A Guide to the China Tax System for Foreign Companies
This article will give a China tax system overview and explain China’s tax rates. The China tax system for foreign companies is not instantly straightforward, and frequently subject to change. But it is very important for any company operating in China to understand – both to better plan business in the country and to comply with legal requirements.
This article will discuss:
- The China tax system as it is now and how it continues to evolve
- An overview of all taxes that effect WFOEs in China
- Rules and allowances for China Income Tax
- The use of CIT in offering tax incentives in China
- Withholding tax and dividend/profit payment
- A look at the VAT system and categories
- Other applicable taxes – Business Tax, Consumption Tax, Stamp Tax, Real Estate Tax
- Our thoughts on possible future changes to the taxation system
Taxation in China
Taxation in China is administered by the State Administration of Taxation. This government body establishes the tax laws in China and sets the tax rates for all companies. Handling and collection of taxes, however, is dealt with at a local level by the regional tax bureaus.
In general, most taxation schemes apply nationally but there are often cases where regional differences can arise. These can occur for several reasons, for example:
- Tax incentives in China that apply only to specific regions or industries (for example lower CIT rates)
- Policies and changes that are first tested/trialed regionally before expansion nationwide (for example recent VAT reform)
- Special tax rates or policies which apply to Free Trade Zones
To many companies, the tax system in China can appear complex and confusing. One of the main reasons for this is that the rules and tax rates change frequently. This comes partly from a rapidly changing business environment (and a modern taxation system that only really started in the 1980s), and partly from the government’s ongoing desire to improve the market for both domestic and foreign companies in China.
Progress has already been made in this area of market improvement through overall tax reduction in recent years. For example VAT reforms carried out since 2012 have to date delivered overall tax reductions of approximately 2.1 trillion Yuan (according to China Daily).
Tax faced by WFOEs in China
There are two main types of tax that apply to companies in China.
- Those related to company income/profit– including Corporate Income Tax and Withholding Tax
- Taxes related to Sales/turnover – including VAT, consumption tax, Stamp Tax, and Real Estate Ta
1. China Business Tax – China tax rate
China Business Tax or Corporate Income Tax (CIT) applies to all companies in China. It is levied on company profits at a rate of 25%. These days, CIT applies equally to all companies. There used to be separate rates in place for domestic and foreign companies, but these were equalized as part of reforms to Corporate Income Tax Law in 2008.
CIT is calculated on an accrual basis – that is income and expenses are recorded at the time they are earned/spent. It is calculated and paid monthly or quarterly (within 15 days of the period end), and then reconciled annually as part of a company’s year-end audit. Additional tax is paid or a rebate applied for as appropriate at this time.
CIT is calculated based on total income less allowable deductions. Deductions allowable for CIT generally include:
- Business costs and expenses incurred in relation to income received
- Appropriate other taxes and losses
- Charitable donations (up to 12% limit)
- Depreciation of fixed assets
- Amortization of intangible assets
- Any reductions based on local tax incentives
Tax incentives in China are a common method of encouraging investment in particular industries or regions, and these are often offered through CIT. There are currently several general CIT reductions in place, including:
- A rate of 20% for low-profit companies (companies with taxable income not exceeding 1 million RMB)
A rate of 15% for some high tech industries, in certain cities (including Beijing, Shanghai, Guangzhou, and Shenzhen). Criteria and application requirements for such companies are set out in government regulations “Guokefahuo” 32 and 362. Note that companies engaged in business in separate industries would need to prepare CIT returns for each industry (discount qualifying and non-discount qualifying).
- A temporary reduction to a rate of 15% until 2020 for encouraging industries in the western regions of China.
Infrastructure projects in areas of basic infrastructure (e.g. railways harbors, highways, public transport, and water resources) and environmental protection projects (including sewerage treatment, desalination, energy saving, and emission reduction projects) can apply a scheme offering 3 years CIT exemption, followed by 3 years at 50% CIT reduction.
Withholding Tax (WT) applies to payments of China derived income to non-resident enterprises. For such payments, a tax must be “withheld” before remittance. The current rate of withholding tax is 10%, but note that this is a general reduction from a higher rate of 20%, and could change in the future.
This would apply to the following:
- Dividends or other equity investment proceeds from a China source
- Interest, Royalties, and rent
For certain countries, there are double taxation treaties in place to offset some of this tax paid. These treaties may specify a rate lower than 10% to be used, in which case this can be adopted. For further details on double taxation treaties, see our separate article.
Withholding tax is of importance when looking at Chinese profit repatriation. The most straightforward way to repatriate profit is to do so using dividends out of profits. This, however, means that CIT will have to pay on profits, then WT paid on the dividends. This has several disadvantages:
- a higher total tax on remittance
- the consideration that dividends can only be paid on accumulated profit (having offset losses and paid 10% of profits into a capital reserve fund if needed).
The alternative way to repatriate profits is to pay profits out as service fees or royalties. Tax on remittance can be saved here – service fees are subject to VAT and WT, and royalties subject to VAT and WT – but both can be deducted against CIT, as long as they are properly set up and documented.
Capital Gains Tax
It should be noted that China does not have a specific Capital Gains Tax policy. Any capital gains are treated as normal company income and therefore taxed as part of CIT.
2. Value Added Tax – VAT
Value Added Tax (VAT) is applied as a consumption tax, based on a percentage of the invoiced sale amount for goods and services in China.
VAT was first introduced in China in 1984. The system was notoriously complex, with many different rates and regional differences being applied, and a separate “Business Tax” soon being introduced for certain service sector sales. A major reform of the VAT system was carried out between 2012 and 2016, first applied only regionally but then expanded nationwide. From July 2017 the new VAT system in China covers all appropriate goods and service sectors, with three different levels of VAT – 6, 11 and 17 percent.
VAT is calculated using the following formula:
VAT Payable = Output VAT – Input VAT
For most companies, VAT is calculated based on total applicable sales/invoices raised, as a specified percentage of sale amount – this is known as Output VAT. The total VAT payable is calculated by subtracting from this Input VAT. This is an allowance for VAT paid for purchases by the company.
VAT – Registration and Options
Any company in China needs to register to pay VAT on its sales once its sale reaches a minimum level. It varies by region from approximately 5,000 to 20,000 RMB sales per month. This is particularly low and foreign companies will likely be used to much higher thresholds in their home countries.
There is an important distinction in China whether a company is registered as a general VAT payer or a small-scale payer. The criteria for this is based on annual taxable sales amounts, but there are often cases where a small-scale company may be better of registering as a general payer.
- “Small scale tax payer.” A company with low sales turnover can register for small scale taxpayer status. This level is set at 800,000 RMB annually for commercial companies (e.g. sales of goods) and 500,000 RMB for industrial companies (e.g. manufacturing).
- This limit is raised to 5 million RMB for companies providing certain service offerings (generally those that have recently moved from Business Tax to VAT).
- Small scale companies pay VAT under a different scheme. VAT is calculated at a flat rate of 3% of sales, with no ability to deduct input VAT. They also cannot issue VAT Fapiao (receipts) to Chinese clients.
- “General taxpayer.” Registration as general taxpayer offers the tiered 6, 11 and 17 percent VAT bands, and offset of the input VAT liability.
Note that for some companies it is beneficial to register for general status even with low income. Depending on the company finances, the ability to offset input VAT can be important, and to do business with some Chinese suppliers and clients it may be necessary to be able to issue VAT Fapiao.
VAT – Tax Rates
There has been a significant change in the VAT system in China in recent years. In the past, there were a number of different rates applied for different areas, alongside a separate Business Tax applied for some areas of service income. These have gradually been simplified and merged, resulting in a new VAT system applied nationwide from July 2017 that has three different levels of VAT – 6, 11 and 17 percent.
These rates were altered again in May 2018 as part of ongoing efforts by the Chinese government to lessen overall tax burdens for companies. The 17% tier was lowered to 16% and the 11% tier lowered to 10%, with no change to the 6% tier.
Which rate applies to which goods and services?
The following is a summary of the VAT rates applied. For a full listing consult a China accountant, or obtain the government provided listings.
- Note that exports of most goods are generally zero-rated. This may require re-claim from the local tax authority, however.
- There are some areas exempt from VAT (simpler than zero-rated as no reclaim process is required). These include the sale of agricultural products, contraceptive drugs and devices, antique books, and certain exported services.
- The general VAT rate of 16% (previously 17%) applies to domestic sales and imports of most goods. It also applies to the provision of repair, replacement and processing services, and the leasing of tangible moveable assets.
- The lower rate of 10% (previously 11%) applies to certain goods – including some agricultural products, food grains, and vegetable oils, some agricultural chemicals, printed and electronic media, heating and air-conditioning.
- The 10% rate is also applied to many service areas – such as transportation, postal services, construction and real estate, and basic telecommunications services (e.g. voice).
- The 6% rate applies to a number of other services areas:
- Financial (including loans, insurance, and financial products transfer)
- “Modern” services – such as research, consulting services, IT, business support and radio, film and TV services.
- “Life” services – such as cultural and sports services, medical services, tourism, and entertainment services.
- Sale of intangible assets (such as trademarks, copyright, and technology) is at the 6% level.
Consumption tax is another sales based tax, this time applied to manufactured or imported consumables and luxury goods. It is based on the sale value of the item. Tax should be calculated and paid monthly.
Consumption tax rates vary from 1% to 56% depending on the item. The highest rates are applied to tobacco and alcohol.
Some examples of rates for some of the main product groups include:
- Tobacco: Cigarettes 36% or 56% depending on strength, cigars 35%
- Alcohol: Beer 220-250RMB/ton, white spirits 20%, others 10%
- Gasoline: 1.52 RMB/litre
- Cars: 1% to 40% based on engine cylinder size
- Motorcycles: 3% to 10% based on engine cylinder size
- Luxury watches: 20%
- Golf equipment: 10%
- Yachts: 10%
- Wooden flooring 5%
- Lead batteries: 4%
- Paints: 4%
In general, this tax is no longer applied in China but it is included here for completeness.
Business Tax was applicable for many years for various areas of service income (including financial, construction, leisure and entertainment) as well as various property and land use rights transactions. Business Tax was applied on a scale ranging from 3% to 20%, on gross turnover.
Following major VAT reform up to 2017, the areas where business tax was applied have now mostly been incorporated into the VAT system. There is a chance however that in some areas, WFOEs may still come across references to Business Tax.
Stamp Tax / Stamp Duty
Stamp Tax or Stamp Duty is a tax levied on various contracts, licenses and accounting books. This includes purchases and sales contracts, transfer of property rights, property leasing, engineering and design contracts, technology contracts, storage, and financial loans.
The rate varies from 0.005% to 0.1% depending on the contract type.
Real Estate Tax
Owners or users of property for commercial purposes must pay Real Estate Tax. Residential property is not included for individual use, but tax does apply for the leasing of residential property.
Real Estate Tax is charged at a rate of 1.2% of the purchase price of a property. There is a discount of 10% to 30% offered on this by most local governments. Additionally, Real Estate Tax is eligible for deduction from CIT.
Land Value Appreciation Tax
This tax applies to all transfers of land use rights for state-owned land or buildings. Any income earned from the transfer is taxed on a sliding scale depending on the total appreciation. This starts at 30% tax for an appreciation of less than 50%, and increases to 60% tax for an appreciation in excess of 200%. Costs incurred in the transfer, and also in development of the land during ownership, can be deducted.
Future Changes to the taxation system
The taxation system in China has undergone many changes since the 1980s and will most likely continue to do so. The Chinese government remains supportive of improving the business environment in China, for both domestic and foreign companies. Simplification of the tax system and reduction of the overall tax burden for companies is a key part of this.
Some areas we think likely to see future changes include:
- Further reform and simplification of VAT. There is some opinion that it may move to a simpler two rate system from the current three.
- Simplification to the Consumption Tax system, and possible inclusion within VAT.
- Ongoing changes to CIT reductions, as the government’s regional and industry development, focusses change.
- Continued to move online. Many parts of the tax registration, filing, and management system have moved online in recent years, along with many areas of business license and registration. This is likely to continue, making tax management simpler.
- More tax registration “automatic” as part of a business license. A new “5 in 1” business license now includes several government-required business licenses. This could well be extended to include registration with different tax bureaus as well.
- Future revisions to IIT likely to be made, with IIT new policy due to be announced in October 2018.
The information contained in this article is valid on August 5th, 2018. For updated information, please contact us via email at [email protected]