Corporate Restructuring

Key Clarifications on Preferential Tax Treatment in the Enterprise Income Tax

 
By Crystal Li and Billy Lau

crystalli@khattarwong.com; lauyanwei@khattarwong.com

The Enterprise Income Tax Law (??????) (EIT Law) was promulgated by the National People’s Congress on March 16 2007 and took effect from January 1 2008. It introduced the uniform enterprise income tax (EIT) rate and set out general rules on taxable income, income tax payable, preferential tax treatment, withholding at sources, special tax adjustment, tax assessment and collection administration. The EIT Law replaced the Income Tax Law for Foreign Invested Enterprises and Foreign Enterprises (???????????????).

The EIT Law implementation rules, the Enterprise Income Tax Implementing Rules (??????????) (the Rules), were promulgated by the State Council on December 6 2007 and took effect on January 1 2008. On December 26 2007, the State Council also issued its Circular on the Transitional Preferential EIT Rate (?????????????????????) (Circular 39) and its Circular on the Transitional Preferential Tax Treatment for the Newly Established High-Tech Enterprises in the Special Economic Zones and Shanghai Pudong New District (?????????????????????????????????????) (Circular 40) (collectively, the Circulars). The Rules and Circulars were introduced to clarify and supplement the EIT Law.

Highlighted below are key clarifications on preferential tax treatment.

(1) Lower EIT rates for selected enterprises

The unified tax rate under the EIT is 25% and is applicable generally to both foreign and domestic enterprises. However, lower tax rates are levied on small-scaled low-profit enterprises and high-tech enterprises generally supported by the State.

A small-scaled low-profit enterprise is defined in the Rules as:

(a) an industrial enterprise (i) engaged in industries other than those restricted or prohibited by the State; (ii) has an annual tax payable of not more than Rmb300,000; (iii) assets valued at not more than Rmb30 million; and (iv) employs not more than 100 employees; or

(b) an enterprise not being an industrial enterprise which has (i) an annual tax payable of not more than Rmb100,000; (ii) assets value of not more than Rmb 30 million; and (iv) employs not more than 80 employees

Small-scaled low profit enterprise are levied EIT at a reduce rate of 20%.

A high-tech enterprise may qualify for a lower EIT rate of 15% if it independently owns the core technology utilized in its business and fulfills other prescribed conditions. Such conditions will be stipulated in guidelines to be issued by the State Council. Pursuant to Circular 40, high-tech enterprises incorporated after January 1 2008 and within the five Special Economic Zones (Shenzhen, Zhuhai, Shantou, Xiamen and Hainan Provinces) and the Shanghai Pudong New District, may enjoy a two-year tax holiday and a reduced EIT rate of 12.5% for the three years following.

(2) Tax Incentives

The general “two year holiday and three year reduction” (????) tax incentive afforded to foreign invested manufacturing enterprises have been abolished under the EIT Law. However, enterprises with income sources from (i) investment and operation of certain public infrastructure facilities; and (ii) certain environmental protection and energy and water saving projects are exempted from EIT for a three year period from the year the enterprise has first obtained its manufacture and operation, followed by a 50% reduction on unified EIT rate for a period of three years.

For a venture capital firm engaged in start-up investments supported and encouraged by the State, 70% of its investment in equity/shares of unlisted high-tech small and medium sized enterprises may be deducted against its taxable income – provided such investment exceeds a period of more than two years.

(3) Transitional adjustment of EIT rate

Under the EIT Law, preferential tax rates enjoyed by enterprises will be gradually increased to the unified EIT rate of 25% by 2012 Pursuant to Circular 39, the applicable EIT rate for the enterprises enjoying a prior preferential EIT rate of 15% will be revised at rates of 18% in 2008, 20% in 2009, 22% in 2010, 24% in 2011 and 25% from 2012 onwards. For enterprises enjoying a preferential tax rate of 24%, the unified EIT rate of 25% will apply with effect from January 1 2008.

Under the EIT Law, certain public infrastructure facilities and environmental protection projects may be qualified for the preferential tax treatment - however, the conditions for qualification remain unclear at this point in time. Similarly, the prescribed conditions mentioned in paragraph (1) above also require further clarification. While rules and circulars have been introduced to facilitate the implementation of the EIT Law, we expect further guidance to be released in the near future to remove any ambiguity that remains unaddressed.

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