Investing in China

Investment Guidelines

Investment Guidelines

Investment Guidelines	Major Taxes Applicable to FIEs	Corporate Income Tax (CIT)
Personal Income Tax (PIT)	Value Added Tax (VAT)	Business Tax
Resources Tax	Stamp Duty	Comsumption Tax
Urban Real Estate Tax	Vehicle Usage and License Tax

Investment Guidelines

Types of Foreign Investment

Currently, there are three main types of foreign investment enterprises, namely, Equity Joint Ventures (EJV), Cooperative Joint Ventures (CJV) and Wholly-owned Foreign Enterprises (WOFE). As a whole, they are referred to as Foreign Invested Enterprises (FIEs).

In addition to these, other types of investments are also available to foreign investors. They can be done through Foreign-Invested Holding Companies (FIHC), Foreign-Invested Joint Stock Companies (FIJSC), and Build-Operate-Transfer (BOT). With the relaxation of laws and regulations in accordance with China’s WTO commitments, these three types of investments are becoming increasingly popular.

Six Types Of Foreign Investment Enterprises

- Equity Joint Venture (EJV)
- Cooperative Joint Venture (CJV)
- Wholly-owned Foreign Enterprises (WOFE)
- Foreign-invested Holding Companies (FIHC)
- Foreign-invested Joint Stock Companies (FIJSC)
- Build-Operate-Transfer (BOT)

Equity Joint Ventures (EJV)

Equity Joint Ventures (EJVs) are enterprises that are co-established, co-invested in, or co-operated by foreign enterprises, other economic entities or foreign individuals within the territory of the PRC, and Chinese enterprises or other economic entities, in accordance with the principles of equality and mutual benefit, and subject to approval by the Chinese government.

EJVs are legal entities that must adhere to the Chinese laws and have the right to own assets, sue others and also face the risk of being sued. Both foreign and Chinese participants share the profits and the burdens of the losses. Joint Ventures are limited liability companies, which means that the personal wealth and property of the shareholding partners are shielded from corporate loss.

The investment proportion contributed by one or more foreign participant(s) as its share of the registered capital of a Joint Venture must be 25% and above, generally speaking.

Cooperative Joint Ventures (CJV)

Cooperative Joint Ventures (CJVs) are otherwise known as contractual operative enterprises. When Chinese and foreign partners establish a cooperative enterprise, the terms regarding the investment, co-operation, distribution of earnings or products, sharing of risks and losses, methods of business management, and ownership of property on the expiration of the contract term, would all be prescribed in the co-operative enterprises contract in accordance with the provisions of Chinese law.

Convenience and flexibility are the defining characteristics of this type of investment. It is thus easier for co-operative partners to reach an agreement in such a venture. A cooperative enterprise that complies with the Chinese law will acquire the status of a Chinese legal person.

In other words, a CJV with a non-legal person status will be the legal equivalent of a partnership establishment. However, it would not be able to enjoy limited liability protection. In practice, the majority of CJVs are set up as limited liability companies with legal person status.

As a general practice, investment or terms of co-operation provided by the foreign partners will be given in the form of cash, equipment and technology. As for the Chinese partners, investment or terms of co-operation may come in the form of land-use rights, labor and related services.

Major differences between EJVs and CJVs

The most significant difference between EJVs and CJVs is the allocation of profits and liabilities. In an EJV, profits and liabilities are allocated based on the ratio of the capital contributions by the partners. It simply means that if one party contributes 30% of the capital investment, they will be rewarded 30% of the total profits and will be required to assume responsibility for 30% of the liabilities.

In contrast, CJV allows for greater flexibility in the agreement between the joint venture parties. In a CJV, profit sharing is generally prescribed by the joint venture agreement between the parties. In practice, the foreign party generally receives a higher percentage of profit in the initial years of the CJV while their Chinese partner will become the owner of the fixed assets of the CJV at no cost after termination of the joint venture.

Wholly-owned Foreign Enterprises (WOFE)

Wholly-owned Foreign Enterprises (WOFE) are enterprises established within Chinese territory in accordance with the relevant Chinese laws. All capital will be provided by foreign investors in such enterprises. However, WOFEs do not include any foreign enterprises in China or other economic entities. They are Chinese entities registered within the territory of China, and will be governed and protected by Chinese regulations.

WOFEs are subject to the Law of the People’s Republic of China on Wholly Foreign-Owned Enterprises. The law was approved by the State Council on October 28, 1990, and amended on April 12, 2001. It is noted that under the revised rule, the restrictions imposed on WOFEs in areas such as foreign exchange balance, export obligation, priority of domestic sourcing, and reporting requirements for production and operation plans have been removed.

Export Obligation

According to the old law, enterprises with foreign capital should be established in a way that helps promote China’s economic development by utilizing advanced technology and equipment, and by marketing most (if not all) of their products outside China.

Under the revised rules, WOFEs no longer have to export all or the majority of their products. It simply states that foreign enterprises are encouraged to market their products outside China and use advanced technology. This change gives a greater degree of autonomy to WOFEs and permits them to legally sell their products in China’s domestic markets.

Sourcing

According to the previous law, WOFEs were required to purchase their production equipment and raw materials from domestic markets.

However, the revised law now stipulates that when making purchases of raw materials within the permitted scope of its operation, an FIE can either buy the goods from China or from international markets. With this amendment, WOFEs in China enjoy greater freedom in purchasing.

Foreign Exchange

The original regulation required WOFEs to achieve a balance in foreign exchange income and expenditure. The current amendments have removed this regulation.

Production and Operation Plans

Previously, WOFEs were required to submit their production and operation plans to the authorities for filing. This requirement, to a certain extent, impeded the daily operations and management of WOFEs.

The revised laws on Foreign Capital Enterprises and Sino-foreign Equity Joint Ventures have removed this requirement and WOFEs now have greater independence in their operations.

Foreign-invested Holding Companies (FIHC)

Foreign-invested Holding Companies (FIHCs) refer to companies established in China by WOFEs or by EJVs to engage in direct investment. They are set up as separate legal entities with limited liability status and are independent of the enterprises in which they invest (i.e. their subsidiaries). The business scope of an investment company is strictly limited to that provided by the Chinese laws. From 2001 onwards, FIHCs were allowed to act as promoters or shareholders of a joint stock company in China. Unlike foreign manufacturing and trading enterprises which are only permitted to carry out business in the location specified in its business registration, FIHCs are able to invest in projects all over China.

Foreign-invested Joint Stock Companies (FIJSC)

Foreign-invested Joint Stock Companies refer to enterprises with corporate status with a total capital that is composed of the equivalent value of stock. Shareholders assume an amount of liability equal to the amount of shares purchased, which offsets its total assets against responsibility assumed for the company debts. Their company shares are jointly held by Sino-foreign shareholders. Shares purchased and held by foreign shareholders constitute more than 25% of such companies’ registered capital.

A Foreign-invested Joint Stock company may adopt the promotional method or share floating method for its establishment. The registered capital of a company is equivalent to the total amount of paid-up share capital which the company signs up with to the relevant authority. The minimum amount of registered capital of a company is RMB 30 million.

Build-Operate-Transfer (BOT)

Build-Operate-Transfer (BOT) is one type of private business investment utilized by a government to build infrastructure for highways, railways, power stations and so forth. To date, BOT has been progressively employed by the Chinese government to encourage foreign investment in their infrastructure projects. Commitment by the government is one of the key features of BOTs.Over an agreed period of time, the project company will own, operate and maintain the project while reclaiming investments and making reasonable profits by charging fees. Once the contract period is over, the ownership of the project will be transferred to the government.

Taxation System

China’s rapidly-changing corporate and individual tax regulations make ongoing tax planning an essential part of doing business in China. Tax incentives are one of the most important factors to be considered by foreign investors when making their investment decisions in China.

Tax Administration

The Law on Taxation Administration is the basic law on taxation and is also a procedural law. All enterprises, domestic and foreign, are treated equally under this law.

Joint Ventures (JVs), wholly-owned foreign enterprises (WOFEs), representative offices and other similar organizations in China are required to register with local tax authorities within a specified time as regulated. In general, this must be completed within 30 days after the business license is issued.

Registrations are to be filed with both the State Taxation Administration (local branch) and the local Taxation Administration. These two administrations have their own tax jurisdictions. To qualify as an ordinary Value Added Tax (VAT) payer and be able to issue VAT invoices, a taxpayer has to undertake VAT registration as well.

Upon completion of the tax registration, the tax authorities will issue the applicant a tax registration certificate that must be renewed every year. Any changes in business license or operating office will require re-registration with the tax authorities.

Taxation Control

A tax year follows the calendar year, i.e., from Jan. 1 to Dec. 31. If a foreign enterprise experiences difficulties in computing its taxable income on the calendar-year basis, it may apply to the tax authorities for the right to adopt its own financial year as the tax year. For an enterprise that commences business in the midst of a calendar year or has been in operation for less than 12 months of a calendar year, its operating period will be treated as the tax year.

An FIE is required to file its annual tax returns, audited financial statements and the auditor’s report to the tax administrations within four months after the end of the year. The application for deferring the filing of the above documents should also be submitted within this period of time. The penalty for failure to file the above documents within the prescribed time limit is calculated at 0.2% per day on the tax amount overdue.

Tax Audit

The tax authorities have the right to carry out tax audits to examine taxpayer records and relevant documents. Refusal of tax examination will be subject to a maximum penalty of RMB 50,000. In general, tax authorities will provide enterprises with a written notice about impending tax audits.

Tax Reporting and Payment

Different taxes have different reporting periods and payment due dates. In general, Corporate Income Tax (CIT) is paid on a quarterly basis whereas VAT, Business Tax and Individual Income Tax (IIT) are given on a monthly basis. Tax authorities will not send taxpayers tax return forms. Rather, taxpayers must collect blank forms from the relevant offices, complete them and file them accordingly.

Acceptable modes of submission differ from place to place and depend on the nature of the tax. For some locations, reporting via mail is acceptable, while at others, submission must be made in person. More technologically advanced regions like Shanghai have adopted electronic filing.

Late payment of tax will incur a fine of 0.05% a day on the tax owed. Withholding agents who fail to observe these obligations will be subject to a maximum penalty of 500% of the tax involved. Under the regulations, you may apply to the tax authorities to defer tax filing and payment.

Tax Applicable to Foreign Invested Enterprises

Over the past 20 years, China has made significant progress and has gained more experience in its tax legislation, in particular, those relating to foreign invested enterprises. While China continues to use preferential tax treatment as an important strategy to attract Foreign Direct Investment, it has shifted its emphasis from the amount or quantity of foreign investment to the quality of foreign investment, believing that this will help promote the country’s overall and sustainable economic development.

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Major Taxes Applicable to FIEs

Currently, the major taxes applicable to foreign invested enterprises (FIEs) include:

- Corporate Income Tax
- Personal Income Tax
- Value Added Tax
- Business Tax
- Resource Tax
- Land Appreciation Tax
- Stamp Duties
- Consumption Tax
- Tax for Vehicle Usage and License
- Customs Duty
- Tax on Urban Real Estate
- Vessel Tonnage Tax.

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Corporate Income Tax (CIT)

On March 16 2005, the 10th National People’s Congress enacted the new CIT Law, which unifies the income tax treatment of domestic and foreign enterprises. The new taxation system will be implemented in the 2008 tax year with some provisions taking immediate effect.

The following summarizes the key aspects of the New Law and its impact on foreign investors.

The new standard corporate income tax (CIT) rate is 25%. The reduced CIT rate of 20% will apply to small-scale and thin-profit enterprises and the preferential CIT rate of 15% is only available to high/new technology enterprises that require support from the State.

Taxpayers. The New Law introduces the concepts of ‘tax resident enterprise’ and ‘non-tax resident enterprise’ to differentiate taxpayers:

CIT Preferential Policies

The New Law grants tax preferential treatments on an industry basis rather than on a location basis. The main tax preferential polices in the New Law include:

High-tech enterprises that enjoy support from the State are eligible for a reduced 15% CIT regardless of location in China;

A CIT exemption or reduction remains for specific technology transfer and investments in infrastructure, agriculture, forestry, animal husbandry and fishery industries;

‘Super deduction’ is allowed for R&D expenses and salary expenses for employment of handicapped workers;

CIT credit is granted to specific venture capital enterprises and investments in environmental protection, energy, water conservation and specific safety equipment.

Some CIT preferential policies currently available exclusively to FIEs will be revoked, including:

Five-year tax holiday for manufacturing FIEs;

Extension of tax holiday to export-oriented FIEs;

Reduced 15% or 24% CIT rate applicable to FIEs in special zones;

CIT refund on reinvestment;

50% CIT reduction for an additional three years after the tax holiday for FIEs that are considered as ‘technologically-advanced enterprises’;

CIT exemption for after-tax profit repatriation by foreign investors.

Transition Period

The New Law allows for a five-year transition period. The transition arrangement is as follows:

FIEs enjoying a 15% or 24% tax rate will be eligible for a 5-year transition period to move up to a 25% tax rate. The New Law does not provide details for the transition, but FIEs are expected to increase their 15% tax rate by 2% per year over the five-year transition period to reach 25%.

Manufacturing FIEs which have not fully utilized the five-year tax holiday before the effective date of the new tax law will continue to enjoy the remaining holidays.

Manufacturing FIEs which have not started their tax holidays under the old law will start their tax holidays from the effective date of the New Law.

Withholding Tax Rate. The New Law provides a flat 20% tax rate for dividends, interest, royalties, rentals, capital gains or other income derived by non-resident enterprises from sources in China. However, it is still uncertain whether:

Withholding tax on dividend remittance will continue to be exempted;

Withholding tax on other income, e.g. interests, royalty and capital gain, will continue to be reduced to 10%.

Impact on Foreign Investors

As the detailed implementation rules have not been released by the State Council, many points have yet to be clarified. However, the New CIT Law has provided the general principles which may change future investment strategies for foreign investors in China.

Foreign investors are advised to re-examine their tax planning schemes to optimize tax preferential policies available under the old law prior to the effective date of the New Law to ensure their eligibility for tax benefits under the New Law.

The New CIT Law represents a significant change in direction for China. For the past decade and a half, China has operated on a dual tax system, with differing tax and incentive laws and non-standardized calculation of taxable income.

So far, where domestic enterprises are concerned, the CIT is 33%, while the CIT for FIEs is 30%. In addition, there is a 3% local surtax for the FIEs when no preferential tax treatments are applicable. CIT for enterprises at the coastal regions, border regions and certain other regions is at 24% whereas only a 15% CIT is applicable for the Special Economic Zones. There are also quite a number of tax incentives available to FIEs specially tailored to specific industries and locations.

This has resulted in considerable disparities in the effective tax rates generally applicable to domestic enterprises and to FIEs. The New Law eliminates these differences and introduces a level playing field.

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Personal Income Tax (PIT)

The PIT Law was adopted by the Third Session of the Fifth National People’s Congress on September 10, 1980. The Law has been amended three times in 1993, 1999 and 2005.

Individual income tax was levied on the following:

- Income from wages, salaries;

- Income from production, operation derived by industrial and commercial households;

- Income from contractual or leasing operations to enterprises or institutions;

- Income from labor service payment;

- Income from authors remuneration;

- Income from royalties;

- Income from interest, dividends and extra dividends;

- Income from lease of property;

- Income from transfer of properly;

- Contingent income;

- Other income specified as taxable by the finance department of the State Council.

Like most other countries, China does not adopt a flat tax system. Instead, there are 9 marginal tax rates. According to the current tax rate, the first RMB 500 of taxable income will be taxed at 5%; the next RMB 1500 will be taxed at 10%. Any income exceeding RMB 100,000 will subsequently be taxed at 45%. Currently, the threshold income is RMB 1,600, as stipulated in 2005.

For foreign taxpayers, the threshold was increased to RMB 4,800 in 2006 from the previous RMB 4,000 per month. Income from compensation for personal services, royalties, interest, dividends, bonus, lease of property, transfer of property, contingent income and some other kinds of income is taxed at a proportional rate of 20%.

From the 1st of January 2007, individuals with an annual income over RMB 120,000 will have to declare their individual income tax personally to the local tax authority.

Currently, the wealth gap is widening and the ratio of residents’ income and consumption to GDP is decreasing. Since the 1970s, the proportion of people’s salaries to GDP has been falling. In 16 of the past 23 years, the ratio deteroriated from the previous year. The new regulations target taxation of the high-income group in a bid to bridge the wealth gap.

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Value Added Tax (VAT)

There are three kinds of rates for VAT:

For taxpayers selling or importing goods, or providing services of processing, replacement and repairs, the tax rate is 17%.

For taxpayers selling or importing grains, edible vegetable oil, coal gas, natural gas, coal or charcoal products for household use, books, newspapers, magazines, chemical fertilizers, agricultural chemicals and agricultural machineries etc., the tax rate is 13%.

Taxpayers exporting goods, except those otherwise stipulated by the State Council, are exempted from VAT.

Enterprises and individuals engaged in the production or the provision of taxable labor services with annual sales volumes not exceeding RMB 1 million face a tax rate of 6% on a tax-in price basis. The same applies for those participating in wholesale and retailing with annual sales volumes of less than RMB 1.8 million (or designated by the tax authority as small VAT payers).

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Business Tax

Business tax will be levied on organizations and individuals involved in supplying taxable labor, transfer of intangible assets and the sale of real estate. The rate of business tax is 3% for communications and transportation, civil construction, post and telecommunications, and culture and sports industries, and 5% for banking and insurance services, transfer of intangible assets, and real estate sales industries. The business tax rates for entertainment industries range from 5% to 20%. Generally, this tax is applicable to companies in the service industries.

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Resources Tax

Foreign enterprises that mine and explore minerals and natural resources within the territory of China are subject to a resources tax. Land appreciation tax is imposed on the income from the transfer of state-owned land use rights, buildings and their attached facilities. The appreciation amount is the balance of proceeds received by the taxpayer on the transfer of real estate after deduction of the following:

The sum paid for the acquisition of land use rights;

Cost and expenses for land development;

Cost and expense for the construction of new building and facilities, or the assessed value for used properties and buildings;

The taxes related to real estate transfer; and,

Other items as stipulated by the Ministry of Finance.

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Stamp Duty

Activities involving purchases and sales, processing, contracting, leasing, transportation, storage, loan lending, property insurance, technology contract and property transfer vouchers, business account books and licenses are subject to stamp duty. The minimum rate is fixed at 0.005% and the maximum at 0.3%.

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Comsumption Tax

Consumption tax is charged on the sale of goods and covers 11 taxable items and 25 tax rates (for details, refer to the rules for the Implementation of PRC Interim Regulations on consumption tax), with 3% as the minimum and 45% as the maximum.

The tax on the goods used in the production process is based on the price of the goods, while any tax levied on yellow rice wine, gasoline and diesel depends on value per unit basis.

Apart from the taxable consumer goods subject to export restrictions imposed by the Chinese government, taxpayers are exempted from paying consumption tax for the consumption goods they export.

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Urban Real Estate Tax

Real estate tax is assessed according to the following criteria and tax rates:

The tax on buildings will be assessed annually at a rate of 1.2 % of the standard value of buildings;

The tax on land will be assessed annually at a rate of 1.8% of the standard value of land;

The tax will be provisionally assessed annually at a rate of 1.8% of the consolidated standard value of land and building in cities in which it is difficult to determine the standard value of land and the standard value of buildings separately;

The tax will be provisionally assessed annually at a rate of 18% of the standard rental value of real estate in cities in which it is difficult to determine the standard values of land and buildings.

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Vehicle Usage and License Tax

The rate for vessels and vehicles is assessed on the basis of weight capacity, vehicle type and the number of seats (in the case of passenger vehicles). For instance, the tax payable for passenger vehicles with no more than 10 seats would be RMB 55 per six months.

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