Our previous articles looked at some of major issues relevant to selecting an investment vehicle in China and how foreign investors are taxed under the enterprise income tax (EIT). The fifth article in our series focuses on foreign-invested partnerships (FIPs), as well as other taxes on businesses in China.

An FIP is a Chinese partnership with at least one of its partners being a foreign enterprise or foreign individual. A typical FIP is depicted as follows:

From an income tax perspective, a Chinese partnership is somewhat like a fiscally transparent entity; in other words, the partnership is not a taxable entity. Instead, the partnership’s income will be taxed in the hands of the partners. Taxable income is generally calculated at the level of the partnership and then “allocated” to each partner who is taxed on its proportionate share of the partnership.

Notwithstanding the increased interest in FIPs for certain industries (fund industry in particular), it is a relatively new business vehicle available to foreign investors (since March 2010). Tax rules governing partnerships in China lag far behind investors’ expectations and the lack of guidance has created many issues. For example, a key concern of foreign investors is whether a foreign enterprise partner will constitute an “establishment” simply by holding interest in an FIP. If so, a foreign partner’s share of income derived from the partnership could be subject to a 25-percent EIT, instead of a 10-percent EIT on a withholding basis - a result that could detract from the attractiveness of FIPs. Given the uncertainties surrounding the tax treatment of FIPs, potential foreign investors should take steps to understand local practice, communicate with the tax authorities and seek professional assistance where necessary.

Other Taxes on Businesses in China

In addition to income tax, businesses in China may also be subject to other Chinese taxes (e.g. certain indirect or transaction taxes).

i) Value Added Tax (VAT) and Business Tax (BT)

VAT applies on the supply of goods and certain services, as well as the importation of goods. The applicable VAT rates are:

• General goods, repair/replacement services, leasing of tangible and movable goods – 17 percent;

• Specific goods (e.g. foods, books and utilities) – 13 percent;

• Transportation, postal services – 11 percent;

• Modern services (i.e. R&D and technology, information technology, culture and innovation, auxiliary logistics, attestation and consulting, radio/TV/film related services) – 6 percent.

A 3-percent tax applies under the small-scale taxpayer scheme. Exports of goods and specified services generally are zero-rated.

BT is a non-recoverable indirect tax (i.e. there is not a mechanism to obtain an input credit, as is the case with VAT) imposed on the provision of certain services (e.g. construction, financial, catering, entertainment, etc.) and the sale of immovable property or land use right within China. BT rates are 3 or 5 percentage points for most services, although a 5 to 20 percentage rate applies to the entertainment industry as determined by local tax authorities.

China currently is undergoing a nationwide VAT reform program that aims to shift all BT-able services to VAT. The reform is expected to be completed within the next two years.

ii) Consumption Tax (CT)

CT applies to alcohol, cosmetics, diesel fuel, fireworks, jewelry, motorcycles, motor vehicles, petrol, luxury watches, tobacco, golf equipment, yachts, etc., at rates ranging from 1 to 45 percent of the value of the goods. For certain goods (e.g. petrol, beer), CT is calculated based on the taxable volume of the goods.

iii) Import Duties

Import duties are levied on imports of goods at general or preferential rates. The preferential rates (e.g. most favored nation rates or conventional rates) apply to imports originating from countries or regions that have signed agreements with China containing reciprocal preferential tariff clauses, and the general tariff rates apply to imports originating from all other jurisdictions. However, as approved by the State Council Customs Tariff Commission, an interim rate may prevail over certain preferential rates in order to encourage the import of certain goods.

To encourage foreign investment, foreign-invested enterprises that meet certain requirements may be exempt from import duties on the importation of machinery and equipment for self-use.

iv) Miscellaneous

Land appreciation tax – Land appreciation tax is imposed on gains realized on the transfer of real estate. The gain is calculated based on sales proceeds less certain deductions, and the tax is charged in four bands ranging from 30 to 60 percent.

Stamp duty – Stamp duty at varying rates applies to dutiable contracts, agreements and certain legal documents.

Deed tax – Deed tax is imposed on the buyer at 3-5 percent on total value of land use rights or building ownership rights when transferred.