservation, commerce, finance, service industries, exploration and exploitation, and in other trades.

(2)Other incomes

"Income from other sources" mentioned in Article 1, paragraph 1 and paragraph 2 of the Tax Laws means profits (dividends), interest, rents, income from the transfer of property, income from the provision or transfer of patents, proprietary technology, income from trademark rights and copyrights as well as other non-business income.

The balance of the proceeds from re-transfer of the assigned land-use rights by EFIs shall, after the deduction of the original assigning fees and development costs, be entered into the profit and loss account of the current year, and subject to income taxes.

Net proceeds from stock or equity transfer by EFIs, or from transfer of holdings in enterprises within the Chinese territory by the Chinese establishment of foreign enterprises should be reckoned into their current taxable incomes. The net losses arising from the above mentioned stock transactions may be deducted from their current taxable incomes.

Lump-sum membership fees, qualification guarantees or other similar fees collected by EFIs during their preparation stage shall be included into taxable incomes averaged in five years from the day the said EFIs start operation.

EFIs and foreign enterprises are not liable to pay income taxes on interests obtained from treasury bonds they have purchased, but are so liable on interests obtained from transferring treasury bonds.

2.Computation of taxable incomes

(1)Manufacturing:

a.Taxable income = (profit on sales) + (profit from other operations) + (non-business income) - (non-business expenses);

b.Profit on sales = (net sales) - (cost of products sold) - (taxes on sales) - [ (selling expenses) + (administrative expenses) + (finance expenses) ];

c.Net sales = (gross sales) - [ (sales returns) + (sales discounts and allowances) ];

d.Cost of products sold = (cost of products manufactured for the period)+ (inventory of   finished products at the beginning of the period) -(inventory of finished products at the end of the period);

e.Cost of products manufactured for the period = (manufacturing costs for the period) + (inventory of semi-finished products and products in process at the beginning of the period) - (inventory of semi-finished products and products in process at the end of the period);

f.Manufacturing costs for the period = (direct materials consumed in production for the period) + (direct labor) + (manufacturing expenses).

(2)Commerce:

a.Taxable income = (profit on sales) + (profit from other operations) +(non-business income) - (non-business expenses);

b.Profit on sales = (net sales) - (cost of sales) - (taxes on sales) -[ (selling expenses) + (administrative expenses) + (finance expenses) ];

c.Net sales = (gross sales) - [ (sales returns) + (sales discounts and allowances) ];

d.Cost of sales = (inventory of merchandise at the beginning of the period) + { (purchase of merchandise during the period) - [ (purchase returns) + (purchase discounts and allowances) ] + (purchasing expenses) } - (inventory of merchandise at the end of the period).

(3)Service

a.Taxable income = (net business income) + (non-operating income) -(non-operating expenses);

b.Net business income = (gross business income) - [ (taxes on business income) + (operating expenses) + (administrative expenses) + (finance expenses) ].

(4)In other lines of business, computations shall be made with reference to the above formulas.

<![if !supportEmptyParas]>  <![endif]>

• Computation and payment of tax

Enterprise income tax and local income tax should be calculated on an annual basis and paid on a quarterly basis within 15 days after the end of a quarter, and should be cleared within five months after the end of the tax year with refunds for overpayments   or supplementary payments for any deficiencies.

If the final day of the period for payment of tax falls on a Sunday or a legal holiday, the day

following the holiday shall be used as the last day of the period..  

When enterprises pay income taxes in advance on a quarterly basis according to the Tax Laws, payment shall be made based on their actual profits of the quarter.   If they have difficulty to do so, they may pay the tax on one quarter of the taxable incomes of the previous year or make quarterly payments in other ways approved by local tax authorities.

<![if !supportEmptyParas]>  <![endif]>

• Filing periods and requirements

1.Quarterly and annual filing of tax returns  

While engaged in productions or business operations, EFIs or establishments set up by foreign enterprises within the territory of China shall file provisional income tax returns with local tax authorities within the period for each advance payment of tax, and it shall file an annual income tax return together with the final accounting statements within four months from the end of the tax year.  

Enterprises, no matter profitable or not in the tax year, should file the income tax returns and final statements of account with local tax authorities within the timeline stipulated in Article 16 of the Tax Laws, and unless otherwise provided by the State, shall include when filing the final accounting statement an audit statement of a certified public accountant registered in China

Where, for special reasons, an enterprise cannot file an income tax return and final accounting statement within the period prescribed in the Tax Law, an application shall be submitted within the filing period and, upon approval of the local tax authorities, the filing period may be extended appropriately.

If the final day of the period for filing of a tax return falls on a Sunday or a legal holiday, the day following the holiday shall be used as the last day of the period.

2.Filings during the liquidation period

During the liquidation period, EFIs shall file their income tax returns with local tax authorities before applying for deregistration at the competent administration for industry and commerce.

3.Filings by branches

When branches or business organizations submit their final accounting statements to their head offices or to other business organizations responsible for consolidated filings, they should also send a copy to local tax authorities at the same time.

4.Settlement of income taxes in the event of business mergers, separations and terminations

Enterprises that are merged, separated, or terminated during the year shall, within 60 days of the termination of production or business operations, complete with the local tax authorities procedures for the settlement of any liability for and payment of income tax, with refunds for overpayments or supplementary payments for deficiencies.

<![if !supportEmptyParas]>  <![endif]>

• Income tax settlement by EFIs or foreign enterprises

1.Definitions of applicable enterprises

In principle, except otherwise approved by competent tax authorities, all enterprises that start production and business operations (including trial production and trial business operation) within the tax year, or that experience merger, spin-off and termination in the tax year should, no matter they are profitable or not, settle their tax payments according to the Tax Laws and these measures. During the period of construction, foreign-funded real estate enterprises liable to provisional income taxes do not have to make the final settlement of income taxes for the year.

2.Current income tax settlements of enterprises

Enterprises should make annual returns to competent tax authorities, indicating their taxable incomes, payable taxes, allowances, credits and additional taxes for overseas incomes of the previous year within four months after the end of each year. They should deduct their income taxes already paid in advance from the actual taxes payable for the year, check and pay remaining taxes on their own. Competent tax authorities should conduct general auditing to the annual returns and other documents filed by enterprises, and settle their annual income taxes.

3.Timeline for enterprises to file the annual income tax returns

Enterprises should declare their current annual income taxes to competent tax authorities within four months after the end of a tax year and pay up their due taxes. Enterprises that have experienced mergers, separations and terminations during a tax year should declare their income taxes to competent tax authorities and pay up their due taxes within 30 days following the termination of productions and business operations.

4.Timeline for enterprises to settle taxes

Enterprises should settle their current taxes within five months after the end of a tax year.   Enterprises that have experienced mergers, separations and terminations during a tax year should settle their taxes within 60 days following the termination of productions and business operations.

5.Information to be submitted by enterprises when declaring annual income taxes

(1) Annual income tax returns and its supporting statement;

(2)Final financial and accounting statement of the year;

(3)Audit report of certified public accountants in China;

(4)Other materials required by competent tax authorities.

6.Before declaring annual income taxes, enterprises should check issues already reviewed, approved and confirmed by competent tax authorities.

(1)Preferential tax treatment, mainly including determination of the profit-making year, the offsetting of losses, entitlement to tax exemption and reduction for a given period, reduced tax rate for specific projects or sectors, deduction of technical development expenses, cost of purchasing domestically-made equipment credited against enterprise income tax, and local income tax exemptions;

(2)Itemized pre-tax costs, mainly including bad loan reserves, property losses, loan interests and expenses on wages and benefits.

(3)Changes of accounting methods.

(4)Other issues that must be approved by competent tax authorities.

7.In case enterprises cannot declare their annual income taxes or get all documents ready within the stipulated timelines due to particular reasons, they should complete the Application for Extensions and submit it to competent tax authorities within four months after the end of a year. A reasonable extension may be granted as approved by competent tax authorities; or enterprises may submit the required income tax returns and supporting statements first and furnish other necessary documents at a reasonable later time. The extensions approved by competent tax authorities may not exceed one month.

8.Management of enterprises that adopt the method of consolidated filings and payment

Head offices or business organizations (hereinafter referred to as tax payment organizations) of enterprises that file and pay income taxes on a consolidated basis should obtain the Certificate of EFIs and Foreign Enterprises Filing Consolidated Income Tax from competent tax authorities before May 31 every year, and submit the Certificate, annual tax returns and accounting statements to the tax authorities at the locations of other branches or business organizations (hereinafter referred to as business organizations) before June 30 every year.

In case the tax payment organizations fail to submit the Certificate to competent tax authorities at the locations of the business organizations within the specified timelines and cannot prove any extension is approved, the said tax authorities shall ascertain the income taxes payable by the business organizations, calculate due taxes, collect taxes on site and impose a penalty by taking into account any taxation treatments under the Tax Laws and regulations.   If these enterprises are in the middle of a loss-making or tax-exemption year, the said tax authorities should inform their counterparts at the locations of the tax payment organizations in writing for unified tax adjustment.

9.When declaring annual income taxes, enterprises should request certified public accounts in China to include in their annual audit reports the items, reasons, basis, estimation processes and values in respect of tax adjustments, and to indicate taxable incomes of the year.

10.In case enterprises discover any mistake in their current returns within the timeline for the income tax settlement, they may re-declare and resettle the annual income taxes with competent tax authorities within such timeline.

11.Enterprises that fail to file annual income tax returns within stipulated timelines, delay the filings without the approval of competent tax authorities, or fail to submit complete and satisfactory materials should make the returns again within a new time limit after the Notice on Mandatory Corrections within Stipulated Timeline is served on them by competent tax authorities. If any enterprise fails to file annual income tax returns within stipulated timelines and no extensions are approved by the tax authorities, the tax authority may, in addition to demanding returns be made within another time limit, impose a fine of less than RMB2000 according to the Tax Laws. If any enterprise fails again to meet the timelines, competent tax authority may impose a fine between RMB2000 and 10,000, while verifying the taxes payable of the year and demanding the payment be made within stipulated timelines. After receiving the Notice on Verified Taxes Payable from competent tax authorities, the enterprise should pay the taxes within stipulated timelines.   If any enterprise fails to complete the procedures for the settlement of taxes within stipulated timelines, competent tax authorities may demand payments within a new time limit and impose an overdue fine of 0.05% per day from the date of default.

12.Enterprises that use non-calendar year for tax payment with the approval of competent tax authorities should settle and pay up their annual income taxes within five months after the end of the tax year according to relevant stipulations of these Measures.

13.In case the final day of the period for filing returns falls on a legal holiday, the deadline shall be the day following the holiday. In case a holiday of more than three days falls within the period, the filing may be extended by the same number. In case there is any dispute between enterprises and competent tax authorities on tax payment, enterprises must first pay up their taxes and overdue fines or provide relevant guarantees according to the tax payment decisions made by competent tax authorities, and then apply to the higher level tax authorities for administrative review within 60 days after paying taxes or providing the guarantees. When submitting their final financial and accounting statements, enterprises should use the applicable EFIs format for the year provided by the Ministry of Finance.

<![if !supportEmptyParas]>  <![endif]>

• Management of account books and   vouchers

Under their financial and accounting systems,EFIs and foreign enterprises with productive and business establishments in China should maintain the appropriate accounting vouchers and books, ensuring the correct computation of taxable incomes.

Unless otherwise stipulated by the state, enterprises should maintain the appropriate accounting vouchers and books in China that support the correct calculation of taxable incomes.

Accounting vouchers, books and statements of enterprises shall be completed in the Chinese language or in both the Chinese language and a foreign language.

Enterprises that use electronic computers for purposes of book-keeping shall treat the accounting records in computer storage or in printed form as account books. All records on magnetic tape and diskette that have not been printed out shall be completely retained.

Accounting vouchers, books and statements of enterprises shall be retained for at least 15 years.

Enterprises may print and use their invoices and receipts only with the approval of local tax authorities.

The State Administration of Taxation is responsible for formulating the management measures for printing and using corporate invoices and receipts.

The State Administration of Taxation is responsible for printing the enterprise income tax returns and certificates of tax payment.  

<![if !supportEmptyParas]>  <![endif]>

• Tax Treatment of assets

1.Fixed assets and depreciation

(1)Definition of fixed assets

Fixed assets of enterprises refer to houses, buildings and structures, machinery, mechanical apparatus, means of transport and other such equipment, appliances and tools related to production and business operations with a useful life of one year or more. Items not in the nature of major equipment which are used for production or business operations and which have a unit value of 2,000 yuan (RMB) or less, or with a useful life of two years or less may be itemized as expenses on the basis of actual consumption.

(2)Valuation of fixed assets

The valuation of fixed assets shall be based on original cost. The original cost of purchased fixed assets shall be the purchase price plus transportation expenses, installation expenses and other related expenses incurred prior to the use of the assets. The original cost of fixed assets manufactured or constructed by an enterprise itself shall be the actual expenses incurred in their manufacture or construction. The original cost of fixed assets treated as investments shall, giving consideration to the degree of wear and tear of the fixed assets, be such reasonable price as is specified in the contract, or a price appraised with reference to the relevant market price plus the relevant expenses incurred prior to the use thereof. Depreciation of fixed assets received as gifts by enterprises may be computed on the basis of reasonable valuation.

(3)Treatment of renovated fixed assets

Where expenditures incur during the course of the use of fixed assets due to increased value caused by expansion, replacement, reconstruction and technical innovation of fixed assets (referring to technical innovation in original fixed assets to improve product performance, quality, variety and to reduce energy and raw material consumption, which adds new functions, increases values and extends the life of the fixed assets), the original value of fixed assets shall be increased; where the period of use of fixed assets can be extended, the useful life shall be appropriately extended and the computation of depreciation adjusted accordingly.

(4)Depreciation of fixed assets

Depreciation of fixed assets of an enterprise shall be computed commencing with the month following the month in which they are first put into use. The computation of depreciation shall cease in the month following the month in which the fixed assets cease to be used. In respect of the computation of depreciation of fixed assets, the salvage value shall first be estimated and deducted from the original cost of the assets. The salvage value shall not be less than 10% of the original value; any request for retaining a lower salvage value or no salvage value must be approved by the local tax authorities. Depreciation of fixed assets shall be computed using the straight-line method. Where it is necessary to use any other method of depreciation, an application may be filed by an enterprise which, following examination and verification by the local tax authorities, shall be reported level-by-level to the State Tax Bureau for approval. No further depreciation shall be allowed in respect of fixed assets which can be continued to be used after having been fully depreciated.

(5)Useful life of fixed assets

The computation of the minimum useful life in respect of the depreciation of fixed assets is as follows:

a.For buildings and structures:20 years; buildings and structures refer to buildings, structures and attached facilities used for production and business operations, or as living quarters and welfare facilities for employees, the scope of which is as follows: buildings, including factory buildings, business premises, office buildings, warehouses, residential buildings, canteens, and other such buildings; structures, including towers, ponds, troughs, wells, racks, sheds (not including temporary, simply constructed structures such as work sheds and vehicle sheds), fields, roads, bridges, platforms, piers, docks, culverts, gas stations as well as pipes, smokestacks, and enclosing walls that are detached from buildings, machinery and equipment; Facilities attached to buildings and structures mean auxiliary facilities that are inseparable from buildings and structures and for which no separate value is computed, including, for example, building and structure ventilation and drainage systems, oil pipelines, communication and power lines, elevators and sanitation equipment.

b.For railway rolling stock, ships, machinery, mechanical apparatus, and other production equipment: 10 years. The scope is as follows: railway rolling stock includes various types of locomotives, passenger coaches, freight cars, as well as auxiliary facilities on rolling stock for which no separate value is computed; ships include various types of motor ships as well as auxiliary facilities on ships for which no separate value is computed; machinery, mechanical apparatus and other production equipment include various types of machinery, mechanical apparatus, machinery units, production lines, as well as auxiliary equipment such as various types of power, transport and conduction equipment.

c.For electronic equipment and means of transport other than railway rolling stock and ships, as well as fixtures, tools and furnishings related to production and business operations:5 years. "Electronic equipment" means equipment comprising mainly integrated circuits, transistors, electron tubes and other electronic components whose primary functions are to bring into use the application of electronic technology (including software), including computers as well as computer-controlled robots, and digital-control or program-control systems. "Means of transport other than railway rolling stock and ships" include airplanes, automobiles, trams, tractors, motor bikes (boats), motorized sailboats, sailboats, and other means of transport.

(6)Treatment of accelerated depreciation on fixed assets

a.Scope of fixed assets allowing for accelerated depreciation

Machinery and equipment subject to strong corrosion by acid or alkali and factory buildings and structures subject to constant shaking and vibration; machinery and equipment operated continually year-round for the purpose of raising the utilization rate or increasing the intensity of use; fixed assets of a Chinese-foreign contractual joint venture having a period of cooperation shorter than the useful life specified in the Rules for the Implementation of Income Tax Laws and which will be left with the Chinese party upon termination of the cooperation; used fixed assets acquired by enterprises and having a remaining useful life shorter than that specified in the Rules for the Implementation of Income Tax Laws;   software purchased by EFIs whose cost reached the standard of fixed assets and whose useful life may be shortened to 2 years at a minimum; production equipment of EFIs engaged in integrate circuit production whose useful life may be shortened to three years at a minimum.

b.Authorization of accelerated depreciation on fixed assets

When accelerated depreciation is required on the above fixed assets, enterprises shall submit their applications to competent tax authorities, who, in turn, shall report to Beijing Municipal Office, State Administration Taxation(BJSAT), for examination and approval.

(7)Treatment of fixed assets transfer

The balance of proceeds from the transfer or disposal of fixed assets by an enterprise shall, after deduction of the undepreciated amount or the salvage value and handling fees, be entered into the profit and loss account for the current year

(8)Treatment of leased fixed assets

For fixed assets obtained by EFIs through financial leasing, income taxes payable by leaseholders shall be computed in the following ways:  

a.If the term of lease is longer than the statutory useful life of the fixed asset, the rent in each installment may be fully included in current cost and expense of enterprises provided such rent is less than the depreciation value computed on the basis of the useful life under the Tax Laws.

b.If the term of lease is shorter than the statutory useful life of the fixed asset and the rent in each installment exceeds the depreciation value computed on the basis of the useful life under the Tax Laws, the excess should not be treated as current cost and expense, but as expense to be amortized.   If the asset is transferred to the leaseholder upon the conclusion of the term of lease, such expense should be amortized for the remaining years after deducting the term of lease from the useful life no shorter than that stipulated in the Tax Laws.   If the asset is transferred or sold to a third party after the completion of the lease, the balance between the income so obtained and the expense not yet amortized may be treated as current income/loss.

c.Calculation of the depreciation value of leased fixed asset: the original value of the leased fixed asset includes the price paid by the leaseholder to purchase the fixed asset; the relevant transportation, insurance, installation and adjustment fees; and the price paid by the leaseholder to purchase the asset when the ownership of the asset is transferred to the leaseholder upon conclusion of the term of the lease according to contract.   The useful life and depreciation method for such fixed assets should be subject to the Tax Laws. Any changes in the useful life and depreciation method are applicable only when approved by the Ministry of Finance and its authorized departments.

2.Taxation of intangible assets

(1)Definition of intangible assets

Intangible assets of enterprises include patent right, proprietary technology, goodwill, trademark right, copyright and land/premise utilization right of enterprises.

(2)Valuation of intangible assets

For alienated intangible assets, the original value shall be the actual amount paid based on a reasonable price. For self-developed intangible assets, the original value shall be the actual amount of expenditure incurred in the course of development. For intangible assets used as investment, the original value shall be such reasonable price as is stipulated in the agreement or contract.

(3)Amortization of intangible assets

The amortization of intangible assets shall be computed using the straight-line method. Intangible assets transferred or assigned or used as investments, where the useful life is stipulated in the agreement or contract may be amortized over the period of that useful life; the amortization period in respect of intangible assets for which no useful life has been stipulated or which have been developed internally shall not be less than ten years.

3.Tax treatment of inventories

Inventories of merchandise, finished products, goods in process, semi-finished products, raw materials, and other such materials of enterprises shall be valued at cost. Enterprises may choose one of the following methods: first-in, first-out; moving average; weighted average or last-in, first-out as the method of computing actual costs in respect of the delivery or receipt and use of goods in stock. Once a method of valuation has been adopted for use, no change shall be made thereto. Where a change in the method of valuation is indeed necessary, the matter shall be reported to the local tax authorities for approval prior to the commencement of the next tax year.

4.Tax treatment of organization expenses

For enterprises, the period of organization refers to the period from the date of approval of the organization of the enterprise (the date of approval of the joint investment or cooperation agreement for Chinese-foreign equity joint ventures and Chinese-foreign contractual joint ventures;   the date of approval of the application for starting a business for wholly foreign-funded enterprises)to the date of commencement of production and business operations (including trial production and trial business operations).

Expenses incurred during the organization period of   EFIs refer to those related to the organization of the enterprises, including wages for personnel engaged in the organization, travel fees, training fees, consultant fees, hospitality fees, document printing fees, communication fees and fees for opening ceremonies.   However, such expenses do not include expenditures on purchasing and building fixed assets such as machines, equipment and construction facilities; expenditures on purchasing intangible assets; and expenses that should be borne by the investors according to stipulations in the contract, agreement or articles of associations.  

Expenses on feasibility studies jointly conducted by all parties of a Chinese-foreign equity joint venture or Chinese-foreign contractual joint venture before the joint investment or cooperation agreements and contract is approved may be treated as organization expenses after the approval of competent tax authorities.

Expenses incurred during the organization period should be amortized beginning with the month following the one in which productions and business operations commence.   The amortization period should not be less than five years.   Enterprises with a period of business operations less than five years may amortize their expenses equally in the actual operation period after the approval of the tax authority.

5.Tax treatment of donations

EFIs and establishments set up within the Chinese territory by foreign enterprises should reckon non-monetary assets (including fixed assets, intangible assets and other goods) they have received as donations in their assets according to prices determined by the asset evaluators’ reports. Itemized as current incomes, the donations are subject to income taxes after being set off against previous losses. If the balance after such offsetting is too large for enterprises to pay the lump-sum tax, enterprises may reckon them in the taxable incomes equally in a period of less than five years after the approval of competent tax authorities. They should reckon monetary donations received in their current incomes in lump sum and calculate the income taxes accordingly.

<![if !supportEmptyParas]>  <![endif]>

• Tax treatment of benefits and allowances

Beginning on 1 January 1999, EFIs and foreign enterprises may make provisions for three employee funds (health insurance fund, housing fund and pension fund) according to relevant stipulations of local governments. In addition, they may also make provisions against staff education expenses and workers union expenses according to the current accounting system.   They cannot make pre-tax provisions for any employee benefits and allowances other than those mentioned above. Any actually incurred benefits and allowances other than those mentioned above may be deducted before the payment of current taxes.   However, such deductions should not exceed 14% of the annual pre-tax wage bills of enterprises, and any amount in excess may not be offset in the following years.

<![if !supportEmptyParas]>  <![endif]>

• Tax treatment of business reorganization

According to the Income Tax Laws of the People’s Republic of China for EFIs and Foreign Enterprises as well as the rules for its implementation, the State Administration of Taxation provides for tax issues such as recognition of the continuation of business operations, asset valuation, preferential tax treatment and carrying forward of losses concerning business reorganizations in the form of merger, separation, equity restructuring and asset transfers.

1.Tax treatment of merger

Merger refers to the joining of two or more enterprises into one according to relevant laws and regulations. There are two types of merger. If all the parties in a merger are dissolved to set up a new enterprise, it is a merger by formation of a new company (also known as merger by dissolution). If one enterprise survives while other enterprises dissolve and join in this enterprise, it is a merger by acquisition (also known as merger into the surviving company). In either form of merger, enterprises do not have to go through liquidation procedure. Shareholders (investors) of enterprises before the merger may continue to be shareholders of the merged enterprise unless they withdraw their shares. The merged enterprise shall assume the financial claims and debts of its predecessors according to legally stipulated procedures.    

Business operations of enterprises before and after the merger should be treated as continuous for taxation purpose.   Merged enterprises, if still eligible for the EFI status under applicable legal stipulations, should observe the following rules of taxation:

(1)Treatment of asset valuation

After the merger, all assets, liabilities and shareholders’ equities of enterprises should be valued at the historical book costs before the merger, rather than the adjustment based on asset revaluations enterprises conducted for the purpose of merger.   Any enterprise that has adjusted the book values of assets according to revaluations, made provisions for the deprecation and amortized expenses accordingly should readjust its current taxable incomes to be declared:

a.Yearly readjustment as things really are: during each tax year, the current costs and expenses overstated or understated through depreciation and amortization and as a result of changed asset values should be adjusted under the appropriate expense items of the annual returns, so as to increase or reduce taxable incomes accordingly.

b.Comprehensive readjustment: for the part of change resulting from the revaluation of the enterprise assets, readjustments may be made to the current cost and expense items declared for annual tax payment on an average 10-year period basis without distinguishing the asset items; the taxable amount of income shall be increased or decreased correspondingly.

Before adopting either of the above methods, enterprises should apply to competent tax authorities for approval. They should submit all relevant accounting materials to competent tax authorities when filing their annual returns.

(2)Tax holidays

Merged enterprises whose production and business operations meet the conditions for tax holidays under the Tax Laws should continue to enjoy the tax treatments of their predecessors.   The specific tax arrangements are as follows:

a.A merged enterprise is no longer entitled to the same preferential treatment enjoyed by its predecessors provided the tax holiday expires for its predecessors.

b.A merged enterprise shall continue to enjoy preferential treatment until the date of expiration provided the tax holiday is not complete yet and the remaining term is the same for each of its predecessors.

c.If the remaining period of preferential treatment varies for the predecessors of a merged enterprise, or any of the predecessors is not qualified for preferential tax treatment, the merged enterprise should compute its taxable incomes according to Item 5) of this section. Deduction and exemption is applicable for the income derived from the business portfolio entitled to preferential treatment, with varying date of expiration; the income derived from the business portfolio not entitled to preferential treatment is not subject to any deduction or exemption.

(3)Treatment of reduced tax rate

Region or sector-specific reductions in tax rate for merged enterprises or their business organizations should be determined in light of their actual production and business operations and according to relevant stipulations in the Tax Laws and its implementation rules. The chargeable taxes on incomes should be computed respectively in line with Item (5) of this section.

(4)Treatment of previous losses

A merged enterprise may offset the losses incurred to its predecessors and not yet made up by incomes on annual basis during the remaining period of loss offsetting years under Article 11 of the Tax Laws. If a merged enterprise has business organizations in areas with different tax rates, or has businesses subject to different tax rates or different periods of exemption and deduction, it should calculate incomes derived from these areas or businesses respectively according to Item (5) of this section. The said losses of the predecessors should be offset against incomes subject to the same preferential tax treatment as before merger. Paragraph 2, Article 91 of the Rules for the Implementation of the Income Tax Laws should be observed for this purpose.

(5)Division of taxable incomes

If the predecessors are engaged in businesses where different tax rates apply, or the remaining period of preferential tax treatment varies for each of them, the merged enterprise shall make different tax arrangements for their taxable incomes according to the preceding paragraphs, calculate their taxable incomes separately according to Articles 91, 92 and 93 of the implementation rules of the Tax Laws.   They may follow particular methods listed below:

a.If the predecessors are transferred into business organizations of the merged enterprise and engaged in the productions or business operations as before, the taxable income incurred by each of the business organizations should be separately computed provided separate account books can be maintained to calculate such incomes accurately and properly.

b.If the predecessors are not transferred into separate business organizations, or though so transferred, the merged enterprise fails to calculate taxable incomes of these business organizations accurately and properly in the view of competent tax authorities, the current taxable income of the merged enterprise should be computed by using one ratio of the following or the average of these ratios: ratio of annual business incomes, ratio of costs and expenses, ratio of assets, ratio of the number of employees, or ratio of wage bills between business organizations or business portfolios where different tax treatments apply. In case the above mentioned ratios are not easily determined as they involve any post-merger data, enterprises may use the data for the last full tax year before merger or for a reasonable period.

2.Tax treatment of separation

Separation refers to the act wherein one enterprise separates into two or more according to relevant stipulations in the laws and regulations. It is either in the form of the establishment of new enterprises (also known as dissolution-based separation) whereby the original enterprise is split into two or more with the enterprise itself dissolved; or in the form of spin-off (also known as existence-based separation) whereby the original enterprise continues to exist while a part of it is set up as one or more new enterprises.   Enterprises do not have to go through liquidation regardless of what methods they adopt for separation. Shareholders (investors) of enterprises before the separation may continue to be shareholders of all or some of the enterprises after the separation. Financial claims and debts of enterprises before separation should be borne by separated enterprises according to procedures stipulated by law and agreements in separation contracts.

Business operations of enterprises before and after separation should be treated as continuous for the purpose of taxation. Separated enterprises, if still eligible for the EFI status under applicable legal stipulations, should observe the following rules of taxation:

(1)Treatment of asset valuation  

After the separation, all assets, liabilities and shareholders’ equities of enterprises should be valued at the historical book costs before the separation, rather than any adjustment based on asset revaluation conducted by enterprises for the purpose of separation. Any enterprise that has adjusted the book values of assets according to revaluation, made provisions for the deprecation and amortized expenses accordingly should readjust its current taxable incomes to be declared according to the preceding paragraphs on treatment of asset valuation for merged enterprises.

(2)Preferential tax treatment

Reduced tax rates, tax holidays that enterprises inherit from their predecessors after the separation should be determined in line with their production and business operations and according to relevant stipulations in the Tax Laws and its implementation rules.

a.For enterprises after the separation whose production and business operations meet the requirements of tax holidays, they shall not enjoy preferential tax treatment, provided the period for such treatments has expired before the separation. Enterprises whose productions and business operations do not meet the requirements of preferential tax treatments before the separation but qualify after the separation may enjoy the treatments for the remaining years of the preferential tax treatment period, starting from the first profit-making year of enterprises before separation.

b.Enterprises whose productions and business operations do not qualify for preferential tax treatment stipulated in the Tax Laws after separation may not enjoy or continue to enjoy such treatment.

(3)Treatment of previous losses

The losses not yet made up by incomes before the separation should be borne among all enterprises established after the separation according to their separation agreements.   The latter should offset the losses on annual basis in the remaining period of loss offsetting years stipulated in Article 11 of the Tax Laws.

3.Tax treatment for equity restructuring

Equity restructuring refers to changes in the shareholders (investors) or in the value or proportion of shares held by the shareholders (investors) of enterprises. In particular, it includes equity transfer and equity expansion. Equity transfer refers to the act in which shareholders of enterprise transfer some or all of their equity or shares to another party.   Equity expansion refers to the act wherein enterprises increase their capital by raising funds and issuing shares, when new shareholders invest in the shares or original shareholders increase their shares.

Equity restructuring of enterprises is an investment or transaction act of their shareholders.   It is a reorganization of enterprise equity structures, which does not affect the continuous existence of enterprises, and does not require enterprises to undergo liquidation process.   After equity restructuring, the financial claims and debt relations of enterprises remain effective.   The following stipulations should be observed in the tax treatment of equity restructuring:

(1)Incomes from equity transfer

When transferring their own equities or shares, EFIs or foreign enterprises should calculate, pay or withhold their income taxes according to the Tax Laws and its implementation rules. Losses incurred by enterprises within the Chinese territory in transferring equities or shares may be offset against their current taxable incomes.

Equity transfer incomes refer to the difference between equity transfer price and cost price.   Equity transfer price refers to the value in the forms of cash, non-monetary assets, rights or interests the transferor obtains in exchange for equity.   If a stock enterprise has retained shareholders’ earnings, such as unpaid profits or various funds drawn after taxes, the incomes from transferring the earnings (not exceeding the actual incomes of the transferor in the account books of the enterprise) together with the equities are investment incomes of the transferor, which should not be reckoned in the equity transfer price.   Equity cost price refers to the price actually paid by shareholders (investors) when purchasing the shares of the enterprise, or the equity transfer price actually paid to the original transferor of the equity when the equity was purchased.

(2)Treatment of the issuance of stock at a premium

For an enterprise which issues stocks, the part of premium resulting from the price of the stock issued being higher than the face value of the stocks is regarded as the rights and interests of the shareholder, and not as business profits on which income tax is to be levied; during enterprise liquidation, this part shall not included in the taxable income.

(3)Applicability of reinvestment tax rebate in shares purchased with profits (dividends)

Foreign investors who use profits (dividends) obtained from enterprises to purchase shares (or rationed shares) of the same or other enterprises are not qualified for reinvestment tax rebate.

(4)Tax treatment concerning equity restructuring enterprises  

Business operations of enterprises before and after equity restructuring should be treated as continuous for taxation purpose. The restructured enterprises that remain EFIs or still follow Tax Laws and regulations for EFIs should observe the following rules with regard to taxation:

a.Enterprises may not adjust the original book values of their assets, liabilities and shareholders’ equities according to asset revaluations they have conducted for equity restructuring. Enterprises that have adjusted the book values of assets according to revaluations, made provisions for deprecation and amortized expenses accordingly should readjust their current taxable incomes to be declared according to “treatment of asset valuation” for merged enterprises in preceding paragraphs.

b.Preferential tax treatments enjoyed by enterprises according to the Tax Laws and its implementation rules will not change after equity restructuring. After equity restructuring, enterprises may continue to enjoy effective preferential tax treatments until they expire, and may not enjoy any new preferential tax treatment again.

c.Enterprises may continue on annual basis the offsetting of their business losses not yet made up against incomes before equity restructuring within the remaining period of loss offsetting years according to Article 11 of the Tax Laws.

4.Tax treatment of asset transfer

Asset transfer refers to the act wherein enterprises transfer some or all of their assets (including goodwill, business operations and liquidated assets) or accept them from other enterprises. Transferring or accepting assets must not affect the continuous existence of the transferring and receiving enterprises. Taxation related to asset transfer should be handled according to the following rules:

(1)Treatment of incomes from asset transfer

Enterprises should reckon incomes and losses obtained through asset transfer into their current taxable incomes to pay taxes according to the Tax Laws and its implementation rules

(2)Treatment of transferred assets valuation

Transferees should reckon all assets transferred to them in their asset accounts according to actual transfer prices.   If there are too many asset items or if the assets are transferred together with goodwill and business operations so that calculation of transfer price of each item is impossible, transferees may reckon relevant assets in their asset accounts according to the net values on the account books of transferors. Transferee may use the difference between the actual total transfer price and the net book value of the assets as the transfer price of the goodwill or business operations, and reckon them separately into their intangible assets. They should amortize these prices in no less than ten years from the day when the assets are transferred. Transferees whose remaining operation periods are less than ten years after the transfer should amortize these prices within their remaining operation periods.

(3)Treatment of tax preference

After asset transfer, if transferors and transferees have not changed their production and business operations, they should continue to enjoy their previous preferential tax treatments. Those who enjoy tax holidays should not recalculate the terms of preferential treatment for the transfer.

Asset transferors or transferees may not enjoy preferential tax treatments applicable for their previous business operations if they are no longer eligible as a result of change in operations after the transfer. Those who change their operations and thus become eligible for tax preferences shall enjoy preferential treatments in the remaining years of the prescribed period for such treatment, commencing from the first profit-making year of the enterprises.

(4)Treatment of previous losses

Asset transferors and transferees should offset their own losses incurred before and after the transfer on annual basis within the timeline prescribed in Article 11 of the Tax Laws.   They may not carry over each other’s losses, no matter whether the transfer involves part or all of the assets or operations of the transferor.   

5.Treatment of other issues

After merger, separation or equity restructuring, enterprises who are no longer eligible for the EFI status due to ratios of domestic and foreign equities may not follow the income Tax Laws and regulations for such enterprises, except stipulated otherwise in the Tax Laws, regulations and rules. Instead, they should observe the income Tax Laws and legal regulations for domestic enterprises. The following rules apply to enterprises that enjoyed tax holidays before business reorganizations according to Article 8 of the Tax Laws:

(1)If equities previously held by foreign investors do not exit in the restructured enterprises after the merger, separation or equity restructuring, the restructured enterprises, regardless of their predecessors’ lengthen of business operation, are not liable to repay exempted and reduced taxes according to Article 8 of the Tax Laws.

(2)If foreign investors withdraw their equities or transfer them to Chinese investors during business restructuring, and the actual operation periods of enterprises before restructuring are less than the years required for preferential tax treatments, the restructured enterprises are liable to repay exempted and reduced taxes according to Article 8 of the Tax Laws.

6.These rules shall apply when the establishments and organizations, set up by foreign enterprises and engaged in productions or business operations within China, are involved in business reorganizations in the form of merger, separation, equity restructuring and asset transfer.

7.These rules shall come into effect from 1997. Previous tax decisions by competent tax authorities that differ from these rules should be adjusted from 1997 onwards according to these rules. In principle, all tax decisions made before 1997 that will affect taxation in 1997 or thereafter should be adjusted according to these rules.

<![if !supportEmptyParas]>  <![endif]>

• Taxation of the real estate sector

1.Advance collection of enterprise income taxes

(1)According to Article 2 of the Circular, real estate EFIs that have obtained Advance receipts in the construction period should pay enterprise income taxes in advance. Advance receipts include deposits obtained through contracts, agreements or other arrangements; advance receipts from house sales; and all other funds in the nature of advance receipts.  

(2)In light of the difficulties of the real estate EFIs in our city and the previous settlement of tax upon the completion of construction, these enterprises should pay provisional enterprise income taxes based on an estimated profit of 10% for all advance receipts they have obtained. However, for affordable housing projects approved by the Urban Construction and Comprehensive Development Office of Beijing Municipality, the profit is estimated at 3% for taxation purpose.

2.Final settlement of the tax liability during the construction period

(1)According to Section 3 of the Circular, real estate EFIs should file with the tax authorities a report concerning the final settlement of income tax prepared by certified public accountants or public tax-auditors in China within one year and half from the commencement of property sales. Meanwhile, provisional enterprise income taxes are not charged on incomes obtained since the commencement of property sales. However, if enterprises cannot accurately compute the housing costs and expenses in tax filings, competent tax authorities may charge an enterprise income tax temporarily based on a profit of 10% under the Tax Laws for the period from the commencement of property sales to the final settlement during the construction period.

When the final settlement is made, enterprises should also submit the following attachments at the same time:

a.Description of property sales;

b.Certificate for the provisional enterprise income tax paid (duplicated copies);

c.Annual reports on business transactions between EFIs or foreign enterprise and their associated enterprises;

d.Other materials requested by competent tax authorities.

(2)Competent tax authorities should conduct comprehensive on-site examinations according to requirements of this circular within six months after receiving the above mentioned report. They should determine enterprise incomes, examine their costs and expenses, and clear the taxes including those chargeable during the construction period, with refunds for overpayments and supplementary payments for deficiencies. In particular, they should focus on the following tasks:

a.Verifying sales incomes of enterprises.

(a)Enterprise incomes during the construction period should be determined according to the principle clarified in Article 4 of the circular.   In case a buyer purchases the property with bank mortgage, enterprises should treat the bank mortgage payment as the current income in a timely manner, no matter if they have issued receipts to the buyer in full price for the property or not.

(b)Except discounts and rebates explicitly stated in the sales contract, enterprises may not deduct from their sales incomes any other concessions and allowances.

(c)Enterprises that put up the property as security for a loan and repay their creditors with the property when they cannot service the debt should be considered to have conducted a sale act.   Competent tax authority may determine their incomes from the sale according to the mortgage price. In case the mortgage payment received by the creditor bears interests and the creditor is a foreign enterprise, the interest income is subject to withholding taxes according to law.

b.Verifying the structure of the real estate development costs and the itemization of expenses

(a)Enterprises should provide legal proofs for expenses actually incurred to compensate resettlement and reckon them in their account books.

(b)Enterprises should pay their overseas services (including agency fees, handling fees and commissions) according to the lawful service contracts signed with their overseas agents, and may only reckon these fees in their account books according to stipulated proportions after they have actually paid such fees directly.

(c)Enterprises may only reckon the costs of actually imported equipment and materials (including various machinery equipment and construction materials for development and construction) into their account books according to customs returns and duty paid proofs of the imported equipment and materials.

(d)Enterprises should calculate the hospitality fees incurred based on the sales incomes determined when making the final settlement during the construction period of real estate development projects. They should deduct these fees according to the criterions of the service sector stipulated in Article 22 of Rules for the Implementation of Income Tax Laws of the People’s Republic of China for EFIs and Foreign Enterprises.

(e)Enterprises that have machinery equipment already installed and in use but have not paid for them partially or fully, or have completed construction projects whose construction and installation fees have not been paid partially or fully, may not have obtained formal payment proofs. In such cases, they may reckon the prices for such equipment and services as stipulated in relevant contracts temporarily in their development costs when settling taxes for construction period. Enterprises should treat their payments owed to the above contracts as arrears according to Article 3 of the Circular of the State Administration of Taxation on Tax Treatment of Donations Received by EFIs and Foreign Enterprises (Guo Shui Fa [1999] No. 195). As this Article stipulated that “enterprise arrears should be reckoned in current enterprise incomes if they are overdue for more than two years without creditor’s request for repayment”, enterprises should adjust such arrears overdue for more than two years in a timely manner based on the time of payment stipulated in relevant contracts.

(f)Enterprises may reckon the expenses related to non-sellable areas in a real estate development project, such as green areas, gardens, parking lots, commercial outlets, education facilities and clubs, in costs of sellable areas provided such areas are occupied free of charge by relevant government departments or belong to public properties of the owners. If these areas are owned by EFIs and continue to be used for production and business operations, enterprises may not reckon relevant expenditures in the costs of sellable areas.

c.Examining associated enterprises of real estate enterprises. Any enterprise that transfer profits though exclusive or proxy sales should make adjustments in a timely manner according to law.

d.Calculating taxable incomes obtained from property sales by following the above mentioned procedures and issuing the Decisions on the Final Settlement of Tax during the Construction Period of Real Estate Development Enterprises (attached). Competent tax authorities should review actually paid and pre-paid income taxes of enterprises, refund excesses and request payment for deficiencies.

(3)Competent tax authorities may collect 30% of estimated profits temporarily as advance enterprise income taxes from enterprises that fail to settle taxes of construction period according to the timelines stipulated above.  

3.Post management of real estate enterprises

(1)After settling the taxes of construction period, real estate EFIs may not conduct the settlement of any other form. They should calculate and pay enterprise income taxes by determining their current incomes and recoup current costs incurred according to the principles stipulated in the Tax Laws.

(2)Enterprises that have already reckoned unpaid fees for equipment and construction installation in costs based on contract prices when settling project accounts should not reckon such expenses again in the current costs when they are actually paid after the final settlement for the construction period is made.

(3)In case it is necessary for real estate enterprises to continue to pay expenses on supporting facilities after selling the housing properties, such as building green areas and roads, they should withhold 1% of their annual sales incomes in advance every year and reckon them in their current incomes and losses according to relevant stipulations in government documents, such as the Circular of the Urban Planning Commission of Beijing Municipality on Examination of Design Plans, and by proving the construction projects are not yet completed. They should adjust the amount according to actually incurred expenses upon completion of the projects.

(4)After the settlement of tax for the construction period, real estate EFIs may set aside provisions for depreciation on unsold properties based on the development costs and the useful life of houses stipulated in the Tax Laws, and reckon them in current costs and expenses. In case the properties are sold after provisions for depreciation, enterprises may carry forward outstanding balance of depreciation as current costs after sale.

4.Management of real estate enterprises engaged in rolling development

Real estate EFIs that engage in rolling development businesses should determine their taxable incomes and calculate their enterprise income taxes according to the accrual principle and the actual results of financial accounting, and may not make final settlement of taxes for the construction period for a specific project. Enterprises that have obtained advance receipts such as deposits before their mortgage comes into effect should pay enterprise income taxes in advance according to Article 2 of the circular. They should adjust their advance income taxes in a timely manner when carrying forward the above payments as incomes.

Real estate enterprises engaged in rolling development businesses mentioned above refer to specialized development companies or similar enterprises that do not have fixed development project and have been engaged in real estate development and operation business for a long time.

Attachment: Decision on the Final Tax Settlement for the Construction Period of Real estate Development and Management Enterprises

<![if !supportEmptyParas]>  <![endif]>

Beijing Municipal Office, State Administration of Taxation

Or (XX District or County Office in Beijing, SAT.)

Decision on the Final Tax Settlement for the

Construction Period of Real estate Development Enterprises

〈 Formal document number of the tax office 〉

  _______Company:

According to stipulations of the Income Tax Laws of the People’s Republic of China for EFIs and Foreign Enterprises and the Circular of the State Administration of Taxation on Managing Income Taxes of Real estate Development and Management EFIs (Guo Shui Fa [2001] No. 142), this office has examined the development project of your company during _______ (date) to _______ (date), with the following findings:

Total construction area:                     Sellable area:              Area already sold:

Total costs of sellable areas:        Of which, costs reckoned temporarily:

Costs of sellable units:           

Sales incomes already obtained:        Payable income taxes in construction period:

Income taxes paid in advance:               Income taxes underpaid (overpaid):

If the “costs reckoned temporarily” mentioned above do not actually occur within two years after the tax settlement for the construction period, or are different from the actually incurred costs, you should adjust the current taxable incomes according to actual costs in the third year.

In case the taxpayer does not agree with the decision of the tax authority, it must first pay the taxes and overdue fines according to the taxation decisions of the tax authority or provide relevant guarantee, and then apply to the higher level tax authority for administrative review within 60 days after receiving this notice. If it disagrees with the decision made by the higher tax authority, it may appeal to the People’s Court within 15 days after receiving the decision.

<![if !supportEmptyParas]>  <![endif]>

Stamp of the competent tax authority

Date

<![if !supportEmptyParas]>  <![endif]>

• Withholding income tax

1.Concept of withholding income tax

Foreign enterprises having no establishment or place in China but obtaining profits (dividends), interests, rents, royalties and other income from sources in China, ( or having an establishment or place in China yet with which there are no effective connections,) are subject to withholding income tax. The withholding income tax should be based on the gross incomes they have obtained (except otherwise stipulated in relevant documents and tax treaties).

2.Profits (dividends)

(1)Scope of profits

Profits refer to income obtained after the payment or exemption of income taxes according to the Tax Laws and derived from the profit-sharing rights according to the proportion of investment, equity rights, stockholding, or other non-debt profit-sharing rights.

(2)Tax reduction and exemption for profit

According to the Tax Laws and its implementation rules, profits (dividends) obtained by foreign investors from EFIs are exempted from income taxes; and dividends obtained by foreign enterprises that hold B shares or overseas shares from enterprises within the Chinese territory that issued these shares are temporarily exempted from enterprise income taxes.

(3)Interests

a.Scope of interests

Interests include interests on deposits, loans, bonds, payment made temporarily for others or deferred payments obtained from within the Chinese territory by foreign enterprise that have no establishments or places in China. As the “arrangement fee”, “undertaking fee” and “commission fee” in loan contracts occur in relation to the loan, they should be treated as interest income and are subject to income taxes.

Where real estate EFIs borrow from foreign banks or foreign enterprises use housing properties as mortgage and give them away to creditors at the end of the term due to inability to service debts, if the mortgage price obtained by creditors contains interests, they are subject to withholding tax according to the Tax Laws.

Where foreign leasing companies provide equipments to users within the Chinese territory through financial leasing, the lessee should withhold income taxes on the rent net of the costs of the equipment and the interest payable to the lessor, provided the interest rate is not higher than that of the export credit rate of the lessor’s country.

b.Tax reduction and exemption for interests

(a)Interest income is exempted from withholding income taxes if it comes from loans made by international finance organizations such as International Monetary Fund, the World Bank, the Asia Development Bank, the International Development Association and the International Agriculture Development Funds to the Chinese government, the People’s Bank of China, the Bank of Industry and Commerce of China, Agricultural Bank of China, Bank of China, Construction Bank of China, Bank of Communications and other financial institutions approved by the State Council to engage in credit businesses such as foreign exchange deposits and loans.

(b)Interest on loans made at a preferential rate by foreign banks to state-owned banks in China, or to trust and investment companies (excluding financial institutions with foreign investment) approved by the State Council or its authorized department to operate businesses in foreign exchange are exempted from withholding income tax.

(c)Where Chinese companies, enterprises and government’s institutions purchase technology, equipments and commodities under a seller credit provided by a bank within the seller’s country, the interests on deferred payment passed on by Chinese entities to the seller are exempted from withholding income taxes provided the interest rate is not higher than that under the buyer credit of the bank.

(d)Interests on foreign banks’ deposits in Chinese banks are exempted from the withholding income taxes if the interest rates are lower than those of the foreign bank’s own countries.

(e)Where technology and equipment are provided to Chinese companies and enterprises, the principal and interest on payments of the purchase price made in kind by Chinese side, such as by means of product buy-back or payment in product, or the principal and interest on payments or repayments of the purchase price made by Chinese side through processing of imported materials or assembly, are exempted from withholding income taxes. If only interests are repaid in kind while the principals are repaid with spot exchange, income taxes shall be withheld on the interests.

3.Rents

(1)Scope of rents

Rents refer to income (including packaging fee, transportation fee, insurance premium and documentation fee paid by the lessee) foreign enterprises obtained through leasing properties to enterprises, institutions or individuals within the Chinese territory.   Leased properties include machine and equipment; scientific instruments; buildings and structures; information transmission equipment; satellites; power cables; optical fibers and other communication lines and similar equipments.

Where foreign enterprises lease immovable properties such as buildings and structures located within the Chinese territory without setting up establishments or places in China to carry out day-to-day management, income taxes on rents so obtained should be computed after the deduction of business taxes. Income taxes should be withheld by leaseholders at the time of actual payment. If leaseholders are not enterprises or institutions within the Chinese territory or Chinese residents, tax authorities may also request them to declare and withhold income taxes on their own within the timeline stipulated by the Tax Laws.

Where foreign enterprises lease immovable properties such as buildings and structures located within the Chinese territory and dispatch personnel to carry out day-to-day management of the properties, or lessors, as companies or citizens from countries without taxation arrangements with China, entrust other institutions (or individuals) to carry out day-to-day management of the properties, or lessors, as companies or citizens from countries with taxation arrangement with China, entrust non-independent agencies (or individuals) to carry out day-to-day management of their properties, should pay income taxes for their rent income as enterprises that have set up establishments and places within the Chinese territory.

(2)Tax reduction and exemption for rents

Rents obtained by foreign companies and enterprises that lease ships to Chinese companies and enterprises for international transportation are exempted from withholding income taxes temporality. Rents obtained by foreign companies and enterprises that lease ships to Chinese companies and enterprises for offshore and internal water transportation in China are subject to withholding income tax.

Rents obtained by foreign companies that lease airplanes to aviation companies in China according to contracts signed before 1 September 1999 are exempted from withholding income tax. Rents obtained by foreign companies that lease airplanes to aviation companies in China according to contracts signed after 1 September 1999 are subject to withholding income tax according to the Tax Laws and its implementation rules.   The taxes should be withheld by aviation enterprises.

4.Guarantee fee

Enterprises without establishments or places within the Chinese territory but obtaining income from guarantee fees from China, or enterprises with establishments or places within the Chinese territory and obtaining such income not related to these establishments or places, should pay withholding income tax from 1 March 1998 according to tax rates stipulated in the Tax Laws.   The guarantee fees mentioned above refer to fees paid or borne by enterprises, institutions or individuals within the Chinese territory when accepting guarantees provided by enterprises outside the Chinese territory in economic activities, such as borrowing, and providing loans business transaction, cargo transportation, processing according to contract, leasing and project contracting.  

5.Royalties

(1)Scope of royalties

Royalty refer to fees paid for utilizing patent right, proprietary technology, trademark right, intellectual property right and copyright within the Chinese territory provided by foreign enterprises without establishments or places within the territory of China. Royalty for patent right and proprietary technology include fees for relevant drawings and documents, technical services, personnel training (including training outside the Chinese territory) and other relevant fees. The income thus obtained is subject to withholding income tax after the deduction of business taxes lawfully paid by foreign enterprises.  

Design fees included in the royalty obtained by foreign enterprises for providing proprietary technologies are treated as part of the prices under technical trade contracts.   Unlike those gains derived from usual design services, the said design fees involve the transfer of utilization right and should therefore be categorized as royalties on which income tax shall be withheld.

(2)Tax reduction and exemption for royalties

a.The income listed below is exempted from withholding tax if it does not involve transfer of utilization right of proprietary technology. In contracts signed by Chinese enterprises with foreign enterprises to purchase computers and computer software, if the software is not transferred as patent right or copyright, it is regarded as substantial accessory of the computers. The payment for the software obtained by foreign enterprises is exempted from withholding income tax. In contracts where computer software is transferred as patent right or copyright (including program language, techniques and technical secrets) or with restrictions, for example on the scope of utilization of the computer software, the payments are subject to withholding income tax. Payments obtained by foreign enterprises for designing and developing or jointly developing computer software as requested by Chinese entities are not liable to withholding income tax if they do not involve transfer of the patent right or copyright of computer software. However, enterprises that have establishments and places within the Chinese territory and engaged in contracted design and development services should pay withholding income tax for their establishments and places according to law.

b.Where foreign enterprises provide at a low price copyrights of films, videos and audio programs for the purposes of education, scientific research, environmental protection and healthcare, and such films, videos and audio programs prove to be conducive to research and cultural exchanges between China and foreign countries, they may apply for preferential tax treatment as necessary to State Administration of Taxation through competent tax authorities.

c.Royalties obtained by foreign enterprises providing proprietary technology for China’s scientific research, energy development, communication development; production of agriculture, forestry and animal husbandry; and development of key technologies may be exempted from withholding income tax after the approval of the State Administration of Taxation.

(a)Royalties received in providing proprietary technology for the development of farming, forestry, animal husbandry and fisheries: technology provided to improve soil and grasslands, develop barren mountainous regions and make full use of natural resources; technology provided for the supplying of new varieties of animals and plants and for the production of pesticides of high effectiveness and low toxicity; technology provided to advance scientific production management in respect of farming, forestry, fisheries and animal husbandry, to preserve the ecological balance, and to strengthen resistance capabilities to natural calamities.

(b)Royalties received in providing proprietary technology for scientific institutions, universities and other scientific research units to conduct or cooperate in carrying out scientific research or scientific experimentation;.

(c)Royalties received in providing proprietary technology for the development of energy resources, communications and transportation;

(d)Royalties received in providing proprietary technology in respect of energy conservation and the prevention and control of environmental pollution;

(e)Royalties received in providing the following proprietary technology in respect of important science and technical development: production technology for major and advanced mechanical and electrical equipment, nuclear power technology; production technology for large-scale integrated circuits; production technology for photoelectric integrated circuits, microwave semi-conductors and microwave integrated circuits, and manufacturing technology for microwave electron tubes; optical telecommunications technology; technology for long-distance, ultra-high voltage direct current power transmission; and technology for the liquefaction, gasification and comprehensive utilization of coal.

6.Property transfer income

Income of foreign enterprises also includes gains derived from the transfer of properties located the Chinese territory, such as buildings, structures, their affiliated facilities, and land use right.

The net income derived from the transfer of B shares and overseas shares issued by companies within the territory of China and held by foreign enterprises, rather than their establishments and places in China, is temporarily exempted from withholding income tax.

Where foreign enterprises transfer their holdings in EFIs within the Chinese territory, the transfer income so obtained, after the deduction of the contributed capital, is subject to withholding income tax.

Where foreign enterprises enter into exclusive sales agreements with real estate EFIs to sell houses for the latter, such exclusive sales are deemed of the same nature as the transfer of properties within the Chinese territory and thus subject to withholding income tax.

<![if !supportEmptyParas]>  <![endif]>

? Miscellaneous tax sources from foreign enterprises

Income obtained by foreign enterprises from miscellaneous businesses, such as contracted projects, recreation/sports performances, construction project designs, repair and replacement services, after-sale services, sales of goods at exhibitions and fairs, is subject to enterprise income taxes.

1.Treatment of contracted projects and labor services

Where foreign corporations or enterprises and other economic organizations contracting projects and providing labor services in China purchase or produce on a commission basis the machinery, equipment (including related components) or building materials for the clients, the payment (including international shipment cost and insurance premium supported by accurate certificates and vouchers) can be deducted from the total income derived from the said projects and labor services, provided the deduction does not exceed 70 per cent of the total income and the following conditions are met: contractors and clients have entered into approved contracts (or arrangements, memos attached to the project or service contracts) for procurement and manufacturing on a commission basis; all of the equipment, building materials so purchased or manufactured are utilized in the projects or labor services; invoices in the name of the clients are presented and the clients are responsible for the custom duty; the equipment and building materials so purchased or manufactured belong to the clients. As for the contractors solely engaged in equipment installation or assembling, if the cost of equipment procurement or manufacturing on a commission basis exceeds 70 per cent of the total contract value, after the verification of the tax authorities, the cost actually incurred will be deducted.

The foreign enterprises that have signed the sales contract of machinery and equipment and simultaneously offered the labor services such as equipment installation, assembling, technical training, consultancy, supervision and etc. should pay the tax on income obtained from service charge according to the Tax Laws. If the labor service charge is not listed in the sales contract or is fixed at an unreasonable price, the tax authority should define the income of labor services by the foreign enterprises according to the actual conditions (in principle no less than 5% of total cost of the contract), calculate and levy the income tax accordingly.

For the foreign enterprises who undertake contracted projects and offer labor services within the territory of China and who are liable to pay enterprise income taxes based on the deemed profit rate, the profit rate (in principle no less than 10% of the income) should be assessed with reference to the profitability of the same trade and the enterprise income tax should be imposed, deducted of the contract transfer cost and the cost of purchasing and manufacturing equipment and building materials on a commission basis.

2.Treatment of the construction project designs

When foreign enterprises are entrusted by domestic enterprises with designs for construction and engineering projects, tax preferences may be granted if except for sending work crew to China for site reconnoitering, data collecting and fact-finding before the design, the finalization of the design concepts, calculation, drawing and all the other activities occur outside China, and by the time the design is done, the drawings are presented to the Chinese domestic enterprise. In this case, the total income arising from the design serives could be temporarily exempted from tax.

Where foreign enterprises are entrusted by domestic enterprises or co-operating (or allying) with them to design for construction, engineering or other projects, if except for sending work crew to China for site reconnoitering, data collecting, and fact-finding before the design, the finalization of the design concepts, calculation, drawing and all the other activities occur completely or partly outside China, and by the time design is done, some crews are sent to China to explain the drawings and to supervise the process of construction, the foreign enterprises should be deemed as having set up establishments or places within China to engage in business operations. Therefore, the income derived from the design services, after the deduction of the payment in connection with the service activities occurring outside China, is subject to enterprise income taxes according to the Tax Laws. However, if the design fees outside China are not clearly listed in the contracts concerned, or the taxpayer cannot present accurate supporting documents to accurately divide the domestic and overseas design services, the enterprise income tax can be charged on the total income derived from the design services.

The tax authorities should ascertain the above-mentioned income earned by foreign enterprises. If the tax authorities are convinced that the taxpayer fails to provide accurate certificates and vouchers of costs and expenses or compute the taxable income correctly, the income tax shall be charged on the total business income at a deemed profitability of 15 percent.

3.Treatment of the recreation and sports performance

Where performers and athletes from foreign countries, Hong Kong, Macao or Taiwan give performances in the Chinese mainland, if conditions for tax-exemption are met, the organizers should provide the inter-government agreements or program documents on cultural and sporting exchanges (including those agreements or program documents signed by the national sports federations concerning international sporting events and performances hosted by China) and the performance contract should also be enclosed. After the verification and approval of the tax authorities, exemption from the enterprise income tax may be granted according to the tax treaties. If the conditions for tax-exemption are not met, tax should be levied strictly following the Tax Laws. Any entity shall not violate Tax Laws and tax treaties arrangements by entering into the performance contracts with (clauses releasing the foreign party from tax-paying liabilities). Any contract containing the said clauses shall be invalid.

Where performers and athletes from foreign countries, Hong Kong, Macao or Taiwan give performances as a group in the Chinese mainland and the group is able to present complete, precise certificates for costs and expenses, after the deduction of such costs and expenses, the balance of the income of the performance group is subject to enterprise income tax at the rate of 30 percent and local income taxes at the rate of 3 percent in the light of the Tax Laws. If the group cannot provide such documents or correctly compute the taxable income, remunerations paid to performers/athletes and other operational expenses (equivalent to 30 per cent of the total income) should be deducted from the total income and the balance is subject to enterprise income tax and local income tax according to the principle stipulated in the Tax Laws. For those groups who do not declare their payments to performers/athletes or do not withhold individual income tax, the income net of the operational expenses (equivalent to 30 per cent of the total income) shall be regarded as the taxable amount. Either enterprise income tax or local income tax shall be charged accordingly.

The performance group should pay enterprise income tax and local income tax. Under applicable Tax Laws, the taxable income and the tax payable should be computed based on the earnings derived from performances at a certain place and filed with local tax authorities. For groups that calculate their taxes according to their costs, they can settle the enterprise income tax with the tax authorities where the Chinese organizer is located.

Tax authorities may assign the theatres, stadiums, gyms where the performances will be given or the Chinese organizers to withhold the tax payable by the performance group. If the performance group fails to settle the taxes payable with local tax authorities, the organizer should withhold the taxes by the time of payment. If the organizer fails to do so, penalty will be given by tax authorities according to the Tax Administration Law.

The Chinese organizer entering into a performance contract with a foreign party should submit the contract and other necessary documents to the tax authorities within seven days after the conclusion of the contract. Failure to do so within the time limit shall be subject to penalties under the Tax Laws.

4.Treatment of exhibited commodities

Foreign enterprises participating in exhibitions in China are exempted from enterprise income taxes for the sales of exhibits in small quantities. Foreign enterprises that participate in commodity fairs in China to sell their exhibits shall be deemed the same as selling products in a business place and enterprise income taxes shall be assessed accordingly. For those unable to calculate the exact sum of taxable income, the taxable income should be determined based on a deemed profitability of no less than 10 per cent.

As the above-mentioned business activities occur within a short period of time and are highly mobile, in order to strengthen management and make it convenient for operation, the tax will be levied and collected locally. The tax authorities where the exhibition and exhibiting venues are located are responsible for the tax collection.

In three days after the contract for exhibition takes effect, foreign companies that participate in the exhibition should file returns with the competent local tax authorities for records, and explain the timing of the exhibition and business activities involved. Meanwhile, in three days after the contract for exhibition takes effect, the entities providing venues for such exhibition or fair should present the program and the list of attending foreign companies to the local tax authorities.

In accordance with the Tax Administration Law, competent tax authorities may take preservative measures to guarantee the collection of taxes payable by attending foreign companies. Tax authorities can lawfully assign the exhibition or fair venue provider as the withholding agent.

5.Treatment of consulting business

(1)EFIs and representative offices within China engaged in consulting businesses

The income obtained by EFIs and representative offices through solely signing contracts (including the contracts signed by representative offices on behalf of its head office with and the business performed actually by representative offices) with clients and providing them with consulting services, shall be fully regarded as the income of EFIs and representative offices, and they should file and pay enterprise income tax at the places where their establishments are located.

(2)Consulting firms outside China solely providing clients with consulting services

Where consulting firms outside China solely sign contracts with clients and provide them with consulting services, the firms shall file and pay enterprise income taxes with respect to the entire income so obtained, provided that all the said services occur within China territory. In case the services occur within China as well as outside China, the corresponding income shall be divided into income within China and income outside China according to the place where the service occurs, and the firms shall file and pay tax with respect to the income acquired through providing service within China. Where the consulting services are provided to clients within China territory, the amount of income from within China shall be no less than 60% of the total. If all the consulting services occur outside China, the corresponding income will not be taxed in China.

(3)Consulting firms outside China and EFIs or representative offices within China jointly providing the consulting services to clients

The income obtained by consulting firms outside China and EFIs or representative offices within China through jointly signing the contracts with clients and providing them with consulting services, shall be first divided into the income of enterprises outside China and that of enterprises/offices within China according to the work load or reasonable proportions stipulated in the contracts. EFIs or representative offices within China shall file and pay enterprise income taxes with respect to their income. Where consulting firms outside China and their affiliated enterprises or representative offices within China jointly provide the consulting services to clients in China, the proportion designated as the income of EFIs or representative offices within China shall be no less than 60% of the total income derived from the said services. Where firms outside China also send staff to the country to participate in the said services, the income the firms obtain shall be further divided into PRC and non-PRC sourced income according to the place where the service occurs and the PRC-sourced part shall be no less than 50%. The said firms shall file and pay enterprises income taxes in accordance with relevant regulations.

(4)The PRC-sourced taxable business income obtained by above-mentioned consulting firms outside China, shall be incorporated into the income of their representative offices within China and be taxed, provided that the said firms and their representative offices within China have jointly provided the business. If the firms have no representative offices within China, or they do not jointly provide the business in spite of having representative offices within China, it shall be deemed that the said enterprises have places of business within China, and the payer shall withhold the taxes.

(5)In case that the above-mentioned provisions involve consulting businesses conducted by consulting firms from those countries or region which have tax treaties or arrangements with China, it shall be determined whether or not they constitute permanent organizations under tax treaties or arrangements. Those that constitute permanent organizations shall be taxed on the enterprises income according to the preceding paragraphs.

<![if !supportEmptyParas]>  <![endif]>

• Taxation for permanent representative offices (RO) of foreign companies

The ROs engaged in the consulting service businesses, including commercial operation, law, taxation, accounting and auditing, shall establish and complete account books, correctly calculate incomes and taxable amounts, and honestly declare the taxes.

For ROs engaged in agent service trade (including self-trade and trade agent), trading (including trading own products and agenting others' products) and other services, their incomes thus arising shall be determined by calculation of their expenditures and taxes shall be assessed accordingly.

The ROs engaged in taxable businesses, except for the above-mentioned two kinds, shall file returns on schedule to the local competent taxation authorities based on their actual incomes from their business activities, including incomes received by the head offices. If there is no business income in the current year, the RO may report its annual business operations to the competent tax authorities within one month after the end of the fiscal year.

<![if !supportEmptyParas]>  <![endif]>

<![if !supportEmptyParas]>  <![endif]>

<![if !supportEmptyParas]>  <![endif]>