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Sunday, May 20, 2018

Tax System in China

The Chinese tax administration has at the top the Ministry of Finance and the SAT (State Administration of Taxation). Three levels of taxation: customs, local and central.

  • STATE TAX: taxes that generate revenue for the central Government which collects them..
  • LOCAL TAX: taxes that generate revenue from the local Government which collects them.

With its transition to a market economy, China has bought market-based approaches. 

Into force from January 1st 2008 the Enterprise Income Tax Law (CIT): it is a law that combines two schemes of tax on business income, namely that for companies based on domestic capital - Domestic Invested Enterprises (DIE) - and one for companies based on foreign capital - Foreign Invested Enterprises (FIE). Tax incentives were high while the average EIT rate was decreased.

From January 1st 2009 we are witnessing the transformation of the production-oriented VAT system to the consumption-oriented VAT system. The Chinese tax law is not codified in a single document but scattered in different instruments referring to different taxes.

The National People's Congress and its Standing Committee, the State Council, the Ministry of Finance (MOF), the State Administration of Taxation (SAT), the Tariff and Classification Committee at the Council of State and the General Administration of customs are state bodies with power to issue tax Laws or fiscal policies. The S.A.T. is the highest tax authority in China. Because of revenue sharing, the tax authorities at the provincial and local offices are divided into the SAT and branch offices of taxes. The S.A.T. has a vertical leadership towards its field offices as regards the organization, size, staff, budgets; it assists local Governments in a sort of parallel supervision of the tax branch offices.

The "Tax System" is divided into two kinds of taxes: 

  1. Direct Taxes:
  • Income taxes for physical persons (IIT).
  • Inome taxes for legal entities (CIT).

  2.  Non-Direct Taxes, including for example:

  • Enterprise Income Tax (CIT).
  • Business Tax (BT).
  • Value Added Tax (VAT).
  • Import Duties.
  • Duty on real estate properties.
  • Duty on revalutation of land.
  • Stamp tax.

In China companies operating on the territory are classified into two categories:

  • Resident Companies or business that, legally established in China or abroad, carry out their activities of administration and control on the Chinese territory, such as companies totally based on foreign capital (Wholly Foreign Owned Enterprise - WFOE), Joint Venture (JV) and trading companies.
  • Non-resident Companies, i.e. companies, which, despite having income in China or abroad, do not have an office or a seat on the Chinese territory.

TAX ON THE INCOME OF PHYSICAL PERSONS - (IIT)

The tax on the income of physical persons is characterized by progressive taxation on income brackets, with increasing rates. The following categories of income make up your taxable income:

  • From employee.
  • From self-employment.
  • From royalties.
  • From income from interests and dividends.
  • From rental of real estate properties.
  • From the proceeds coming from the sale of real estate properties.
  • The Tax rates are between 5% and 45%.

Under current Chinese law, people who have domicile in China or individuals who do not have a domicile in China but live in China for a year or more, are subject to the payment of the tax on the income of physical persons in connection with the their global income, while people who do not have a domicile in China but reside in China for less than one year must pay the tax on the income of physical persons only in relation to the income generated in China.

The income earned in China by individuals who are not domiciled in China and who receive income from a foreign employer without a permanent establishment in China are excluded from the tax on the income of physical persons as long as they are not physically present in China consecutively or cumulatively for more than 90 days in a calendar year or 183 days in the case of the existence of a treaty on double taxation.

A special rule is applied to expatriates who hold the office of director, representative in representative offices of foreign companies or general manager or senior management in companies with foreign participation.

Subject to the approval of the competent tax Authorities, there is the possibility for individuals who are not domiciled in China but have lived there for more than a year and less than five years to pay the tax on the income of physical persons for the part of the income generated in China and that there is paid by individuals or entities. In contrast, the income derived abroad but not perceived in China may be excluded from taxation in China. The foreign expatriates who reside in China for more than five years are subject to tax on whole income from the sixth year onwards.

As for legal entities also physical entities must move with caution, taking advantage of the support of those who know the Chinese system; it is strategic and important to benefit from “Warranty & Assistance” and so properly deal with the instructions issued by local authorities, among which between the Ministry of Finance and the SAT (State Administration of Taxation). To this purpose Bright Business Consulting LLP offers knowledge and expertise as essential elements.

TAX ON THE INCOME OF LEGAL ENTITIES - (CIT)

The main legislation on the taxation of legal entities is represented by the Law on the taxation of corporate income, or the Enterprise Income Tax Law which came into force on January 1st 2008.

This legislation represents an important innovation for the Chinese tax system as a process of standardization of the tax treatment for the domestic-owned companies and those companies invested in by foreign entities, providing for the application of the unified rate of 25%. There are reduced rates for particular categories of companies: in particular, 15% and 20%, respectively, for companies operating in the high technology sector and for smaller companies with low profits. A subsidized regime is intended also to the businesses belonging to the fields of environmental protection and energy saving. Resident companies are taxed on worldwide income products.

The tax base follows, in general terms, the principle of derivation from the accounting records. The losses in a given tax year can be deducted for a maximum period of five years. Non-resident companies are taxed only on income earned in China.

The foreign-owned companies must register with the relevant tax offices. There will be a quarterly tax returns, in addition to the annual year-end tax returns. The related payments should be carried out on a quarterly basis, based on the corresponding declarations, and is then expected an adjustment following the submission of the Annual Statement.

The Corporate Income Tax (CIT) belongs to the category of taxes on corporate profits and is applied to the taxable income of the company which is the gross income earned in the tax year in which you deducted the tax-free income, other deductions permitted and the amount of the losses of the previous five years. Resident companies are taxed on total income received in the fiscal year, the non-resident enterprises incorporated in China are taxed on income in China or abroad directly connected to their constitution. The non-resident enterprises and unincorporated in China are taxed only on income earned in China during the same period. 

The tax rate of the tax on the income of local companies and foreign-invested firms is unified at 25%. Its payment must be made at the place where the company is registered. For companies incorporated outside China, the payment must be made in the Chinese city in which business activities are carried out.

The Value Added Tax (VAT) which is the value added tax is a consumption tax charged on the value added during the production of goods, sale and supply of taxable services. In China, VAT payers (VAT) are divided into two types according to the system of accounting and control systems and their functioning:

  • Small-sized contributors: those without a complex system of accounting and auditing, whose taxable value of sales is less than 500 thousand RMB to taxpayers engaged in the production of goods or the provision of services, or 800 thousand RMB to those who are engaged in the retail or wholesale.
  • General contributors: businesses with a rateable value of annual sales in excess of the taxpayers of small size.

The VAT is 3% for small-sized taxpayers, 13% for the general taxpayers who sell or import cereals, gas, oil, newspapers, books and agricultural products and 17% for other general taxpayers. Only the general taxpayer must issue invoices, which are prepared in accordance with pre-established forms printed by the tax from which they must be purchased.

The taxpayer is required to pay the VAT, from which, however, it is necessary to deduct the so-called: Recover Input Tax (RIT), which is the VAT paid on the purchase of raw materials and on certain fixed costs (machinery, transport vehicles and other instruments and appliances associated with the production and activity of the business). Real estate properties, houses and buildings are excluded.

The reference period of the VAT may vary from one, three, five, ten, fifteen days, a month or a quarter, and is determined by the tax according to the amount due.

The 2009 reform abolished the exemption of VAT (Free Policy), for import of equipment from abroad and the return of VAT (Returning Policy) for purchases of plants in China by the companies based on foreign capital - Foreign Invested Enterprises (FIE).

The Act states that the VAT on the export products is refundable in whole or in part. The rules vary depending on the trends of economic politics.

Since August 2008, the Central Government has revised the rates of refunds of VAT on the export of many products. The main changes regarded labour-intensive sectors such as textiles, clothing, toys and goods with high added value and technology. The rates of refund of VAT increased by:

  • Textile and clothing (16%).
  • Some plastic products and glass and ceramics (13%).
  • Some medicines, mechanical and electrical products, optical components, bags, shoes and hats, umbrellas, furniture and toys (15%).
  • Signalling equipment used for TV and sewing machines (17%).
  • Some metal products, scissors, fans, some books and other goods (9%, 11% o 13%).

The Business Tax (BT) is an indirect tax complementary to VAT. It applies to those services excluded from payment of VAT, transfers of real estate and sale of intangible assets. BT is calculated on the company turnover with percentages varying from 3% to 20% depending on the type of service: 

  • Transport, building, post and telecommunications, culture and sport - 3%.
  • Insurance, finance, services, land transfer and sale of intangible assets - 5%.
  • Entertainment and show business - from 5% to 20%.

Similarly to what reported about the VAT, the reference period can vary from five, ten, fifteen days a month or a quarter, and is determined by the tax according to the amount of BT due. Payment must be made at the place where the service provider or its receiver are. As a result, the services provided abroad in favour of individuals or Chinese companies are subject to the payment of BT.

There are special exemptions for technology transfer, technology development, for technical advisory services. These exemptions, however, are subject to assessment and authorization of the competent authorities.

The VAT and BT are mirror applying, first, to supplies of goods carried out on the territory of China and a burden, the second, on procurement of services excluded from the VAT scheme and on the transfer of real estate or intellectual property rights. The fundamental difference between the VAT and the BT is that the VAT can be deducted (compensating for the amount paid to purchase the tax rate applied to sales tax) while BT does not provide a similar mechanism resulting in only an additional cost burden on the final consumer and slows the development of the service.

REFORM OF INDIRECT TAXES

On January 1st, 2012 only for the municipality of Shanghai has entered into force, the reform of indirect taxes which involves subjecting certain types of services, previously subject to BT, only to VAT. The reform applies to the transport sector and the services that are defined modern (i.e. research and development, information, cultural activities, activities auxiliary to logistics, certification and consulting). The goal is to unify the BT with VAT thus standardizing the Chinese system to the international one. The Reform has been hampered by local authorities to who remains the 25% of the revenue produced by the VAT, while remained 100% of BT. The Municipality of Shanghai is very sensitive to industry services and is willing to act as a pioneer in the reform process.

Major new features:

  • Transaction of the companies operating in the sectors covered by a reform scheme from BT to VAT regime.
  • Introduction of two new levels for VAT rates: 11% for transport rates; 6% of modern facilities.
  • VAT proceeds for 100% of responsibility of the local authorities with the result that current incentives or tax benefits granted to companies will be maintained after consultation with the local Authorities.

Issues and influence on the company, are the change from BT regime to a VAT regime due to an increase in the rate that from 5% of BT rise to 11% or 6%.

Tax advice aimed at a useful study to identify the most advantageous tax planning (selecting the mode of business, the corporate structures and markets where you can reduce the tax burden) è is what should be done to legitimize the profits. A customized study  to specific areas of activity and according to the different local tax laws is helpful in planning: to this purpose Bright Business Consulting LLP provides the necessary support to achieve this goal.

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