This article looks at how foreign investors are taxed in People’s Republic of China (PRC) under the enterprise income tax (EIT), regardless of whether the investor is operating as a wholly foreign-owned enterprise, equity joint venture or legal person cooperative joint venture (collectively, foreigninvested enterprises or FIEs).

PRC EIT law

The current PRC EIT Law came into effect in 2008 and applies to PRC resident enterprises and nonresident enterprises. An enterprise is a resident of China if it is established in China or if its place of effective management is in China. Effective management is defined as substantial and overall management and control over manufacturing and business operations, human resources, and financial and property aspects of an enterprise. Thus, an enterprise registered outside China, but with its place of effective management located in China, is still considered a resident enterprise.

A resident enterprise is taxed in China on its worldwide income. A nonresident enterprise with an establishment in China is subject to EIT in China on all income effectively connected with the establishment; an establishment for these purposes is any establishment engaged in business operating activities within the territory of China. A nonresident enterprise without an establishment in China is subject to tax on its income derived from China.

The standard EIT rate for a resident enterprise is 25 percent, which may be reduced by specific tax incentives. For instance, a preferential tax rate of 15 percent is applicable to high and new technology enterprises. This rate also applies to qualified high-tech service enterprises in 21 specified cities (e.g., Beijing, Shanghai, Tianjin, etc.) between July 1, 2010 and December 31, 2018. Encouraged industries in west China also can enjoy a reduced 15 percent EIT rate from 2001 to 2020.

The EIT rate applicable to a nonresident enterprise with an establishment in China is 25 percent. PRC-source income received by a nonresident enterprise (such as dividends, interest, royalties and capital gains) is subject to PRC income withholding tax at a rate of 10 percent, provided the enterprise does not have an establishment in China, or if the enterprise does have an establishment in China, the income is not effectively connected with the establishment. The 10-percent domestic rate may be reduced under a tax treaty.

Tax treaties

China has 96 comprehensive double tax treaties in force, including many treaties with African countries, and seven comprehensive treaties signed but not yet in force. China’s treaties largely follow the OECD Model Convention, but they also have adopted certain provisions from the UN Model Convention.

The taxation of a PRC resident enterprise is not affected by the existence of a tax treaty. However, the taxation of a nonresident enterprise may be affected by the treaty between China and the jurisdiction in which the nonresident enterprise is resident. Thus, in determining how a nonresident enterprise may be taxed in China, it is always necessary to look at both PRC domestic tax law and the applicable treaty, if any.

In the following discussions, we will first examine how an FIE will be taxed in China and in next month’s column we will use the China-South Africa tax treaty to illustrate how an investor from South Africa may be subject to tax in China on its investment in an FIE (except for capital gains derived from a transfer of the parent company’s interest in the FIE, which will be addressed in a separate article).

Taxation of an FIE

An FIE is a resident enterprise and thus subject to tax in China on its worldwide income at a rate of 25 percent, unless it qualifies for a tax incentive.

Taxable income for PRC tax purposes is the amount remaining from the gross income of the FIE in a tax year after the deduction of allowable expenses and losses, nontaxable and tax-exempt items, and any prior year loss carry forward. All documented and reasonable costs actually incurred in connection with operating activities are deductible, unless they are specifically identified as nondeductible in the tax law. A 50-percent super deduction is granted for qualified R&D expenditure if so approved by the responsible tax authorities.

For further information, contact Kevin Ng (kevng@deloitte.com.cn) and Delia Ndlovu (delndlovu@deloitte.co.za)