PWC Doing Business and Investing in China

Doing Business and Investing in China
Welcome
Dear Readers, PricewaterhouseCoopers China is proud to present you with the latest Doing Business and Investing in China guide. China is the most dynamic trading economy in the world, so it should be no surprise that companies who are serious about expanding and remaining globally competitive continue to head to China. Ever since 1978, when Chinas economic reforms began, the nation has been developing at an unprecedented pace. Today, Chinas economy continues to power ahead, presenting ever greater opportunities for foreign investors. In fact, Chinas Foreign Direct Investment increased to about US$75 billion in 2007, while merger and acquisition activities in China also continue to grow in strength. As China rapidly transforms to becoming one of the worlds largest and fastest growing marketplaces, and a home for the worlds emerging global companies, the question on most executives minds is this: How can I become part of the action at this unique time in Chinas history? Multinational investors have entered into an era where they are facing new challenges in operating their business in China issues of increasing complexity that touch on the war for talent, local market expansion and competition, risk management and frequent regulatory change. These issues form the foremost concerns for corporate executives in China. This guide has been prepared to assist foreign investors who are taking initial steps to establish and grow their business in China, as well as those who have significant operations in China and are interested in being updated with the most recent important changes in tax, accounting and investment related regulations.
Welcome
All the chapters in this guide are contributed by the practice leaders in the PricewaterhouseCoopers China Assurance, Tax and Advisory lines of services. The material contained in this guide was assembled on 31 December 2007 and, unless otherwise indicated, is based on information available at that time. We hope you find this guide practical and insightful and that it will become your regular reference material. That said, please note that the guide is not intended to exhaustively cover the subjects it addresses but rather to answer some of the important, broad questions that may arise for investors. When specific problems occur in practice, it will be necessary to refer to the specific laws and practices and to obtain appropriate professional advice. Please contact us at one of our 12 offices in China should you wish to know more about how we can help you do business in China. We look forward to helping you succeed in one of the fastest growing emerging markets in the world.
Silas Yang () Executive Chairman & Senior Partner
Table of contents
1-3 4-6 7-8 9 10-19 20-28 29-42 43-50 51-57 58-76 77-90 91-101 102-108 109-126 127-134 135-144 145-158 159-166 167-168 169-172 173-184 185-194 195-200 201-212 213-223
Introduction to PricewaterhouseCoopers PricewaterhouseCoopers China Offices Key contact people Our locations in China Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Peoples Republic of China A Profile Business environment Business entities Restrictions on foreign investment and investors Investment incentives Banking and finance Exporting to and from China Labour relations and working conditions Audit requirements and practices
Chapter 10 Accounting principles and practices Chapter 11 Tax system Chapter 12 Tax administration Chapter 13 Taxation of corporations Chapter 14 Taxation of foreign enterprises Chapter 15 Taxation of shareholders Chapter 16 Partnership enterprise Chapter 17 Taxation of individuals Chapter 18 Indirect taxes Chapter 19 Tax treaties Chapter 20 Transfer pricing Chapter 21 Mergers and Acquisitions
Table of Contents
224 225-226 227 228-234 235 236 237-238 239-243 244-251 252-254 255
Appendix I Appendix II
Corporate income tax rates Tax depreciation rates
Appendix III Corporate tax calculations Appendix IV Tax treaty summary Appendix V Tax rates Foreign nationals working in China
Appendix VI Personal allowances Foreign nationals working in China Appendix VII Individual tax calculation Foreign nationals working in China Appendix VIII Selected indirect taxes Appendix IX Illustrative financial statements Appendix X Comparison between China Accounting Standards and IFRS
Appendix XI Government of the Peoples Republic of China
Introduction to PricewaterhouseCoopers
About PricewaterhouseCoopers Globally PricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 146,000 people in 150 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. About PricewaterhouseCoopers China PricewaterhouseCoopers China is the leading professional services firms in China (www.pwccn.com), Hong Kong (www.pwchk.com), and Macau with a total strength of over 9,000 people, including close to 330 partners. Complementing our depth of industry expertise and breadth of skills is our sound knowledge of the local business environment in mainland China and Hong Kong. We are committed to working with our clients to deliver the solutions that help them take on the challenges of the ever-changing business environment. The firm had its origins in China in 1906, when it established an office in Shanghai, and has been established in Hong Kong since 1902. Today PricewaterhouseCoopers has offices on the mainland of China in Beijing, Chongqing, Dalian, Guangzhou, Qingdao, Shanghai, Shenzhen, Suzhou, Tianjin and Xian, as well as in Hong Kong and Macau (Special Administrative Regions).
Helping multinational companies to invest in China Comprising specialist business advisors and accountants, PricewaterhouseCoopers China has the most extensive resources, widest geographical coverage and the greatest in-depth expertise of all the professional services firms in China. The primary focus of the firm is our commitment to providing high-quality services to multinational companies investing in China. Our strong capability to meet this commitment is based on a strategy of identifying the nature and extent of services to be provided and committing the level of investment necessary to provide these services to standards required by international investors. Helping Chinese companies with securities listings and to succeed domestically and internationally Many Chinese enterprises have already listed in local and overseas stock exchanges. Many have expanded internationally, making their debut on the globe stage. PricewaterhouseCoopers China has made a significant investment and has built a leading presence in assisting Chinese companies in this endeavour. Services We provide a full range of business advisory services to foreign investors in China, including the following: Advice on market entry to international companies, including general business advice, market research, market analysis, strategy studies, joint venture identification and negotiation, establishment and registration of offices and personnel, feasibility studies, due diligence, business valuation, capital verification, tax structuring and planning, completing audits and management systems and processes.
Operational support to international companies, including business effectiveness, amalgamation and restructuring of joint ventures, IT systems advice, corporate, personal and indirect tax advice and risk management, labour practice compliance, foreign examination reports, management and head-office reporting and statutory auditing services. The business environment in China is unique. An effective business advisor must have the experience of the business environment in China to meet the business advisory needs of international and domestic clients. We have acted as advisors to multinational companies, state-owned enterprises, joint ventures, representative offices, and other business entities engaged in a wide range of activities throughout the country. This experience ensures that we are in a position to provide our clients with the highest quality advice available.
PricewaterhouseCoopers China Offices
Beijing
7 A26 100020 26/F Office Tower A Beijing Fortune Plaza 7 Dongsanhuan Zhong Road Chaoyang District Beijing 100020, PRC Tel: +86 (10) 6533 8888 Fax: +86 (10) 6533 8800 Shanghai
202 11 200021 11/F PricewaterhouseCoopers Center 202 Hu Bin Road Shanghai 200021, PRC Tel: +86 (21) 6123 8888 Fax: +86 (21) 6123 8800 Hong Kong
22 22/F Princes Building Central Hong Kong Tel: +852 2289 8888 Fax: +852 2810 9888 Chongqing
68 191905 400010 Room 1905 19/F Metropolitan Tower 68 Zou Rong Road Chongqing 400010, PRC Tel: +86 (23) 6393 7888 Fax: +86 (23) 6393 7200
4 Doing Business and Investing in China
Dalian
147 8 116011 8/F Senmao Building 147 Zhongshan Road, Xigang District Dalian 116011, PRC Tel: +86 (411) 8379 1888 Fax: +86 (411) 8379 1800 Guangzhou
161 25 510620 25/F Center Plaza 161 Lin He Xi Road Guangzhou 510620, PRC Tel: +86 (20) 3819 2000 Fax: +86 (20) 3819 2100 Macau
28C Unit C, 28/F Bank of China Building Avenida Doutor Mario Soares Macau Tel: +853 8799 5111 Fax: +853 8799 5222 Qingdao
59 4601 266071 4601, Qingdao International Finance Center 59 Hong Kong Middle Road Qingdao 266071, PRC Tel: +86 (532) 8089 1888 Fax: +86 (532) 8089 1800
Shenzhen
5002 38 518008 38/F Shun Hing Square Di Wang Commercial Centre 5002 Shennan Road East Shenzhen 518008, PRC Tel: +86 (755) 8261 8888 Fax: +86 (755) 8261 8800 Suzhou
188 1501 215028 Room 1501, Genway Tower 188 Wang Dun Road Suzhou Industrial Park Suzhou 215028, PRC Tel: +86 (512) 6273 1888 Fax: +86 (512) 6273 1800 Tianjin
189 117 300051 17/F The Exchange Tower One 189 Nanjing Road, Heping District Tianjin 300051, PRC Tel: +86 (22) 2330 6789 Fax: +86 (22) 2339 3662 Xian
30 728 710002 Room 728 Zhongda International Mansion 30 Nan Da Street Xian 710002, PRC Tel: +86 (29) 8720 3336 Fax: +86 (29) 8720 3335
Key contact people
Frank Lyn - China Markets Leader Tel: +86 (10) 6533 5015 Email: frank.lyn@hk.pwc.com Cassie Wong - China Tax Leader Tel: +86 (10) 6533 3195 Email: cassie.wong@cn.pwc.com NORTHERN CHINA Tax Edward Shum Tel: +86 (10) 6533 3256 Email: edward.shum@cn.pwc.com Assurance Thomas Leung Tel: +86 (10) 6533 5532 Email: thomas.w.leung@cn.pwc.com Advisory Malcolm MacDonald Tel: +86 (10) 6533 7804 Email: malcom.macdonald@cn.pwc.com
Key contact people
CENTRAL CHINA Tax Tony Kwan Tel: +86 (21) 6123 2538 Email: tony.kwan@cn.pwc.com Assurance Randy Ko Tel: +86 (21) 6123 3332 Email: randy.ko@cn.pwc.com Advisory Benjamin Ye Tel: +86 (21) 6123 2458 Email: benjamin.ye@cn.pwc.com SOUTHERN CHINA Tax Charles Lee Tel: +86 (755) 8261 8193 Email: charles.lee@cn.pwc.com Assurance Richard Sun Tel: +852 2289 1161 Email: richard.sun@hk.pwc.com Advisory David Brown Tel: +852 2289 2369 Email: d.brown@hk.pwc.com
Our locations in China
Beijing Xian Chongqing
Dalian Tianjiin Qingdao
Suzhou
Shanghai
Guangzhou Macau
Shenzhen Hong Kong
Chapter 1
Peoples Republic of China A Profile
Key messages On 12 November 2001, China was admitted to become a full member of the World Trade Organization (WTO), which has resulted in greater liberalisation of many services and industry sectors, as well as a reduction in customs duty. Foreign investors operating in distribution, logistics, financial services, telecommunications, and other sectors have benefited from this liberalisation. Most of the WTO liberalisation should have been realised by December 2007, i.e. six years after accession. Many new laws, business regulations and tax rules have been issued after Chinas WTO accession in 2001, resulting in the continuous need for investors to adapt their operations and entity structures in China. China today is the fourth-largest economy in the world, with sustained average economic growth of 9.5% for about the past three decades. In 2007, its nominal gross domestic product totalled more than US$3.4 trillion, reaching an overall GDP growth rate of 11.4% in 2007. Chinas Foreign Direct Investment increased to about US$75 billion in 2007. China was awarded the right to host the 2008 Olympic Games in Beijing and is the third Asian country to receive such an honour. Shanghai, China will be the host city of the World Exposition in 2010. The Exposition will be the first to be held in a developing country.
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Legal system The National Peoples Congress and its Standing Committee are empowered to exercise legislative power. The State Council is also authorised to adopt administrative regulations and measures in accordance with the Constitution and laws. At the local level, the Peoples Congress of the provinces, autonomous regions and municipalities directly under the Central government may also adopt local regulations, provided they do not contravene the Constitution or the State laws. The Peoples Courts are the judicial organs of the state, and the judiciary is able to exercise independent power in accordance with the law. The Supreme Court is the highest in the land and is accountable to the National Peoples Congress and its Standing Committee. It supervises the administration of justice by the Peoples Courts, which are established at different levels. There are also special courts, such as those dealing with military and maritime issues. The Economy General description Prior to 1978, China maintained a centrally planned, or command economy. Subsequently, China launched several economic reforms. The Central government initiated price and ownership incentives for farmers. It also established four Special Economic Zones (SEZs) along the coast for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms, which followed in stages, sought to decentralise economic policymaking in several sectors, especially trade.
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Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment. Chinas transition was highlighted to the rest of the world when former leader Deng Xiaoping famously toured economic enclaves in southern China in 1992 as a way of further promoting Chinas need to stick to a path of economic liberalisation. Beginning from 1993-94, the reform of the state sector became a priority, with the central government aiming to restructure many of its state-owned enterprises (SOEs). The change in policy direction had a profound impact. Chinas economy grew at an average rate of about 10% per year during the period 1990-2006, the highest growth rate in the world. Real GDP growth is forecast to slow slightly but will remain impressive. The government is attempting to boost the contribution of private consumption to overall growth. The tax burden on rural residents will fall, increasing their disposable income. The growing trend for urban Chinese to buy homes and cars will also give a positive stimulus to consumption spending during the forecast period. Chinas trade surplus hit a record US$262.2 billion in 2007, overtaking Japan to make China the worlds thirdlargest trading nation after the US and Germany. Such high growth is necessary if China is to generate the 15 million jobs needed annually for new entrants into the job market.
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Foreign investment In the early days of Chinas economic reform, China still adopted a centralised, planned economy under which the domestic economy, enterprise management, production management, material supply and salary system were centrally controlled and managed. However, in order to attract foreign investment and facilitate the operations of foreign investment enterprises, the Chinese government has adopted numerous preferential policies that were different from those for domestic enterprises. The success in attracting foreign direct investment has greatly contributed to the modernisation of China and set the scene for the current economic growth and success in China. In recent years, with the constant improvement of the investment environment and the adoption of the socialist market economy, China has begun to introduce greater uniformity in taxation policies and business regulations to both domestic and foreign-invested companies. In March 2006, the National Development and Reform Commission announced its 11th five-year programme. Specifically relating to the utilisation of foreign investment, the programme has called for a radical change from quantity to quality of foreign investment. Actions are called for shifting the focus of foreign investment from quantity of Foreign Direct Investment (FDI) to attracting projects that bring in advanced technology, management expertise and highcalibre talent. In addition, more emphasis is given to attracting projects that help with ecological construction, environmental protection and conservation, and the more efficient use of resources and energy. In 2007, exports from Foreign Invested Enterprises (FIEs) increased by 23.4%, accounting for 57.1% of Chinas total exports. Imports increased by 18.4%, or 58.5% of total imports. The number of newly approved foreigninvested projects fell by 8.7% to 37,871 while utilised foreign direct investment (FDI) increased by 13.6% to US$74.77 billion.
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The leading sources of investment include Hong Kong, Japan, the US, Taiwan, Singapore and South Korea. Foreign exchange Starting from the beginning of the open door policy in 1978, there have been foreign exchange restrictions in China. It is not completely free to convert foreign currency in China. In the past, a maximum limit to keep foreign currency was set for each enterprise. Enterprises were required to sell excess foreign currency to banks. After years of strong economic growth and waves of foreign direct investment, a substantial foreign currency reserve has been accumulated by the Chinese government. As of 31 December 2007, according to the State Statistics Bureau, the foreign currency reserve has reached US$1.53 trillion. With this sizeable reserve, the relevant foreign exchange restrictions have been relaxing gradually. Foreign trade Chinas foreign trade was originally conducted through foreign trade corporations under the Ministry of Foreign Trade and Economic Corporation. Since joining the WTO, the import and export trading sector has been liberalised, except for a small number of products. Geography Situated in East Asia along the coastline of the Pacific Ocean, China is the worlds third largest country, after Russia and Canada, with an area of 9.6 million square kilometres and a coastline of 18,000 kilometres. Although China is more commonly known for being one vast land area, people tend to divide China into four main regions the North, South, Northwest and the QinghaiTibetan areas. Due to the geographical differences, residents of each region have distinctive lifestyles and customs.
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There are 23 provinces, five autonomous regions, four municipalities, and two special administrative regions. The municipalities are Beijing, Shanghai, Tianjin and Chongqing. Most industrial development and foreign investment is based along the coast, especially in Shanghai and in the further southern areas of Guangzhou, Shenzhen and Fuzhou. There is also significant foreign investment in the northern coastal cities of Dalian and Tianjin. The capital, Beijing, which is located inland in the north, has attracted many multinational holding companies. Climate China has a climate dominated by monsoon winds. It features clear temperature differences in winter and summer. In winter, northerly winds coming from high latitude areas are cold and dry, and in summer, southerly winds from sea areas at lower longitudes are warm and moist. Precipitation varies regionally even more than temperature. China south of the Qin Ling mountain range experiences abundant rainfall, most of it coming with the summer monsoons. To the north and west of the range, however, rainfall is uncertain. The farther north and west one moves, the scantier and more uncertain it becomes. The northwest has the lowest annual rainfall in the country and no precipitation at all in its desert areas. North Northern winters, from December to March, can be extremely cold. Beijing may experience temperatures reaching below 0oC at night. Further north, -10oC is not uncommon, and you can see the curious sight of sand dunes covered in snow. During the summer, from May to August, temperatures in Beijing can hit 38oC, coinciding with the rainy season for the city.
Doing Business and Investing in China 15
The best time for visiting the north is in spring and autumn. Daytime temperatures range from 20oC to 30oC and drop considerably at night. South Near Guangzhou, the summer is a season of typhoons between July and September. Temperatures can rise to around 38oC. Winters are short, between January and o March. The average temperature in winter is 15 C. Autumn and spring can be good times to visit, with o o daytime temperatures in the 20 C to 25 C range. Sometimes, it can be miserably wet and cold, with rain or drizzle. Northwest It gets hot in summer, dry and sunny. The desert regions can be scorching in the daytime. Turphan, which sits in a depression of 150m below sea level, is referred to as the o hottest place in China with maximums of around 47 C. In winter this region is as severely cold as the rest of northern China. Temperatures in Turphan during winter are only slightly more favourable to human existence. This area of China experiences little rain, and as a consequence, the air is very dry. Summers, however, o o can exceed 40 C, while winters may drop below -10 C. Language The Chinese language uses a pictographic system and employs many thousands of characters, making it remarkably difficult to learn. The characters used in mainland China are a simplified type versus those used in Hong Kong and Taiwan, which are traditional characters.
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Putonghua (or Mandarin), based on the Beijing dialect, has been the national language since 1957. It is taught in all schools and is the language of government, although there are numerous other dialects used in various regions including Cantonese, Shanghainese, Fukienese and Hakka. Non-Chinese languages are also spoken by minorities including Mongolian, Tibetan, Uighur and other Turkic languages and Korean. On 1 January 1979, the Chinese government officially adopted the pinyin system for spelling Chinese names and places in Roman letters. A system of Romanisation invented by the Chinese, pinyin is widely used in China on street and commercial signs as well as in elementary Chinese textbooks as an aid in learning Chinese characters. Variations of pinyin are also used as the written forms of several minority languages. Tips for the business visitor Visitor visas A foreign business visitor must obtain a visa, which is issued by Chinese embassies and consulates. It is necessary to stipulate on the visa application form the points of entry and exit. Currency The currency of China is the Renminbi RMB. The basic unit is the Yuan , which is divided into ten jiao. The smallest division is the fen, or cent. One jiao equals ten fen; one yuan equals 100 fen. Notes of the latest version are issued in denominations of 100 yuan, 50 yuan, 20 yuan, 10 yuan, 5 yuan, 2 and 1 yuan as well as 5 jiao, 2 and 1 jiao. Coins are in denominations of 1 yuan, 5 jiao, 1 jiao, 5 fen, 2 and 1 fen.
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Prevailing exchange rates as at 3 April 2008 were as follows: Table 1 Currency American Dollar Australian Dollar British Pound Canadian Dollar Euro Hong Kong Dollar Japanese Yen New Zealand Dollar Singapore Dollar South Korean Won Swiss Franc Taiwan Dollar RMB 7.0185 6.4107 13.9156 6.8991 10.9615 0.9012 0.068293 5.5481 5.0903 0.007193 6.9161 0.2311
using values from 3 April 2008. Source http://www.x-rates.com
International Time All of China is on Beijing time. China is 8 hours ahead of Greenwich Mean Time and 12 -13 hours ahead of US Eastern Standard Time. Business Hours In most cities in China, businesses and government offices are usually open Monday through Friday and from 8:00am to noon and from about 1:00pm to 5:00pm, although this can vary depending on the organisation. China has a five-day working week consisting of 40 hours. Banks are open Monday through Friday from 9:00am to 5:00pm. Shops are generally open every day.
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Most of Chinas business world slows down considerably during the spring festival in late January and early February. Business visitors would be wise to avoid this two to three week holiday period. Statutory Holidays Chinas public holidays are: January 1 New Years Day January/February (depending on the lunar calendar) Chinese New Year (3 days) April (depending on the lunar calendar) Qing Ming Festival May 1 Labour Day June (depending on the lunar calendar) Duan Wu Festival September (depending on the lunar calendar) Mid-Autumn Festival October 1-3 National Day Note that in addition to the holidays listed above, individual provinces may observe provincial holidays. Weights and Measurements Conducted mainly in the metric system. Dates and Numbers For dates written in English, sequence of day, month, year is normally adopted, e.g. 15 June 2007 or 15/06/2007. In Chinese characters, the reverse is the case.
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Chapter 2
Business environment
Key messages China joins the WTO and market access gradually phased in. Despite considerable bureaucracy, the government is making efforts to promote foreign investment. Although many industries are largely state-owned, the non-state sector, made of collectively-owned, foreignowned and private companies, is rapidly gaining importance in the Chinese economy. China has been proactive in removing tariff and non-tariff barriers for trade in goods through the negotiation and implementation of regional free trade agreements. Certain foreign exchange restrictions are in place. Preferential tax treatment such as tax holidays and reduced tax rates for enterprises in Special Economic Zones have been removed with the implementation of a new corporate income law effective from 1 January 2008. Incentives are now available for high tech businesses. There are market access and production controls, as well as restrictions on operations. Distribution and some service sectors are open to foreign investors. Chinas new anti-monopoly law will come into effect on 1 August 2008, and China will join other countries with anti-trust laws that regulate competition. Managers and skilled labour are in short supply. Protection of intellectual property is an area of concern.
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General business climate China officially joined the WTO in November 2001, and foreign investment and trade has grown rapidly as a result. Under the WTO, tariffs on agreed products have been reduced, and market access to various regulated industries has been phased in gradually. Industrial sectors opened up in the past 5 years are trade and distribution, including franchising, advertising services, inspection services, freight forwarding agency services, for example. A more open market will attract knowhow, technology, services and materials. These imports, together with Chinas rich manpower, both skilled and unskilled, have turned China into one of the most important manufacturing bases in the world. China still holds a number of challenging areas for foreign investors. Nevertheless, the government is making efforts to address some of the issues in order to further encourage foreign investment. For example, through the amendment of the Law on Wholly Foreignowned Enterprises (WFOEs), the Law on Cooperative Joint Ventures (CJVs) and the Law on Equity Joint Ventures (EJVs) in 2000 and 2001, China has relaxed its requirements on foreign exchange balancing and raw materials sourcing for Foreign Investment Enterprises (FIEs). Now, FIEs are no longer required to give priority to the local market when purchasing raw materials, fuels and other materials. Similarly, the requirement for WFOEs and CJVs on balancing foreign exchange incomes and expenditures has been repealed. Large areas of Chinas economy are increasingly becoming more market oriented, and a smaller range of sectors and products is now under administrative control. Current industrial policy places emphasis on the need to strengthen basic industries, infrastructure, energy, and transport. Market forces are now playing a more dominant role in China, and the business climate
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is less subjected to state administrative guidance than before. Foreign participation in investment projects continues to be encouraged by the Chinese authorities, and measures are being taken to make the investment climate more favourable and less bureaucratic. The Chinese government gradually delegated more foreign investment approval authority to local governments. This is considered another step towards reducing bureaucracy. Priority areas for foreign investment remain those where modern technology, environmental protection, energy and water conservation are required. The coastal areas have experienced a greater degree of industrial development than the inland areas, offering improved infrastructural facilities and a number of other benefits to foreign investors. In addition, the government has issued a series of laws and regulations intended to encourage foreign investment in the central and western regions of China. Framework of industry State-owned enterprises (SOEs) still maintain an important role in the economy. Notwithstanding this, the non-state sector, made up of collectively-owned, foreign-owned and private companies, is rapidly gaining importance and now accounts for the majority of gross industrial output value. The private sector is becoming increasingly important as China transits to a socialist market economy. To enhance the growth of private enterprises which have been dominated by small and medium enterprises (SMEs), the Chinese government has chosen several municipalities in which to launch SME-facilitating policies. SOEs still dominate in some sectors such as oil, power, tobacco, steel, petrochemical, automobile, communication, railway, aviation and financial industries.
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Both FIE and domestic enterprises are encouraged to participate in high tech industries (including software, integrated circuit, R&D, for example). Overseas trade relations Memberships in trade blocs China officially became a member of the WTO in November 2001. In this connection, China has phaseby-phase lowered tariff rates and eliminated non-tariff barriers to trade, including quotas, import licenses and unwarranted inspection requirements. In addition, China needs to address the issues of legal and regulatory transparency, the protection of intellectual property and the opening up of banking, telecommunications, insurance, and other service industries. Regional free trade agreements At the regional and bilateral level, China has been proactive in removing tariff and non-tariff barriers for trade in goods through the negotiation and implementation of free trade agreements (FTA). China signed an FTA with ASEAN (Association of South East Asia Nations) in November 2002 which provides for enhanced economic cooperation in trade in goods, services and investment. The more important areas and sources of preferential ASEAN market access, in terms of fewer tariff and non-tariff barriers have come into effect at varying times beginning 1 January 2005. The FTA represents a significant opportunity for companies trading between ASEAN and China to reduce supply chain costs and increase overall price competitiveness and profitability.
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In addition, China has signed CEPA agreements (Closer Economic Partnership Arrangement) with Hong Kong and Macau which were originally implemented in 2004 and subsequently expanded in 2005, 2006 and 2007. In principle, China has agreed to grant zero tariffs to all goods of Hong Kong and Macau origin other than prohibited imports. The implemented FTAs also include the Bangkok Agreement (consisting of members of China, India, South Korea, Sri Lanka, Bangladesh and Laos), the China and Chile Agreement, and the Early Harvest Programme of China and Pakistan Agreement. More FTAs are under negotiation including with Australia, Iceland, South Korea, GCC (Gulf Cooperation Council) and SACU (The Southern African Customs Union), among others. In April 2008, New Zealand was recognised for being the first developed nation to sign an FTA with China. Exports With the exception of certain items subject to state export restrictions, most products exported by foreign investment enterprises are exempt from export duties. The general rate for value-added tax (VAT) is 17%. By law, except for certain special products, exports are zero rated, i.e. no VAT will be levied on exports, and input VAT will be refunded. With the pressure of persistent trade surpluses with major foreign trading partners and with concerns about resource preservation and environmental protection, there have been adjustments (i.e. lowered or eliminated) to the export VAT refund rate since 2004, which increase exporters operating costs.
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Investment climate Government attitude towards foreign investment The Chinese government actively encourages foreign investment, particularly in priority industries. China utilises a number of methods to attract investment in order to acquire foreign technology, equipment and know-how. These include preferential tax treatment and other incentives made available to foreign investors in particular industry sectors such as high tech industries. While encouraging foreign investment on the one hand, the government is cautious in controlling and monitoring the pace of opening up. This is achieved through restrictions being imposed on foreign investors, including the requirements for approval, specific requirements on the amount and nature of capital contributions as well as the restriction on foreign participation in certain sectors. The Chinese government achieves its foreign direct investment objectives through the Foreign Investment Catalogue. The Foreign Investment Catalogue outlines sectors where foreign investment is encouraged, permitted, restricted and prohibited. Encouraged investments are for foreign investment or technology that the Chinese government would like to attract. Foreign investment is restricted for sectors that are not in line with the national economic development of China. Prohibited investment includes sectors such as exploitation of certain precious metals, the media, and other sectors that are not open to foreign investment. Nevertheless, many years after Chinas accession to the WTO, the areas of the investment restrictions have been gradually narrowing down. Trade policy Development of foreign trade and economic relations with other nations plays an important role in Chinas present policy of maximising the potential contribution of foreign trade to its economic development.
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Foreign exchange restrictions There are certain restrictions on foreign currency exchange in China. Foreign investment enterprises are required by the State Administration of Foreign Exchange (SAFE) to separate their foreign currency bank accounts into capital accounts and current accounts. The capital accounts hold the capital funds injected by an enterprises foreign investors, foreign currency loans borrowed, or foreign loans repaid, for example. The current accounts hold foreign exchange used by the enterprise for regular day-to-day operating items. After the separation of the capital account and the current account, RMB transactions under the current account are freely convertible (subject to certain procedural controls) as long as the transactions are considered commercially legitimate. However, in the case of capital accounts, the convertibility of the currency is still subject to the approval of SAFE on a transaction-by-transaction basis. After years of strong economic growth and waves of foreign direct investment, a substantial foreign currency reserve has been accumulated by the Chinese government. With the sizeable reserve, the relevant foreign exchange restrictions have also been relaxing gradually. Taxation policy In 1980, China initiated the concept of tax incentives and established the Special Economic Zones. These were followed by the 14 coastal cities that were designated as special investment areas in 1984, the Delta Regions/ Coastal Open Economic Zones, the High and New Technological Industrial Development Zones and the Free Trade Zones.
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These zones were created primarily to attract foreign investment by offering investors tax and other incentives. Tax incentives, including preferential income tax rates and tax holidays, were offered under the Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises and its Implementation Rules. With the new Corporate Income Tax Law, which took effect from 1 January 2008, tax incentive policy is shifting from geography-based tax incentives to predominantly industry oriented and limited geography-based tax incentives. The new tax incentive policy is focused on high and new technology industries. Aside from income tax preferential treatments, exemptions or reductions in business taxes and VAT are also available to certain technology related arrangements or projects, subject to satisfying certain conditions. Anti-Trust Law impact foreign investment China has passed an anti-monopoly law which will come into effect on 1 August 2008. Foreign investors doing business in China need to consider the immediate impact of this new law on their businesses. Merger and acquisition transactions in China involving foreign parties will be subject to review and can be halted due to antitrust reasons. Acquisitions of domestic enterprises by foreign investors that may have implications for national security shall be subject to more stringent review. Local competitor attitude toward foreign investment In order to acquire foreign technology, capital and know-how, Chinese domestic enterprises recognise the importance of entering into joint ventures with foreign enterprises. However, there are restrictions on the extent of foreign participation allowed in certain sectors and in some sectors foreign investment is not permitted at all.
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Such restrictions, however, are gradually being phased out with Chinas accession to the WTO. In addition to joint ventures, WFOEs are also allowed, provided the sectors in which they operate are not subject to 100% equity restrictions. Labour attitude toward foreign investment The differences between Chinese and western management styles can often prove a problem for foreign joint venture partners due more to cultural differences, language and communications rather than prejudices against foreign management. Major improvements have been made in recent years as a pool of talented local staff is being developed in major cities through training in modern management techniques and exposure to overseas work experiences.
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Chapter 3
Business entities
Key messages Foreign companies may operate through permanent establishments or representative offices or establish foreign investment enterprises, i.e. Sino-foreign joint ventures and wholly foreign-owned enterprises. Foreign invested banks are permitted to establish corporations and branches in designated locations. Enterprises, including foreign investment enterprises, can set up branches in other parts of China. Foreign enterprises may be able to open branches on a restricted basis. Certain foreign investment enterprises and foreign projects require prior government approval. Capital and profits are generally allowed to be repatriated, subject to certain requirements. A national company law allowing for the establishment of limited liability companies and companies limited by shares became effective on 1 July 1994. Forms of business The principal forms of business open to foreign investors in China are classified under the following headings: Foreign investment enterprises An FIE refers to equity joint ventures, cooperative joint ventures with limited liability, WFOEs, and foreign investment companies limited by shares. Equity joint ventures An equity joint venture is a separate legal entity and takes the form of a limited liability company registered in China. The partners have joint management of the company and profit sharing is according to the ratio of each partners capital contribution.
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Business entities
Cooperative joint ventures The parties to cooperative joint ventures may apply for approval to have the company structured as a separate legal entity with limited liability. Profit sharing is defined in the contract and can vary over the contract terms. In addition, there is a form of unincorporated cooperative joint venture which is not a legal entity. Income and expenses are shared amongst partners based on the contract terms. Income tax should be imposed on the individual joint venture parties instead of the unincorporated cooperative joint venture. Wholly Foreign-owned Enterprises WFOEs are established exclusively with the foreign investors capital. They are limited liability companies. Joint stock companies Joint stock companies, also known as companies limited by shares, are established primarily in order to be able to list on Chinese or foreign stock markets. The capital stock of a joint stock company is made up of equal value shares. Contributions are made by both domestic and foreign shareholders. Foreign enterprises In general, foreign enterprises are enterprises other than foreign investment enterprises in China that have establishments or places of business in China and engage in production or business operations. Foreign enterprises that do not have establishments or place of business in China but derive certain China-source income are also included in this category. Foreign enterprises include representative offices, sites for the exploitation of natural resources, contracted project sites, and companies providing labour services or employing business agents.
30
Business entities
Branches of foreign enterprises Under the Company Law a foreign company may establish branches in China. A branch does not have the status of a Chinese legal person, and the foreign company assumes the civil liabilities of its branches in China. However, in practice, only foreign banks have been granted licenses to open branches. Equity joint ventures Formation procedures Equity joint ventures are governed by the Law of the Peoples Republic of China on Joint Ventures Using Chinese and Foreign Investment that was promulgated in 1979. The latest amendments to the law were made in 2001. The Ministry of Commerce (MOFCOM) has overall responsibility for approving joint ventures and for issuing the approval certificates. The local MOFCOM authorities generally undertake the examination and approval procedures. Once the approval certificate has been received, the venture has to register within one month with the administrative bureau of industry and commerce in the relevant locality to obtain a business license. Thirty days after the business license is issued, the joint venture must register with the local tax authorities. Capital structure The equity joint venture law requires that the foreign partner to the venture contribute generally at least 25% of the registered capital. No upper limit on the foreign partners contributions has been set, except in some special industries where regulations require the Chinese partners share to give them dominant control.
31
Business entities
Capital contributions of an equity joint venture can take the form of cash, capital goods, industrial property rights and other assets. In general, the Chinese partner will contribute cash, land development or clearance fees and land use rights, while the foreign partner will contribute cash, construction materials, equipment and machinery. All joint venture contracts should contain a schedule for capital contributions. If the capital contribution is to be a single payment, all partners must pay the full amount within 6 months of the date the business license is issued. A temporary business license can be issued during the period in which capital contributions are to be made. If the partners do not make their contribution within the stipulated time frame, the temporary business license will not be renewed. All capital contributions must be certified in a report from a Chinese registered CPA firm (this may be either an international accounting firm acting through a Sino-foreign joint venture or a Chinese CPA firm) as confirmation that the contributions listed in the contract have been received. During the life of an equity joint venture, the foreign partners equity contribution should normally not be repaid. However, once the venture has been liquidated, the net assets (if any) are distributed according to the partners shareholdings. Relationship of shareholders, directors and officers The partners of an equity joint venture share joint management of the venture. The board of directors has the authority to make all major decisions concerning the financial position of the venture. The joint venture partners are responsible for appointing the board members, and representation generally matches the proportion of ownership interest in the venture. Also, the law requires that a meeting of the board be held at least once each year. The board of directors is required to
32
Business entities
engage a general manager and deputy managers. The general manager is responsible for carrying out board decisions and is in charge of the daily management of the venture. The profits and losses of an equity joint venture are distributed according to the ratio of each partners investment. After the payment of taxes and before the distribution of profits, the joint venture is required to make allocations to three funds, namely, a staff bonus and welfare fund, an enterprise expansion fund and a general reserve fund. The amount contributed to the three funds by the venture may be designated in the joint venture contract or decided by the board of directors. All the previous years losses must be cleared before the current years profits can be distributed. Liquidation and receivership Liquidation of an equity joint venture must be conducted pursuant to the Foreign Investment Enterprises Liquidation Procedures, effective as of July 1996. Once dissolution has occurred, the board of directors must establish the liquidation procedures and principles and appoint a liquidation committee. The ventures directors are usually appointed to the liquidation committee, although, if problems arise in this respect, local PRC accountants or lawyers may be invited to carry out the liquidation procedures. If the examination and approval authority deems it necessary, it may appoint its own personnel to supervise the process. The joint venture must settle all its debts, including the cost of liquidation, before the remaining assets can be distributed among the joint venture partners. These will be distributed according to the investment ratio, unless other provisions are contained in the contract and articles of association. If the foreign partners remaining net assets exceed its investment contribution, the foreign partner would be required to pay income tax on the remaining portion.
33
Business entities
Books and records For statutory requirements regarding the keeping of books and records see Chapter 9. Statutory audit Joint ventures are required to engage a CPA firm registered in China to audit their annual accounting statements and books of accounts. The national deadline for submission of audited statutory accounts is 31 May; however, local authorities may impose earlier deadlines in certain cases (See Chapter 9). Cooperative joint ventures Formation procedures Cooperative joint ventures are governed by the Law of the Peoples Republic of China on Chinese-Foreign Cooperative Joint Ventures, promulgated in April 1988 and revised in 2000. The law provides that the venture can operate as a legal person, which means that a limited liability company can be formed. Under the limited liability structure the company would own all of the ventures assets, but the liabilities of the investors would be limited to their investment contributions. To establish a cooperative venture the Chinese and foreign partner(s) must submit documents such as a project proposal, the signed agreement, contract, and articles of association to the Department of Commerce or the relevant local government authority for examination and approval. If approval is granted, the partners have 30 days in which to apply to the administrative authorities of industry and commerce for registration and a business license. The date on which the business license is issued is the date of the establishment of the venture. The venture then has 30 days in which to register with the tax authorities.
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Business entities
Capital structure Capital contributed to the venture by the two parties may be in cash or in kind. Land use rights, industrial property rights, and other property rights are included as capital contributions. The cooperative joint venture law requires that both parties fulfill their investment and cooperation requirements as set out in the joint venture contract. Failure to do so within the prescribed time limit will result in another time limit being set by the relevant authorities, and further failure will be handled in accordance with the relevant state provisions. Capital contributions by both parties must be verified by a Chinese-registered CPA firm (this may be either a Chinese CPA firm or a Sino-foreign joint venture accounting firm), which will provide a verification certificate. Relationship of shareholders, directors and officers As with an equity joint venture, a cooperative joint venture operating as a limited liability company is required to appoint a board of directors or a joint managerial committee, that will make all major decisions and oversee the management of the company. The profits and losses of a cooperative joint venture would normally be distributed according to the ratio established in the contract, which may vary over the contract terms. While the total amount provided for the three reserve funds (staff welfare and bonus fund, general reserve fund and enterprise expansion fund) by an equity joint venture is expressed as a percentage of the after-tax profit, the total amount provided for these funds by a cooperative joint venture is expressed as a percentage of pre-tax profit.
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Business entities
Liquidation and receivership Similar to equity joint ventures, liquidation of cooperative joint ventures must be conducted pursuant to the Foreign Investment Enterprises Liquidation Procedures, effective as of July 1996. If it is agreed in the cooperative joint venture contract that all of the ventures fixed assets will belong to the Chinese party after the ventures operating period has expired, the parties to the venture may also state in the contract that the foreign party can recover its investment during the contract period. Subject to examination and approval, the foreign party may then recover its investment before the payment of income tax. Books and records The books and records to be maintained are the same as for equity joint ventures (see Chapter 9). Statutory audit Requirements for audits are the same as for equity joint ventures (see Chapter 9). Wholly foreign-owned enterprises Formation procedures WFOEs are governed by the Law of the Peoples Republic of China on Enterprises Operating Exclusively with Foreign Capital. Although this law came into force in 1986, it was subsequently amended in 2000. A WFOE is a limited liability company. The law and regulations prohibit or restrict the establishment of WFOEs in certain industries.
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Business entities
MOFCOM is responsible for the examination and approval of WFOEs. Local governments are also authorised to approve these enterprises, provided certain conditions are met. Before applying to establish a WFOE, the investor must submit a report, which must include specific information requested under the regulations, to the relevant government authority in the location in which the enterprise is to be established. The investor will receive a written response within 30 days of submitting the report. The investor must apply for registration and obtain a business license within 30 days of receiving approval, or the approval certificate will automatically become void. The date the business license is issued will be the date of the establishment of the enterprise. Tax registration must be performed within 30 days of establishment. Capital structure The amount of registered capital of a WFOE should be consistent with the scale of intended operations. The registered capital cannot be reduced during the term of operation unless special approval is received, and increases must receive prior approval from the authorities. Foreign investors may contribute capital in the form of freely convertible foreign currencies or certified RMB profits from other FIEs. Subject to certain requirements set out in the regulations, such items as machinery, equipment, industrial property and proprietary technology may be capitalised according to their monetary value.
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Business entities
The time limit within which the capital contributions are to be made must be specified in the application and articles of association. The contributions can be made in installments. The first installment representing no less than 15% of the total registered capital must be made within 90 days and the last installment within three years of the issuance of the business license. Other contributions must be made pursuant to the published schedule. After all the capital contributions have been made, a Chinese-registered accountant must be engaged to verify the contributions and issue an investment verification report. Relationship of shareholders, directors and officers WFOEs are required to make allocations to a reserve fund and a bonus and welfare fund for its employees from its after-tax profits. The reserve fund allocations must be not less than 10% of the after-tax profits. Profits may not be distributed until the prior years losses have been cleared. Liquidation and receivership As with joint ventures, liquidation of a WFOE must be conducted pursuant to the Foreign Investment Enterprises Liquidation Procedures, effective as of July 1996. The specific tasks that the liquidation committee is required to perform are set out in the procedures and include paying off the enterprises debts, recovering any unpaid contributions from the shareholders and distributing the remaining property. Any remaining assets of the enterprise that exceed the registered capital should be subject to income tax. Books and records The requirements for keeping books and records are essentially the same as for joint ventures (see Chapter 9).
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Business entities
Statutory audit See Chapter 9 for information on this topic. Joint stock companies Joint stock companies, also known as companies limited by shares, are governed by the Company Law of the PRC issued in December 1993 and amended in October 2005. In addition to the Company Law, joint stock companies are governed by the provisional regulations regarding certain issues relating to the establishment of a foreign investment company limited by shares, promulgated on 10 January 1995. The provisional regulations add certain requirements for the formation of a joint stock company, including requiring a minimum of 25% of the capital to be invested by foreign investors and a minimum capital requirement of RMB30 million. Partnerships See Chapter 16 for information on this topic. Representative offices Foreign enterprises are permitted to open representative offices in China. Legally, these are to be established purely for liaison purposes, and their activities are limited to the provision of services that do not give rise to any earnings. The permissible activities of representative offices include the following: 1. Investigating and collecting market information. 2. Providing introductory services to potential buyers and sellers, such as setting up meetings and passing on price and technical information to Chinese customers.
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Business entities
3. Assisting in making arrangements for trade visits to China. 4. Coordinating with the parent company and other associated companies or affiliates. In practice, many representative offices provide services that are outside this legal scope. With the circular issued by the State Council in May 2004, representative offices do not need to be approved by MOFCOM or other relevant authorities except for representatives whose headquarters are engaging in some special industries. Representative offices are required to register with the State Administration of Industry and Commerce. Upon approval of the representative office, the chief representative should visit the office in person to receive the business registration certificate and complete some additional forms to formalise the registration. The company is required to register with the local tax authorities within 30 days of receiving the business registration certificate. Company law The Company Law of the Peoples Republic of China was promulgated in December 1993 and amended in December 1999, August 2004 and October 2005. It went into effect on 1 January 2006. This national company law provides for the establishment of two types of corporate entities, namely, limited liability companies and companies limited by shares (also translated as joint stock companies). It includes requirements on the number of shareholders or promoters, minimum registered capital, capital contribution timeframe, share transfer, board of directors, supervisory committee, for example.
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Business entities
The Company Law applies to foreign-invested limited liability companies. However, where the laws on Sinoforeign equity joint ventures, Sino-foreign cooperative joint ventures and WFOEs have different provisions, the provisions of such laws apply. The Company Law may pave the way for a larger number of options for foreign investors to invest in China. For example, under the Company Law, a foreign company may establish branches in China. A branch does not have the status of a Chinese legal person, and the foreign company assumes the civil liabilities of its branches in China. Any conditions for setting up a branch and any applicable limitations should be clearly set out when the implementation regulations are issued. So far, branches of foreign companies have only been approved in the area of financial institutions and insurance companies. Other business arrangements open to foreign investors To acquire foreign technology, equipment and knowhow, China utilises different methods of attracting foreign investment. In addition to the forms of business enterprise mentioned above, these include barter trade, compensation trade and processing arrangements. Barter trade Under barter trade arrangements, China may import machinery, equipment or foodstuffs in exchange for other products. However, these arrangements are becoming less common in practice.
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Business entities
Compensation trading Under compensation trade arrangements, a foreign trade partner may supply China with equipment, technical services and raw materials where needed. In return, it may receive the manufactured products as payment. China trade partners are compensated for the processing fee. In addition, it may acquire the equipment subsequently. Similar to barter trade, this type of business has become less common in China. Processing and assembling trade The processing and assembling trade constitutes a form of cooperation in which foreign firms place orders with Chinese factories to carry out certain manufacturing activities for export. These activities generally consist of processing or assembling commodities according to the foreign firms specifications, with the parts or semiprocessed items supplied by the foreign firm.
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Chapter 4
Restrictions on foreign investment and investors
Key messages The local currency, the renminbi (RMB), is not fully convertible. Capital account items are closely monitored by the State Administration of Foreign Exchange. Capital may be repatriated on liquidation of the company or on reduction of capital if approved. Profits may be repatriated subject to certain conditions. 100% foreign ownership is permitted if certain requirements are satisfied. Foreign investment is categorised as encouraged, permitted, restricted or prohibited. Foreign investment in sectors which are regarded as high resource-intensive, energy exhausting or polluting are not welcome. Regulatory climate Regulatory authorities The Peoples Bank of China (PBOC) is Chinas central bank, and its many functions include formulating national financial regulations and policies. The State Administration of Foreign Exchange (SAFE) regulates the flow of foreign exchange in China and all foreign exchange expenditure and outward remittances. In practice, SAFE performs a supervisory function with regard to foreign exchange transactions conducted by FIEs. SAFE regulates the flow of foreign exchange, and SAFEdesignated foreign exchange banks handle the foreign exchange and banking transactions of enterprises with foreign investment, i.e. equity joint ventures, cooperative
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joint ventures and WFOEs. The SAFE-designated foreign exchange banks can be both domestic and foreign invested financial institutions. The Ministry of Commerce (MOFCOM) and its local subsidiaries are the major government authorities that deal with matters relating to foreign investment in China. They have authority over the approval of enterprises with foreign participation and import of technology. MOFCOM and its local subsidiaries are likely to have the most contact with foreign investors. Other industrial ministries such as the China Banking Regulatory Commission, the China Securities Regulatory Commission, the China Tourism Administration, the Ministry of Communications, for example. also play a role in granting pre-approval to foreign investment in their respective industries. Regulatory legislation The foreign exchange administration of China is based primarily on the Regulations on Foreign Exchange Administration of the Peoples Republic of China effective from 1 April 1996. Apart from this regulation, the Peoples Bank of China issued another major foreign exchange regulation to govern the settlement, sale and purchase of foreign exchange on 1 July 1996. FIEs are required by SAFE to separate their foreign currency bank accounts into capital accounts and current accounts. The capital accounts hold the capital funds injected by an enterprises foreign investors, foreign currency loans borrowed, and foreign loans repaid, for example. The current accounts hold foreign exchange used by the enterprise for regular day-today operating items. After the separation of the capital account and the current account, RMB transactions under the current account are freely convertible (subject to certain procedural controls) as long as the transactions
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are considered commercially legitimate. However, in the case of capital accounts, the convertibility of the currency is still subject to the approval of SAFE on a transaction-by-transaction basis. In addition, in the past, a maximum limit was placed on the amount of hard currency deposited in the current account, based on the level of the enterprises capital contribution and export activities. Recently, such restrictions have been removed. Enterprises are allowed to keep all their hard currency received. Subsequent to the issuance of the revised Law of Sinoforeign Joint Ventures and the Law of Wholly Foreignowned Enterprises effective from 15 March 2001 and 31 October 2000 respectively, FIEs are no longer required to balance their foreign exchange income and expenditure by means of export activities and instead, may purchase foreign currencies from the bank for payment of current account items overseas if such needs arise. Registration of foreign capital and technology Capital Capital contributed to an equity joint venture by a foreign investor is generally required to be at least 25% of the total investment. All capital contributions to foreign-invested enterprises must be registered with the appropriate authorities. Any increases, assignment or other disposal of the registered capital of a foreign-invested enterprise must be approved by the original examination and approval authority. Investments can be made either in cash or in kind, and the value of the capital contributions must be certified by a Chinese certified public accountant who issues a capital verification report relating to the contribution. Cash contributions will be held in the capital accounts in foreign currency, and the conversion from foreign currency to RMB is subject to SAFE approval.
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There are rules governing the ratios of registered capital to total investment for equity joint ventures, cooperative ventures and WFOEs. Registered capital represents the capital contributions of the foreign and Chinese parties, while total amount of investment includes the registered capital as well as loans borrowed by the enterprise. The ratios are shown in Table 2. Table 2: Foreign Investment EnterprisesRatios of Registered Capital to Total Investment Total investment Under US$3 million ($3 million inclusive) Between US$3 and 10 million ($10 million inclusive) Between US$10 and 30 million ($30 million inclusive) Over US$30 million Loans FIEs may apply to designated foreign exchange banks to borrow both foreign currency and RMB loans. FIEs are also permitted to take out foreign currency loans with overseas banks. Foreign currency loans must be registered with SAFE within a certain period of time after the execution of the loan documents in order to enable the subsequent loan repayment. Penalty provisions apply for failing to comply with the debt registration requirements. Ratios 0.7:1 1:2 Minimum registered capital 70% of total investment US$2.1 million
2:5
US$5 million
1:3
US$12 million
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Technology agreements Technology agreements that cover the licensing of the use of patents, trademarks, the provision of technical consultancy services and technical know-how, require registration with the MOFCOM. Royalty payments for technology transfer agreements may be subject to the approval of MOFCOM or its local subsidiaries. Repatriation of capital and earnings Capital One of the major differences between an equity joint venture and a cooperative joint venture relates to the repatriation of registered capital. In the case of a cooperative venture the foreign partners may recover and repatriate their invested capital during the operating period of the venture, provided they have obtained the agreement of all the parties concerned and the approval of the relevant authorities. The partners in an equity joint venture, however, cannot obtain repayment of their registered capital until the end of the venture period or its liquidation. This restriction also applies to WFOEs. Reduction of capital is possible with approval from MOFCOM or its local subsidiaries. Earnings FIEs may repatriate their profits from China subject to certain restrictions, as follows: 1. All the prior years losses must have been recouped. 2. All relevant taxes must have been paid. 3. The board of directors approve the distribution of profits. 4. Profits may be repatriated through designated foreign exchange banks.
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Profits earned by a foreign enterprise with a permanent establishment in China are subject to income tax. However, they will not fall into a withholding tax regime when the profits are repatriated. Foreign companies without permanent establishments in China are subject to withholding tax at a concessionary rate of 10% on dividend, interest, rental, royalty, and other income sourced in China unless the rate of tax is further reduced by a double taxation treaty. Restrictions on foreign investment Restrictions on foreign ownership Wholly foreign ownership The Chinese government permits 100% foreign ownership in industries not prohibited or restricted by the state that are conducive to the development of Chinas economy and capable of achieving remarkable economic benefits in accordance with the Catalogue on Guiding Foreign Investment issued by the State Council and effective from 1 January 2005. According to the revised Law of Wholly Foreign-owned Enterprises and its implementation rules effective 12 April 2001, WFOEs that are able to achieve the following objectives will be encouraged: 1. Use of advanced technology. 2. Research and development of new products. 3. Upgrading of products. 4. Capable of saving energy and raw materials. 5. Export-oriented. Ventures with Chinese partners Joint ventures between foreign and Chinese enterprises are encouraged by the state if they promote the development of the Chinese
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economy and help to raise the countrys scientific and technological levels. In this respect, they are permitted mainly in industries involved with energy development, building materials, chemicals, metallurgy, machine manufacturing, instruments and meters, offshore oil exploitation equipment manufacturing, electronics, computers, communications equipment manufacturing, textiles, foodstuffs, medicines, medical apparatus, packaging, agriculture, animal husbandry, fish breeding, tourism, and certain service trades. Under the law governing equity joint ventures, the foreign partner must contribute a minimum of 25% of the ventures registered capital. No upper limit has been set. Land-use rights Restrictions are also imposed on the assignment of landuse rights. Foreign investment enterprises that acquire land-use rights may retain them only for a prescribed period, for example, 70 years for residential purposes; 50 years for industrial purposes; 40 years for commercial, tourist and recreational purposes; and 50 years for educational, technological, cultural, hygiene, sports, comprehensive utilisation or other purposes. The landuse rights may be used only for the purpose that has been approved. Bilateral investment treaties China has entered into bilateral investment treaties with various countries. Issues dealt with in the treaties include the following: 1. Protection upon expropriation. 2. Arbitration. 3. Most-favoured-nation treatment.
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4. Repatriation or transfer of investment proceeds. 5. Assignment and subrogation rights. 6. Guarantees regarding exchange rates on transfers or remittances. 7. Definition of investments and returns. Policy trends Effect on foreign investment Chinas current policy is to restrict foreign investment that will impair Chinas sustainable development. Foreign investment in sectors which have low technological contents, cause high exhaustion of resources or bring about serious pollution, is not welcome. Quality rather than quantity seems to be what China is aiming for in its current foreign investment policy. The focus has shifted from acquiring foreign capital and foreign exchange to attracting advanced technology, management know-how and talents, with increasing consideration being given to environmental protection. Currently, foreign investors in general may find it more favourable for purposes of full management and control to set up WFOEs than joint ventures except in those restricted industries where WFOEs are not allowed. Setting up an investment project in China requires careful planning, particularly in such areas as raw material sourcing, marketing and distribution, and the taxation implications of different types of projects and activities. See Appendices XII, XIII and XIV for more detailed itemisation of points to consider.
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Chapter 5
Investment incentives
Key messages Qualified small and low-profit enterprises and qualified high/new-tech enterprises are subject to reduced income tax rates. Enterprises or projects with a focus on technological development, environmental protection, energy and/ or water conservation, production safety, for example, may be entitled to various types of income tax incentives. Tax incentives for foreign investment enterprises of a productive nature and most of the geography-based incentives have been removed. A grandfather period is available for certain incentive policies. Passive income derived by foreign enterprises from sources in China was subjected to a withholding tax of 20%, which has since been reduced to a concessionary rate of 10%. However, an exemption is available under certain circumstances. Qualified projects may enjoy certain VAT incentives. Technology transfer, technology development and related services are exempt from business tax (BT). Investment policy Under Chinas Corporate Income Tax Law (CITL) that took effect on 1 January 2008, a predominantly industryoriented, limited geography-based tax incentive policy has been adopted which represents a significant change from the former regime. Key emphasis is placed on industry-oriented incentives aimed at directing investment toward those industry sectors and projects that are encouraged and supported by the Chinese government. The CITL clearly reflects the governments focus on technological development, environmental
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protection, energy and/or water conservation, production safety, venture capital and continuing investment in agriculture, forestry, animal husbandry, fisheries and infrastructure development. The CITL has also delegated authority to the State Council to propose the scope and definition of eligible projects and to adjust such scope of tax incentives from time to time in accordance with the countrys needs. Tax incentives and concessions Eligibility Unlike under the old income tax law, the CITL has introduced a number of different types of tax incentives, including tax exemptions or reductions, discounts on taxable income, super deductions of expenses and investment tax credits on qualifying expenditures. The qualifying criteria are different amongst the various tax incentives. While some tax incentives are granted after fulfilling certain criteria for an enterprise or a project, some incentives may be granted only after meeting certain criteria for a particular transaction. In addition to the income tax incentives noted above, qualified enterprises or projects may also enjoy certain VAT and BT incentives. The major tax incentives are set out below: Income tax incentives Income tax rate Under the CITL, a flat tax rate of 25% applies to all enterprises, including domestic enterprises, enterprises with foreign investment and foreign enterprises.
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Income tax exemption and reduction The following income is exempt from corporate income tax: (1) Interest derived from government bonds. (2) Dividends and income from equity investments, for example, derived by a resident enterprise from another resident enterprise. (3) Dividends, income from equity investments, for example, derived by an establishment of a non-resident enterprise whereby the income is effectively connected to the establishment. (4) Qualified small and low-profit enterprises are entitled to a reduced income tax rate of 20%. (5) Qualified new high-tech enterprises are entitled to a reduced income tax rate of 15%. (6) Income derived from the following types of projects may obtain an income tax exemption or reduction: - Agriculture, forestry, animal husbandry and fishery projects. - Infrastructure projects supported by the Chinese government. - Environmental protection projects and/or energy and/or water conservation projects. - Qualified technology transfers. Other income tax incentives - A super deduction is allowed for R&D expenses for new technology, new products or new craftsmanship. - A super deduction is allowed for salary costs incurred for hiring the disabled.
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- The taxable income of a venture capital business may be reduced by a certain amount with reference to the investment amounts made in high and new tech enterprises. - Shorter tax depreciable life or accelerated depreciation methods are allowed for particular types of fixed assets related to technology advancement. - A reduction in taxable income is allowed for revenue derived from products manufactured with comprehensive resources pursuant to state industry policies. - An investment tax credit is allowed on qualified expenditure for plant and machinery that furthers environmental protection, energy and water conservation, production safety, and other benefits. - Other incentives formulated by the State Council to address requirements for economic and social development or where emergency circumstances within the country may so require. Grandfathering of previous preferential tax treatments - Foreign investment enterprises established before the promulgation of the new CITL and which currently enjoy a lower income tax rate are entitled to a gradual increase to the rate of 25% over a period of five years starting from 2008. - Unused tax holidays of foreign investment enterprises established before the promulgation of the new CITL can be enjoyed until their expiry. Where the tax holiday has not yet started because of tax losses, it shall be deemed to commence from 2008.
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- New high-tech enterprises that are regarded as supported by the State established in the SPZs and Pudong New Area enjoy certain transitional preferential tax treatment. - Enterprises in encouraged industries located in the Western Regions will continue to enjoy existing preferential tax treatments until expiry of the preferential policy. VAT incentives VAT on import and export Many categories of goods imported for the production of export items may be exempt from import VAT. In most cases, the exemption will not apply if the finished goods made from the imported items are sold on the domestic market. In regards to export, currently the standard rates for export VAT refund range from 0% to 17%. After deducting refundable VAT from the general input VAT at 17%, enterprises incur a cost of the nonrefundable VAT ranging from 17% to 0% for most export items. Please refer to Chapter 18 Indirect Taxes for details of export VAT refund mechanism in China. However, it should be noted that the Chinese government has been reducing the export VAT refund rate in recent years. VAT reform towards consumption based VAT system The current production based VAT system precludes general VAT taxpayers from claiming credit for input VAT incurred on fixed assets. Such input VAT has to be capitalised as part of the fixed assets costs and charged to the income statement through depreciation.
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Beginning on 1 July 2004, China launched a trial run of a consumption based VAT system in the Northeast Region as a means to stimulate the regions investment and economy. Thereafter, general VAT tax-payers engaged in at least one of the eight selected industries in the region have been allowed to claim input VAT incurred on fixed assets subject to certain limits. In May 2007, China decided to further expand the consumption based VAT reform to eight slightly different industries in the Central Region of China. These trial runs of VAT reform are believed to have mitigated the tax burden of investors and encouraged them to make fixed asset investments and upgrade their production with more advanced technology. VAT incentives on sales of self-developed software products According to the existing tax regulations, sales of self-developed software products by a VAT general taxpayer would be eligible for a refund of VAT liabilities exceeding 3% of net sales before 2010. VAT exemption on import equipment under encouraged projects The equipment and machinery imported by FIEs within their total investment for self use are exempt from import VAT and customs duty. In order to qualify for the exemption, the FIEs should be engaged in industries listed as encouraged in the foreign investment catalogue.
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BT incentives In general, transfer of intangible assets in China is subject to BT at a flat rate of 5%. In order to encourage technology advancement, the government has allowed that the income derived from technology transfer, technology development services and related technical consultancy and technical services be exempt from BT after meeting certain assessment criteria. Individual Income Tax (IIT) Relief In general, all compensation paid to employees in China is subject to PRC IIT at progressive rates. However, there is special relief for foreign individuals working in China in that some of their income from Chinese employment may be exempt from IIT. The non-taxable income includes housing allowances, meal and laundry allowances, home leave allowances, relocation allowances, and must meet certain conditions. Please refer to Chapter 17 Taxation of Individuals.
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Chapter 6
Banking and finance
Key messages The central bank is responsible for implementing monetary policy, preventing and resolving financial risks, and safe guarding financial stability. In accordance with commitments by China to the WTO, foreign invested banks are allowed to conduct foreign currency business with Chinese enterprises and individuals throughout China, and are able to conduct domestic business with Chinese individuals without geographic restrictions. National stock markets in Shanghai and Shenzhen are accessible to domestic and foreign investors. FIEs have access to local financing. Banking system The commencement of the reform programme in the late 1970s saw major changes in the banking system, with the Peoples Bank of China (PBOC) retaining the role of central bank and specialised banks given more autonomy to make transactions on their own authority rather than in accordance with state plans. The reforms of the 1980s saw a number of major developments, including decentralisation of decision-making power to local bank branches and the development of money markets and of stock and bond trading. Further reforms were introduced in 1993. In these reforms, the role of the PBOC as the central bank was strengthened, and the operation of government-owned specialised banks were commercialised.
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Banking and finance
In 1998, two critical reforms were implemented by the PBOC. These include the reorganisation of PBOC branches according to economic regions, which effectively reduced the number of branches from 32 to 9 and removed the insurance supervision function from the PBOC and gave it to the newly established China Insurance Regulatory Commission. Early in 1994 saw major changes in the foreign exchange system, when the dual exchange rate policy was abolished and the renminbi (RMB) was placed in a controlled-float situation based on market supply and demand. In 2003, a new institution the China Banking Regulatory Commission (CBRC) was established to take over from the PBOC the supervisory responsibility for the financial industry. Central bank The PBOC has ministry-level status and reports directly to the State Council. Its main responsibilities include the following: Drafting and enforcing relevant laws, rules and regulations that are related to fulfilling its functions. Controlling the money supply. Formulating and implementing monetary policy in accordance with the law. Regulating financial markets, including the inter-bank lending market, the inter-bank bond market, the foreign exchange market and the gold market. Maintaining the RMB exchange rate at an adaptive and even level. Holding and managing the state foreign exchange and gold reserves. Performing other functions prescribed by the State Council.
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China Banking Regulatory Commission In 2003, the responsibility for supervision of banking institutions, asset management companies, trust and investment companies and other depository financial institutions was taken up by the CBRC, which was established to supervise the financial industry. The main functions of the CBRC include: Formulating supervisory rules and regulations governing the banking institutions. Authorising the establishment, changes, termination and business scope of the banking institutions. Conducting onsite examination and offsite surveillance of the banking institutions, and taking enforcement actions against rule-breaking behaviours. Conducting fit-and-proper tests on senior managerial personnel of the banking institutions. Compiling and publishing statistics and reports on the overall banking industry in accordance with relevant regulations. Providing proposals on the resolution of problem deposit-taking institutions in consultation with relevant regulatory authorities. Being responsible for the administration of the supervisory boards of the major state-owned banking institutions; and other functions delegated by the State Council. In principle, the PBOC concentrates on regulations concerning monetary conditions and financial system liquidity with a view to promoting economic growth and price stability. The CBRC, on the other hand, focuses on the strength of financial institutions, capital adequacy issues and the restructuring of the banking sector. In practice, however, there is no clear division between the functions of the PBOC and those of the CBRC.
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Other government organisations also play a part in the control of Chinas domestic banks and financial institutions. These include the Ministry of Finance, the State Administration of Foreign Exchange and the China Securities Regulatory Commission (CSRC). Banking market Domestic banks The domestic banks include four state-owned commercial banks, three policy banks, joint-stock commercial banks and small and medium-sized financial institutions (including urban credit unions; urban commercial banks; urban cooperative banks and rural credit unions; and rural commercial banks). Four state-owned commercial banks The role of specialised banks has changed and become more commercialised due to reforms introduced in 1993, which called for the establishment of three policy lending banks the State Development Bank, the Import and Export Credit Bank and the Agriculture Development Bank. These specialised banks were converted into commercial banks, including the four biggest stateowned banks. 1. Bank of China The Bank of China (BOC) is the countrys largest foreign exchange bank and deals with international transactions. Its functions are wide-ranging and include commercial and investment banking. The commercial banking business has been the BOCs core business in terms of both net profit and assets.
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2. Industrial and Commercial Bank of China The Industrial and Commercial Bank of China (ICBC) issues industrial and commercial loans and handles savings and deposits across the nation. It has the largest network of business branches and outlets in China and is the most powerful e-commerce online payment service provider in China. 3. Agricultural Bank of China The Agricultural Bank of China (ABC) deals with banking matters in rural areas, including approving funds for agricultural projects and extending commercial loans to rural enterprises. Before 1996, the Agricultural Bank of China supervised the rural credit cooperatives. 4. China Construction Bank The China Construction Bank (CCB) deals mainly with investments for capital construction projects. It is the first bank to grant individual mortgage loans in China. Joint-stock commercial banks The government has also allowed joint-stock commercial banks to be formed to engage in a wide range of banking services, including accepting deposits, extending loans, and providing foreign exchange and international transaction services. These banks have become the most dynamic sector in Chinas banking system. They are relatively less vulnerable to policy-lending pressures. A large bulk of the shares of most joint-stock commercial banks is still held by the State.
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Other domestic financial institutions Other domestic financial institutions include the following: 1. Urban commercial banks and rural commercial banks Urban commercial banks have evolved from urban credit cooperatives. China has more than 100 small urban commercial banks in operation and recent years have witnessed their fast expansion. However, their business scope is limited to the city where they were founded, which impedes their further expansion. In 2007, Nanjing and Ningbo urban commercial banks launched IPOs on local bourses. 2. Credit cooperatives Before 1996 there were two types of credit cooperatives, rural and urban. Rural credit cooperatives operated under the supervision of the Agricultural Bank of China. They did not deal with foreigners and their activities were governed by specific regulations. In 1996, the PBOC encouraged the urban credit cooperatives to merge and form the City Cooperative Banks and in 1997, issued the Administrative Rules of City Cooperatives Banks. The PBOC also issued the new Administrative Rules of Rural Cooperatives in 1997 to strengthen control over the combined rural cooperatives. Credit cooperatives typically provide credit to small-and medium-sized enterprises as well as individuals. Given their small size, major restructuring is expected in the next few years.
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Banking and finance
Foreign banks Foreign banks are permitted to establish representative offices in China and to set up branches, fully foreignowned banks and Sino-foreign joint venture banks. Representative offices In accordance with the Regulations of the Peoples Republic of China on the Administration of Foreigninvested Banks promulgated at the end of 2006, the scope of work of the representative offices of foreign banks is restricted to consultancy, liaison, market surveys, and other non-profit-making activities. Branches of foreign banks, Sino-foreign joint venture banks and foreign-owned banks A considerable number of foreign bank branches have received approval to conduct RMB business in China, and it is believed that RMB licenses have been granted at a quicker pace in recent years. By December 2006, the government removed regional restrictions and other limits on foreign-funded banks, giving them the same treatment as Chinese banks under the promulgation of the Regulations of the Peoples Republic of China on the Administration of Foreigninvested Banks. To obtain a license for offering a full range of banking services, including RMB retail business, the CBRC requires banks to incorporate a banking subsidiary or WFOE in China. Sino-foreign joint venture banks and WFOE banks incorporated in China may carry out part or all of the following foreign exchange and RMB services within the business scope approved by the CBRC: Taking public deposits. Issuing short-term, medium-term and long-term loans.
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Handling the acceptance and discount of negotiable instruments. Buying and selling government bonds, financial bonds and securities denominated in foreign currency other than stocks. Providing a Letter of Credit service and guarantee. Handling domestic and foreign settlements. Buying and selling per se or as agent foreign exchanges. Insurance agent service. Conducting inter-bank offer. Conducting bank card services. Providing safe deposit box service. Providing credit investigation and consulting service. Conducting the business of settlement and sale of and payment in foreign exchange upon approval of the PBOC. WFOE banks or Sino-foreign joint venture banks can establish branches within the territory of the Peoples Republic of China. The minimum registered capital for a WFOE bank or an equity joint venture bank should be an amount, in a freely convertible currency, equivalent to no less than RMB1 billion. Wholly-owned foreign banks or equity joint venture banks intending to set up branches in China should allocate working capital in a freely convertible currency equivalent to no less than RMB100 million per branch. The total capital used for setting up these branches should not exceed 60% of that of the WFOE bank.
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Branches of foreign banks may carry out part or all of the above foreign exchange services as well as RMB services with clients other than Chinese citizens within the approved business scope. However, these branches are still subject to certain restrictions, though these restrictions, for instance services for fixed deposits less than RMB1 million and bank card services, will be relaxed by phases. Specialised financial institutions Finance companies Around 70 finance companies representing major Chinese groups have been approved by the PBOC to conduct finance services for its group companies in relation to improvement of technology, development of new products and sales of products. The establishment of finance companies that provide financing for the general public has not been permitted since 2004. The minimum registered capital requirement is RMB100 million, only one third of the amount required before. Foreign investment companies are also allowed to establish finance companies. Only a few have been approved for establishment to date. Finance leasing companies The first finance leasing company was established in 1981. In order to encourage technological improvements in SOEs and economic development in western China, the PBOC promulgated the Measures for Administration of Finance Leasing Companies in 2000 with updates made in 2006.
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Banking and finance
Trust companies The China International Trust and Investment Corporation (CITIC) is a SOE operating under the direct leadership of the State Council. CITIC engages in a variety of specialised financial and investment activities, which include making direct investments in China and overseas, providing financial consultancy services, engaging in trading activities, helping Chinese and foreign enterprises to find appropriate joint venture partners, managing trust businesses, international and domestic leasing, and property development and real estate. Financial markets Securities markets China has two official stock exchanges, one located in Shanghai and the other in Shenzhen. All listing and trading of securities in China are carried out on these two exchanges. The Shenzhen market began trading first in 1990, followed by the Shanghai exchange opening in December 1990. There is strong competition between the two exchanges, and, despite requests from other cities, the authorities have decided not to allow the opening of other exchanges at this time. Currently, the trading volume in Shanghai surpasses that of the Shenzhen exchange. In February 1992, foreign investors had their first opportunity to invest in China. China now has a system whereby companies can issue A or B shares, or both. A shares were intended for local investors, while B shares were initially for foreign investors. In 2001, the B share market was open to Chinese citizens. In response to the demands of foreign investors, international financial institutions were called in to arrange the listings, and international accounting firms produced prospectuses with accounts re-drafted to meet international standards.
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In an attempt to gain more foreign capital, the authorities decided to list a number of enterprises on the Hong Kong Stock Exchange, and these shares became known as H shares. A number of enterprises had already listed overseas, mainly on the Hong Kong exchange through a foreign holding company. Hong Kong developed rules for the listing of these Chinese enterprises. A memorandum of understanding was signed by the CSRC, the two China exchanges, the Hong Kong exchange, and Hong Kongs Securities and Futures Commission. The listing of the first batch of H shares started in 1993. In addition, other enterprises have continued to list on exchanges in New York, London, Singapore, and Australia through foreign holding companies. Both the Shanghai and Shenzhen Stock Exchanges are under the supervision of the CSRC. Each stock exchange has a general assembly of members and board of governors. On 5 November 2002, the CSRC and the PBOC introduced the Qualified Foreign Institutional Investor (QFII) as a provision for foreign capital to access Chinas financial markets. Chinese QFII regulations relaxed some capital controls and allowed foreign institutions to invest in RMB denominated equities and bonds. Indeed, QFII is a Chinese brokerage business, which allows qualified foreign institutions to trade Chinese A-shares via special accounts opened at designated custodian banks, for their clients. A QFII can invest in shares, treasury bonds, convertible bonds and enterprise bonds listed on Chinas stock exchanges and other financial instruments approved by the CSRC. The Qualified Domestic Institutional Investors (QDII) qualification was launched in April 2006. The approved banks, funds and other financial institutions holding QDII qualification can invest in overseas stock markets or fixed income financial products.
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Shanghai Securities Exchange The Shanghai Securities Exchange officially opened in December 1990. By the end of July 2007, there were more than 140 members. In 1997, the Shanghai Exchange Building in Pudong was completed, and exchange activity continues there today. Trading on the exchange is in lots of 100 shares and is fully automated. Trading in A shares is conducted in RMB while trading in B shares is conducted in US dollars. The buyer and seller each pay 0.3% stamp duty, effective from 30 May 2007. Commissions are charged at a rate no more than 0.3%, payable by both buyer and seller. In addition, there is an exchanges transaction fee of 0.1%. A shares are cleared and settled at T-plus-1 (transaction day plus one day) and B shares are cleared and settled at T-plus-3. There are no share certificates. All clearing and settlement are done through China Securities Depository and Clearing Corporation Limited. The Shanghai Stock Exchange is a non-profit-making membership institution directly governed by the CSRC. After several years of operation, the exchange has become the dominant stock market in mainland China in terms of the number of listed companies, the number of shares listed, total market value, tradable market value, securities turnover in value, stock turnover in value and the T-bond turnover in value. Shenzhen Securities Exchange Opened in December 1990, the exchange has more than 150 members and two trading halls. Trading is in lots of 100 shares. The buyer and seller each pay 0.3% stamp duty. Both buyer and seller are required to pay commission of no more than 0.3%.
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The clearing and settlement system, as well as the trading rules of the Shenzhen Securities Exchange, are similar to those of its Shanghai counterpart. Securities Association of China (SAC) More than 100 market participants have formed an association to establish recommended best practices for its members and conduct industry research and training. The SAC, established on 28 August 1991, is a non-profit self-regulatory organisation with legal person status subject to the guidance, supervision and administration of the CSRC and the Ministry of Civil Affairs. The members of SAC include securities companies, securities investment fund management companies, financial asset management companies and securities investment consulting agencies. Listed companies Domestically listed companies have been growing rapidly. In 1990, there were only 10 listed companies in China, but by the end of July 2007, the number had already reached 1,463. Listed companies are located in different parts of mainland China and across various industrial sectors. Securities companies Securities companies must be approved by the CSRC. Initially, foreign brokers authorised by the PBOC were permitted to solicit orders in B shares but had to route them through local exchange members for execution. This allowed them to put a trader on the floor, but they had to clear and settle through a local member with whom they shared commission.
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Securities companies are the leading intermediaries in Chinas capital market. By the end of 2006, there were 104 securities companies under the supervision of the CSRC, regional regulatory bureaus, stock exchanges, securities associations and the Securities Depository & Clearing House. A securities company may undertake some or all of the following businesses upon the approval of the CSRC: Securities brokerage. Securities investment consultation. Financial advising relating to securities trading or securities investment. Underwriting and sponsorship of securities. Securities proprietary trading. Securities asset management. Any other business concerning securities. Regulation Initially the responsibility for regulating the securities industry was with the PBOC. However, as a major investor in a number of listing applicants and as the regulator of the banking sector, it encountered some conflicts of interest. In 1992, a two-tiered body was established to regulate the securities market. The State Council Securities Committee was responsible for setting broad policy guidelines, including the number of companies to be permitted to list each year and the amounts of money to be raised. The CSRC acted as its executive arm.
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The CSRCs responsibilities are as follows: Drafting of laws and regulations for the securities and futures markets. Studying and setting policies and guidelines for the securities and futures markets. Establishment of plans for the development of the market. Leading, coordinating, overseeing and investigating the work done by all agencies in the country in relation to the securities and futures markets. In May 1993, the Interim Regulations on the Administration of Issuing and Trading of PRC Securities were issued. They reaffirmed the authority of the Securities Committee and the CSRC. The regulations were drafted on the basis of securities law in developed countries and cover the issuance and trading of shares, takeovers, disclosure, and dispute settlement. Since 1993, the CSRC has developed a series of administrative and disclosure guidelines addressing the following: Prospectus disclosure requirements for initial public offerings. Annual and interim disclosure requirements for listed companies. Criteria and disclosure requirements for additional public offerings. Establishment of investment funds and administrative guidelines. Establishment of debenture offerings and administrative guidelines. Administrative guidelines for futures brokers to trade futures.
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In 1998, the government transferred the supervisory functions of the Peoples Bank of China and the State Council Securities Committee to the CSRC, making the Commission the sole supervisory body of the securities industry. In December 1998, the Standing Committee of National Peoples Congress promulgated the national Securities Law which took effect in July 1999. Shenzhen and Shanghai have each developed a sophisticated and detailed body of company and securities regulations. The rules are comprehensive and cover the issuance and trading of B shares, market trading and settlement procedures, and procedures for the listing of companies. The regulations of the two exchanges are not identical. In order to further standardise securities trading, the CSRC promulgated the Rules on Trading Securities in Shenzhen, Shanghai Stock Exchange in August 2001. The Rules set the details of the trading system for the two exchanges. The CSRC is mandated to perform the following supervisory functions and duties: Formulating the relevant rules and regulations for the supervision and administration of the securities market and exercising the power of examination or verification. Carrying out the supervision and administration of the issuance, listing, trading, registration, custody and settlement of securities. Carrying out supervision and administration of the securities activities of the securities issuers, listed companies, stock exchanges, securities companies, securities registration and clearing houses, securities investment fund management companies and securities trading service providers.
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Formulating the standards for securities practice qualification and code of conduct and carrying out supervision and implementation. Carrying out supervision and examination of information disclosure regarding the issuance, listing and trading of securities. Offering guidance for and supervising the activities of the securities industry associations. Investigating and punishing any violation of any law or administrative regulation involving the supervision and administration of the securities market. Performing any other functions and duties as prescribed by any law or administrative regulation. Derivatives There is no significant or regulated equity derivatives market in China. Specialised financial markets Commodities and futures market Chinas commodity futures market started almost simultaneously with the securities market. In October 1990, as the first commodity futures market in China, the Zhengzhou Grain Wholesale Market introduced its first futures contract. However, due to the lack of a sound legal and regulatory framework, the following years saw disorder and other problems in the market. In 1994, the CSRC was mandated to consolidate the whole market, and by the end of December 2006, there were four exchanges (the China Financial Futures Exchange, the Shanghai Futures Exchange, the Zhengzhou Commodity Exchange and the Dalian Commodity Exchange).
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The China Financial Futures Exchange (CFFEX) was founded jointly by the Shanghai Futures Exchange, the Zhengzhou Commodity Exchange, the Dalian Commodity Exchange, the Shanghai Stock Exchange and the Shenzhen Stock Exchange on 8 September 2006 in Shanghai. CFFEX will introduce financial derivatives such as index futures, index options, government bonds futures and currency futures. Both the Zhengzhou Commodity Exchange (ZCE) and the Dalian Commodity Exchange (DCE) trade contracts on agricultural products, such as wheat, cotton, corn, soybean, mung bean, bean oil and sugar, while the Shanghai Futures Exchange (SFE) provides futures contracts on other commodities such as copper, aluminium, rubber and fuel oil. International financial market China is not yet an international financial centre. In 1996, Foreign Exchange Control Regulations were issued to facilitate the governments control over the movement of foreign currency. It stipulated that most enterprises cannot maintain foreign currency accounts; rather, companies are required to buy and sell foreign currency as and when the need arises. Trading of foreign currencies is restricted to the US dollar, the Hong Kong dollar and the Japanese yen. Most enterprises trade foreign currencies through approved financial institutions, and, as a result, the use of the foreign exchange adjustment centres was minimal. In December 1998 the government announced that the National Foreign Exchange Trade Center would be combined with the foreign exchange adjustment centers to form the China Foreign Exchange Center. The trading activities of banks with foreign ownership are still subject to certain restrictions.
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Sources of funds Local financing Financing can be obtained from domestic and foreign banks, domestic financial institutions and through the issuance of stocks and bonds. However, Chinese enterprises must adhere to strict approval procedures before they are able to borrow funds from foreign commercial banks, and all foreign loans must be registered with the State Administration of Exchange Control. In 2001, the MOFCOM promulgated the Notice on Issues Concerning Foreign-invested Joint Stock Companies, which sets the regulatory framework for foreign-invested joint stock companies to list in China. Availability to foreign investors Foreign-investment enterprises can obtain loans from both domestic and foreign banks. Domestic banks can issue loans in both local and foreign currencies. When applying for a loan from a bank, the foreign-investment enterprise is required to submit relevant documents, such as cash and production budgets and purchase contracts, to substantiate the need for the loan. Security in the form of a guarantee or mortgage is also usually required. The approval of a loan will generally depend on the availability of funds, the creditworthiness of the enterprise and government policy, and priority will normally be given to export-oriented and technologically advanced enterprises. Enterprises taking out foreign currency loans with overseas banks are required to provide the State Administration of Exchange Control with a copy of the loan agreement for registration purpose.
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Chapter 7
Exporting to and from China
Key messages China accession to the WTO had a great impact on regulations and practices in terms of customs and trade laws. Approved foreign-invested enterprises, for example, can now import and export directly and in their own name, without the use of a local import/export agent or a trade corporation. Many imports are regulated through a licensing system and by commodity inspection. Some items are restricted by the Chinese government. Most imported goods are subject to customs duty and import VAT. Various exemptions and reductions from customs duty and import VAT are available. Import restrictions Since WTO accession, China has revised various import administration systems and eliminated certain import restrictions. Imports are basically classified into the following categories: 1. Prohibited goods China promulgates a Forbidden Catalogues of Imports (FCI) irregularly, for the purposes of protecting national security, public benefit, peoples health and security, as well as the environment. Through to 2007, six FCIs have been promulgated, which cover selected animal products, chemical products, used office machines, waste and the like.
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2. Restricted goods Since WTO accession, China has simplified its import licensing scheme into three categories: Import Licenses, Automatic Import Licenses and Tariff Quotas. Import quota requirements on normally traded goods were abolished in 2005. Details of commodities subject to import licensing are published annually by the Ministry of Commerce (MOFCOM). Import licenses were mostly issued for products in accordance with Chinas obligations under international conventions, e.g. approval is needed for importation of monitored and controlled chemicals as per the Convention on the Banning of Chemical Weapons. An import permit shall be obtained before the importers file the applications for an import license. Tariff quotas apply to wheat, maize, rice, soybean oil, olive oil, rape oil, sugar, wool, wool tops, cotton, and chemical fertilisers. 3. General goods General goods the largest of the three categories include all items that are not classified as prohibited or restricted. General goods may still be subject to automatic import licensing (AIL). If these goods are imported by an entity that is not an authorised import entity, an AIL is still required. The AIL is waived in specified circumstances, e.g. the goods are imported and will be re-exported under Processing Trade (see below). The new Foreign Trade Law, which was promulgated in 2004, allows individuals as well as legal persons and other organisations to engage in foreign trade, after they go through a procedure of registration with MOFCOM. This is a significant regulatory and commercial development as compared to previous years.
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China may subject certain goods to state trading to ensure stable domestic supply, stable prices, safeguard food safety, and to protect the environment and exhaustible resources. At present, those goods under state trading include grain (such as wheat, maize, and rice), vegetable oil, sugar, tobacco, chemical fertiliser and cotton. In principle, goods subject to state trading can be imported (and exported) only by authorised enterprises. In some cases, unauthorised enterprises can also import and export a certain amount of state traded goods. Inspection and quarantine Imports and exports are subject to quality supervision. The Administration of Quality Supervision, Inspection and Quarantine (AQSIQ) is the in-charge authority to supervise the quality and perform quality inspections on imports and exports. AQSIQ will promulgate a Catalogue of Goods Subject to statutory inspection annually. Imports/exports that are not listed in this catalogue may still be subject to random inspection by the local AQSIQ offices. AQSIQ has set out various requirements for importers/ exporters to follow, such as inspection and quarantine requirements for animals, plants, their by-products, and wooden packages, labelling requirements for food, and compulsory certification on a vast category of products. Importers are required to declare the imports to the port office of inspection. They cannot sell or use the imports until the inspection has been carried out. Waivers from inspection are granted in some cases. For example, goods meeting the specified criteria for exemption from inspection, such as being well known for reliable quality, with recognised international quality licenses, never failed specified inspections, and so forth, can be waived from inspection. Samples, gifts, temporary imports and exports, and articles of a noncommercial nature can usually obtain approval for waiver from inspection.
The majority of imports are only subject to landing port inspection. However, in special cases, such as the importation of used machinery, imports may be subjected to up to three inspections: Pre-shipment inspection in the exporting country. Landing port inspection. Post-importation inspection at the final destination place. Customs procedures The Customs Law of the Peoples Republic of China was first issued in July 1987. Amendment was approved by the National Peoples Congress Standing Committee on 8 July 2000 and it took effect on 1 January 2001. The revisions aim to empower Customs with more administrative authority, promote the transparency of customs procedures, and make customs practices more consistent with international best practices, as embodied in the Revised Kyoto Convention for the Simplification and Harmonisation of Customs Procedures. Under the Customs Law of the PRC, importers and exporters must register with Customs before filing customs declarations. Importers should file declarations to Customs at the port of entry within 14 days of the goods arrival. Exporters should file the declaration within 24 hours before the goods are loaded. Customs will review the documents submitted and will randomly perform examinations of the goods. The maximum period for examination on imports should be around 48 hours. The majority of goods are cleared within 48 hours. However, in practice, it may take longer for importers to clear goods from the port due to restrictions in Customs resources.
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Customs duty must be paid to a designated Customs bank account within 15 days after the duty memo is issued. Surcharges will be imposed for late payments, which will be calculated at the rate of 0.05% per day on the total amount of customs duty and import VAT due. Tariff rates Tariff rates shall be determined per the tariff codes, which are known as the Harmonised Commodity Description and Coding System (HS), and the origin of the goods. China adopted the HS coding system with effect from 1 January 1992. China adopted the 2007 version of the HS on 1 January 2007. Imported and exported goods should be classified according to the corresponding HS codes. Since WTO accession, China has lowered the tariff rate gradually. By 2007, all of Chinas multilateral WTO tariff reduction commitments had been fulfilled. Further unilateral tariff reductions are unlikely. Tariff rates remain one of Chinas main trade policy instruments and tariff revenue still plays a significant role in national revenue. In 2007, the overall average most-favoured-nation (MFN) tariff rate is 9.7%, while the average tariff rates for agricultural and non-agricultural products are 15.2% and 8.8%, respectively. The PRC tariff book sets out different types of tariff rates: MFN tariff rates, preferential tariff rates, general tariff rates and interim tariff rates. The MFN tariff rate is applicable to imported goods whose place of origin is a member country of the WTO. The preferential tariff rate is applicable to imported goods whose place of origin is a country or region that has concluded a bilateral or regional free trade agreement. As of 2007, prominent examples include the Asia-Pacific Trade Agreement, China-Pakistan Free Trade Agreement,
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China-Chile Free Trade Agreement, China-ASEAN Free Trade Agreement and the Closer Economic Partnership Arrangement with the Hong Kong and the Macau special adminstrative regions. The list of countries wherein a preferential tariff rate is applicable will continue to grow, as China is actively negotiating free trade agreements with several trading partners. The general tariff rate is the highest tariff rate and it is applicable to imported goods whose place of origin is unknown. In practice, the place of origin is usually known. This means that the MFN tariff will be applicable, unless a lower preferential or interim tariff can be used. The interim tariff rate is applicable to selected imported goods and it is reviewed annually by the Tariff Committee under the State Council. An interim tariff rate is normally 0%, 1% or 3% and is set to support the countrys industry policy. For example, most commodities and aviation parts are subject to an interim tariff rate of either 0% or 1%. China has applied a 0% tariff rate since 2003 for goods covered by the Information Technology Agreement (ITA). Duty exemption and duty reduction China has issued various regulations to stimulate foreign investment and development of certain sectors of the economy. Exemptions from customs duty and import VAT are granted for machinery and equipment imported by an enterprise if the project is recognised as encouraged industry per the Foreign Investment Industry Guidance Catalogue and the Most Encouraging Industry, Products and Technology Catalogue. The Catalogue has been updated several times. The latest Foreign Investment Industry Guidance Catalogue was issued in 2004 by the National Development and Reform Commission (NDRC) and the Ministry of Commerce. The latest Most Encouraging Industry, Products and Technology Catalogue was issued in 2005.
There are other restrictions around this preferential policy, namely the machinery and equipment to be imported shall be within the total investment or the self-generated funds of the importer, restricted for self-use, and the equipment should not fall into the Catalogue of Goods of Non-Exemption for Foreign Investments or the Catalogue of Goods of Non-Exemption for Domestic Investments. Equipment and machinery imported but exempt from customs duty and import VAT is under the supervision of Customs for a period of 5 years from the date of importation. During the supervision period, the equipment and machinery should not be transferred, sold or otherwise disposed of without the pre-approval from Customs. Anti-dumping China will utilise trade remedy measures, i.e. levying an anti-dumping duty, countervailing duty or safeguard duty, to protect the domestic industry from material injury or the threat of material injury. Of these three trade remedy measures, anti-dumping is most frequently used. According to Chinese regulations, anti-dumping complaints may be brought to the MOFCOM in writing by any natural person, legal person or organisation from the domestic industry or on behalf of the domestic industry. The application should contain details such as the full description of the products, the volume and price of domestic production of the like product. The volume and price of the imports and the impacts from the imports on the domestic industry should also be stated. Evidence should be presented to justify the existence of dumping, the damage caused to the domestic industry, and the causal link between the dumping and the injury.
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MOFCOM is responsible for investigating and determining dumping and injury. Investigations should be completed within 12 months from the date that the case is established. The period can be extended by six months in special cases. Anti-dumping duty rates can be imposed for a period as long as five years, unless the period is extended for special reasons. Since the first anti-dumping case in 1997, MOFCOM has enforced anti-dumping duties on 48 cases (MOFCOM data). According to the WTO, China has enforced antidumping duties on as many as 150 cases. Customs valuation The customs value is determined following the customs valuation methodologies as set out in PRC Customs Valuation Measures. These measures essentially implement the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994. The value for customs duty calculations purpose is the CIF (Carriage, Insurance and Freight) price. The primary valuation method is the Transaction Value method and this is applied over 95% of the time. Where the Transaction Value method cannot be used, the customs value shall be assessed by applying the alternative methods sequentially. China has applied the provisions of the decision on the treatment of interest charges for customs valuation purposes and the decision on the valuation of Carrier Media Bearing Software for Data Processing Equipment (G/VAL/5).
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Valuation remains one of the more complex areas of customs law. Since implementation of the WTO-based customs valuation rules in 2001, this area remains one of the most controversial from an importers perspective. It is an area of focus by Customs, and re-assessments in the declared value result in additional customs duty and import VAT liabilities. For example, royalty and license fees, which are related to imported goods and paid as a condition of the import sale, are dutiable for customs valuation purposes. Other taxes Imports, like domestic products, are subject to a VAT. The current import VAT rate is 17% (a limited number of goods may qualify for 13%). Import VAT is creditable. In addition to customs duty and VAT, an excise (or consumption) tax is levied at the border on items including cigarettes, alcoholic beverages, gasoline, motor vehicles and luxury watches. VAT and consumption tax is also imposed on goods manufactured and sold in the domestic market, which conforms with the non-discriminatory principles of the WTO. For other taxes levied on import items see Chapter 19. Rules of origin China has adopted the WTO-based rules of origin. Chinese regulations define origin in terms of goods produced or manufactured wholly within one country or region or, in the case of goods produced in two or more countries or regions, the country or region where substantial transformation has been made and finalised.
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Substantial transformation is defined either as a change in the tariff heading of the goods, or if the value added is no less than 30% of the total value of the product. China has adopted various preferential rules of origin per the respective free trade agreements that it has agreed with trading partners. Intellectual property The State Council enacted the PRC Regulations on Customs Protection of Intellectual Properties in 2003, which replaced the previous version enacted in 1995. China Customs enacted the Implementation Rules to PRC Regulations on Customs Protection of Intellectual Properties in 2004, which replaced the previous version enacted in 1995. Intellectual property owners shall register their intellectual property right protection request with the General Administration of Customs (GAC) in Beijing. The registration fee is RMB800. Where there is suspicion of infringement of the registered intellectual property rights (IPR), both the intellectual property (IP) owner and Customs can take initiatives to protect the IPR. Should IP owners take the initiative and ask Customs to detain the goods in suspicion of an infringement, they should provide a financial guarantee equal to the value of the goods. If Customs does not receive written notice from the Peoples Court, Customs shall release the goods when the detention period expires, which is 20 working days. Consignees can also apply for release of the goods in question within the detained period by submitting a financial guarantee equal to the value of the said goods.
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Should Customs take the initiative in border protection measures, Customs should notify the IP owner within three working days. If the IP owner confirms and submits a guarantee as specified in the regulations, Customs can detain the goods and start an investigation, which should be completed within 30 working days. The IP owner can still file a claim to the Court and request protection measures even though Customs cannot confirm the existence of an IPR infringement. However, Customs shall release the goods within 50 working days after the goods are detained. Also, the consignee can apply for release of the goods within 50 working days by submitting a financial guarantee equal to the value of the goods in question. Port of entry and inland transportation All goods and articles must be brought into or out of China at a location where a Customs Office has been established. Goods may be imported over land, or through seaports and airports open to foreign trade. Certain areas, such as the Special Economic Zones and the coastal cities, are more developed and able to offer more advanced facilities. This is particularly true of Shenzhen, Shanghai, Tianjin and Guangzhou. Trains and inland waterways are the main means of inland transportation. Roads and highways are generally in need of development. Accessibility of inland transportation to a specific destination could be problematic and thus affect the choice of port. Processing trade (bonded manufacturing) Processing trade is widely used in China. In fact, nearly half of imports and exports are traded under this arrangement.
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Under processing trade, raw material imports are held in bond and are not subject to customs duty and import VAT assessment on condition that they are processed into finished products and exported within a certain period of time. Finished products that fail to be exported will be assessed for both customs duty and import VAT, according to the value of the imported raw materials contained therein. All imported raw materials and finished products in bond are under supervision by Customs. They cannot be sold, transferred or otherwise disposed of without approval from Customs. Manufacturers should apply to MOFCOM and Customs before they can carry out processing trade. Customs will issue a paper handbook or electronic handbook to the manufacturer, which they should then use to monitor the imports and exports. All import and export records should be entered into the handbook. The handbook should be verified and cancelled when the processing trade contract is completed or the handbook expires. Not all manufacturing operations are approved for processing trade. China has promulgated forbidden catalogues for processing trade. As of 2007, more than 1,000 HS codes are forbidden from processing trade. This list is updated frequently and often with little forewarning. Customs bonded zones There is now an increasing number and variety of bonded zones throughout China. These bonded zones allow different types of activities to be performed and carry different conditions from a customs, tax and foreign exchange point of view. These special bonded zones are routinely available to foreign-invested enterprises. The special bonded zones are summarised below. Bonded warehouses have been established for a long time and can be used to temporarily store imported and exported goods. Bonded warehouses can be public or private in nature.
Free Trade Zones (FTZ) have also been established for a long time, and can be used for bonded manufacturing as well as other operations, such as a bonded regional distribution centre. Export Processing Zones (EPZ) are well established, and have been historically used for bonded manufacturing for export. The allowable business activity in an EPZ is now being expanded to include activities like research and development, testing and repair. Bonded Logistics Parks (BLP) were newly introduced in 2004 and 2005 to promote the logistics industry, and feature bonded stored and similar processing only (fully fledged manufacturing is not allowed). There are eight BLP located in selected coastal cities, generally adjacent to the port areas. BLP are also favourable for export VAT refund purposes. Bonded Logistic Centres (BLC) are also another newlyintroduced bonded zone. The most prominent public BLC is located in Suzhou. It is expected that new public and private BLC will be introduced throughout China in the years ahead. The Zhuhai Cross-Border Industrial Park is another newly introduced facility, which consolidates the bonded logistics, bonded manufacturing and international trade functions. This bonded zone also allows repair and CEPA privileges. Export Supervision Warehouses (ESW) are also new and are designed for the temporary storage of exported goods. Pilot programmes are being carried out for selected ESW in Shenzhen and Xiamen. Exporters can claim an export VAT refund upon exporting into the ESW.
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For all bonded zones, customs duties and import VAT will not be levied on imported goods that enter the facility. If imported goods are sold on the domestic market, they will then become subject to both customs duty and import VAT. The cost of bonded storage can be included in the customs value for duty assessment purposes. Local representation Market surveys It is essential to conduct surveys of existing and potential markets to assess market size, pricing, distribution channels, and other factors, before considering export sales to China. However, it is generally difficult to obtain the required information and is necessary to rely on official sources. Local agent Historically, foreign-invested enterprises had to use the services of an authorised local import/export agent when importing/exporting goods. With the liberalisation that has taken place post-WTO accession, this requirement no longer applies, but subject to approval. Approvals are readily granted by MOFCOM to foreign-invested enterprises.
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Chapter 8
Labour relations and working conditions
Key messages Noticeable phenomenon shows that more and more multinational companies are transferring their regional headquarters and/or regional R&D centres from other Asian cities like Singapore or Hong Kong to Shanghai or Beijing, in addition to setting up manufacturing plants in China. Statistics from Fortune indicated that around 92% of the top multinational companies would consider moving their regional headquarters to China in the next few years. In the meantime, to offer better protection to local employees, the Chinese government has been introducing or revising labour legislation and regulations that tighten up employment relations, employee benefits, and working conditions. Labour relations Labour demand and supply Due to the continuous economic growth and the surge of foreign companies into China, it is possible to forecast that there will not be any decrease in the demand for qualified executives, professionals and skilled workers in China. Along with the increasing job opportunities in China, the labour supply is also increasing tremendously. Almost 70% of the economic development in China in past decades has been contributed by the labour factor. However, statistics from the Chinese government show that labour supply exceeding demand will exist in China for a period of time. Although the labour supply in China is still increasing and will follow this trend in the immediate future, the rate has been decreasing due to the Chinese governments family planning policy and ageing of the population. Meanwhile, a structural shortage in the labour force is becoming an obstacle for foreign companies expanding into China. In particular, they are experiencing difficulties
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in recruiting managerial staff and skilled workers. The difficulties can be even more acute in second and third tier cities. As a result, foreign companies are facing fierce competition from both foreign and local competitors when seeking to hire employees in the local market. Another phenomenon is that the talent market is becoming much more diversified. In addition to the local workforce, more and more people from western countries, Hong Kong, Singapore, Taiwan, as well as other Asian neighbours are going to China for job opportunities. However, due to their higher salary expectations and limited experience in China, they are not as competitive as local nationals. Labour cost Due to fierce competition in the labour market, the cost of labour has increased significantly in recent years. It is said that China has entered an employee market where companies need to take the initiative to promote themselves in order to win the war for talented professionals. This statement might be true if we look at the current market condition in China. In order to attract local talent, foreign companies, especially newly established foreign companies, offer competitive salary packages, higher positions, and overseas training opportunities to potential candidates. Such a trend might contribute to the labour markets current salary inflation and rising employee turnover. A report shows that the salary inflation rate has reached between 8%-10% per year in recent years. People also expect a high salary increase, say 50% or more, when they change jobs. Although increasing, however, the overall labour cost is still relatively low and gives Chinas labour market an advantage. Additionally, more multinational companies are entering China to compete in the fast-growing local marketplace rather than simply applying the old build-
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and-ship-aboard business model. Therefore, localisation is a strategy that most of the multinational companies have implemented in China. More and more foreign companies fill their management positions by hiring local talent or promoting from internal local staff. For these employees, adequate training/coaching needs to be provided to improve their professionalism and management skills. Recruitment Recruitment methods differ for FIEs and representative offices (ROs) of foreign companies in China. FIEs, for instance, joint ventures and WFOEs, are able to employ staff from the local workforce directly. Joint ventures normally do so through recommendations from their Chinese partner or the local authorities. Staff from the original manufacturing plant of the Chinese partner will often be employed by the joint venture. WFOEs normally have a free hand in recruiting staff locally. However, due to a lack of local networking, they will often need to rely on professional firms, mass media, or other methods to recruit managerial level staff. Recruiting local staff is different for ROs, which are required to hire staff through an authorised labour agency. There are several available authorised labour agencies in China, such as the Foreign Enterprise Service Corporation (FESCO), China International Intellectech Corporation (CIIC), for example. The labour agency is the legal employer of the staff and seconds them to the representative office to provide agreed services. In practice, representative offices need to establish a contractual relationship with the labour agency and pay the required service fee. As the staff working for representative offices are the employees of the agency, many representative offices in China choose to enter into a separate agreement with the staff stipulating the terms and conditions of the engagement.
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Termination of employment Unlike practices in many other countries, employment at will is not permitted in China. Employers have to follow certain procedures and conditions to terminate the employment with the staff, e.g. upon contract expiration, or where the employee is proved to be unqualified, violates the enterprises rules and regulations, discloses criminal convictions, for example. In addition, staff may be made redundant as a result of production or technical changes. However, it is not permitted to dismiss staff who undergo stipulated medical treatment, who lose their ability to work due to an occupational disease or a work-related injury, and who are on pregnancy or maternity leave or in the midst of a lactation period. To terminate an employment relationship with staff, enterprises may need to give a statutory termination notice and provide required severance payment. By law, the severance payment is calculated based on the actual service year and the salary level of the staff. In China, ROs are also able to terminate their staff. As they do not have an employment relationship with the seconded staff, representative offices may terminate the service of these staff through their engaged agency. The service agreement between representative offices and the labour agency serves as the guidance of the termination. Employer/employee relations Foreign investors often experience problems with their employees and China partners arising from the different management techniques and business procedures practised in China and in the West, as well as from cultural and linguistic barriers. In terms of the work relationships, joint ventures experience more problems than WFOEs. Therefore, more and more multinational companies choose to set up WFOEs if permissible.
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The Chinese government is now enforcing the Trade Union Law. According to the Trade Union Law, companies are required to support employees to set up a trade union and provide funds equivalent to 2% of the companys total salary costs for the activities of the trade union. For activities related to employees, for example, re-organisations and layoffs, the company shall notify the trade union and heed its comments before taking action. Legal environment The 1995 PRC Labour Law (Labour Law) is the prevailing labour law applicable to all employment relationships in China. In practice, different cities, provinces and regions may have their own labour regulations. These labour regulations normally provide a detailed explanation and guidance for the implementation of the Labour Law. Thus, when dealing with employment issues in China, foreign companies may need to refer to local regulations in addition to the Labour Law. As stipulated in the Labour Law, except for ROs, foreign companies in China need to enter into an employment contract with their employees to establish an employment relationship. The contract shall be in writing and contain all required clauses such as term of the contract, content of work, labour protection and working conditions, salary, for example. The terms and conditions of the contract must be in accordance with the Labour Law and related regulations. Otherwise, the contract will be deemed invalid. The signed contract will serve as the guidance to the employment relationship. Effective from 1 January 2008, a new Labour Contract Law will be enforced in China. This Labour Contract Law is formulated according to the Labour Law with the purpose of governing the establishment of employment relationships, and the conclusion, performance, amendment and termination of labour contracts between the employer and the employee.
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The Labour Contract Law has imposed new requirements in areas such as term of the contract, probation period, employee termination, severance payment, management of agency staff, non-competition, for example. This Law encourages employers to enter into long term or non-fixed term employment contracts with employees, and sets more strict regulations for the termination of employment, stipulating conditions of termination and increasing any relevant costs. It also increases the penalties for violation of the Labour Law and other related regulations. Working conditions Wages and salaries In China, enterprises have the right to set their own remuneration package, including compensation and benefits. Pursuant to PRC Labour Law, the wages of staff shall not be lower than the minimum wage in the location where the company is registered. Influenced by macro economic conditions and market competition, salaries in China have been increasing in recent years, which means increasing labour costs for enterprises. These enterprises must keep track of salary trends in order to make sure that their salary offerings are attractive and cost effective in the fast-growing market. In addition to compensation, enterprises may also implement effective incentive programmes, e.g. sales incentives, performance bonuses, stock options, and the like, in order to attract talent. This is of great importance for positions in management and sales, which are often the driving force behind company performance. In terms of payroll, salary shall be disbursed to the staff at least once a month in local currency. The date of disbursement can be decided through an agreement between the company and staff. The wage paid to staff shall not be deducted or delayed without justification.
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Delayed payroll disbursement may lead to a financial penalty. In addition, the company is responsible for withholding PRC individual income tax (IIT) that is payable from staff gross compensation. Fringe benefits In China, employers and employees are required to participate in a social benefits system. As a result, they are obliged to make contributions to the statutory social insurance programmes based on the schemes for different locations. For a majority of the workforce, whose salary level falls within the local social insurance contribution base, the social insurance contribution could be between 35-40% of their salary cost. The social insurance programmes cover the following social insurance and funds: Pension. Medical insurance. Unemployment insurance. Work-related injury insurance. Maternity insurance. Housing fund. To participate in social insurance programmes, enterprises need to register with the relevant labour bureau, set up an account with a social insurance management authority and pay the required insurance premiums on a monthly basis. Apart from employer premiums, companies shall withhold the premiums of employees from their monthly salary and make the payment to the relevant authority. For representative offices, because they are not legal entities, premiums should be paid via the authorised labour agency.
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In addition to statutory social insurance, enterprises in China also provide supplementary benefits schemes to their employees as a way to attract and retain local talent. The schemes are different based on the position level of the employee. Many enterprises provide benefits schemes such as accidental death and disability insurance, supplementary medical insurance, supplementary pension programmes, health checks, for example. Working hours The working hours per week were reduced from 48 to 44 hours in March 1994, then further reduced to 40 hours in May 1995 by the State Council. In general, overtime is not encouraged, though permissible under special circumstances. Overtime pay is higher than that for normal working hours, ranging from 150% up to 300% of normal wages, depending on whether the overtime is during weekdays, rest days or statutory holidays. Paid holidays and vacations There are 11 statutory public holidays per annum. Apart from public holidays, companies in China are also required to provide other paid leave, e.g. maternity leave, paternity leave, marriage leave, compassionate leave, sick leave, for example. The entitlement to paid leave depends on local labour regulations. Annual leave is also prevalent in China although there is no specific guidance under current labour law. Enterprises in China normally grant 5-20 days annual leave to their staff based on their position and service year.
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Equal opportunities Under the Constitution of the Peoples Republic of China issued in 1982, all nationalities within China are equal, and any discrimination is prohibited. The Constitution also calls for equal opportunities for men and women in all spheres of life. It protects the rights and interests of women and applies the principle of equal pay for equal work. Health and safety Under current laws and regulations, employers are responsible for ensuring the protection and safety of their employees and shall appoint necessary personnel to take charge of labour protection measures based on the industry which the enterprise belongs to and the number of employees. The regulations also specify that steps must be taken to improve working conditions to ensure that these afford protection and safety to the workers. The governments labour management department is authorised to see that these measures are implemented. Employee training programmes According to PRC law and regulations, companies shall make efforts to provide professional and technical training to their staff and workers. Difficulties are often experienced in recruiting staff with the skills required to operate new and advanced technology, and, as a result, foreign personnel may be brought in to provide the necessary training. Enterprises generally find that their local managerial staff also require training in many areas of operation, including marketing, decision making, quality control and financial management. Senior managers may also be sent overseas for further training. As a general rule, representative offices, which tend to have a far smaller number of employees than joint ventures or WFOEs, do not have the facilities to offer extensive training programmes and are able to provide only on-the-job training to their local staff. Again,
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employees in the most important positions may be sent overseas for technical training, provided the relevant permits can be obtained. Foreign personnel Work permits All foreigners entering China require a visa. Foreigners coming to China for a short-term business visit of no more than six months can apply for an F visa. F visas might be single entry, double entry or multiple entry. The F visa normally allows a stay of 30 days per entry. The validities of single, double and multiple entry are three months, six months and six months/12 months respectively. A foreign assignee who has commenced work in China and acquired the necessary registration and health check report may apply for a work permit, a Z visa and foreigner resident permit, which will allow the foreign employee to stay in China for a period of a year. Work permits and Z visas can be renewed. Foreign personnel who travel to China for short periods of time for business purposes do not require residency or work permits. However, personnel who are to be stationed in China for any length of time are required to obtain a foreigner residence permit. A foreigner working for a representative office is also required to obtain a representative working card before he/she applies for the Z visa and foreigner resident permit. For this purpose, he/she will need to be registered with the Administration of Industry and Commerce. Foreigners based in China working for joint ventures or wholly foreign-owned enterprise must acquire an employment license, an employment permit, a Z visa and a foreigner residence permit.
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Restrictions on employment Although there are no restrictions on the number of foreign personnel that may be employed by a foreign investment enterprise in China, nor is there a time period imposed on their employment, FIEs are required to submit rsums of their foreign employees to the local labour bureau for assessment. Should the labour bureau determine that there is local talent available with similar backgrounds and skills to deliver comparable services, the application for obtaining employment permits for foreigners may not be approved. The costs of maintaining expatriate personnel in China can be extremely high, and this in itself often places restrictions on the number of expatriate personnel a foreign company will send to work in its China operation. Living conditions There is no real shortage of Western-style accommodation in the major cities of Beijing, Shanghai, Guangzhou and Shenzhen, but there are still housing problems in the second-tier cities. Expatriate housing and imported western goods and food items are still relatively expensive, but foreign personnel are generally provided with additional allowances to compensate for the higher costs of living in China. In addition to the base salary, an expatriates package would normally include housing, transportation allowances, foreign service premiums, cost-of-living allowances, childrens schooling, tax equalisation, club membership, and possibly hardship allowances, depending on the location of the assignment and company practices. Foreign personnel employed in China may be accompanied by their spouse and children. There are international schools that cater to expatriate children in Beijing, Shanghai and Guangzhou and expatriate education programmes in other areas.
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Chapter 9
Audit requirements and practices
Key messages Foreign-investment enterprises (FIEs) are required to keep accurate records of all business transactions in accordance with Chinese accounting regulations. Annual financial statements must be audited by CPA firms in accordance with China Auditing Standards and filed with the relevant authorities within four to six months of the following year end (dependent on local government requirements). FIEs must engage a Chinese-registered CPA firm to conduct annual statutory audits. Foreign CPA firms, subject to approval, are permitted to enter into joint ventures with Chinese CPA firms to enable them to become Chinese-registered. Chinese accounting principles have historically followed PRC tax regulations and old concepts may still prevail in certain cities. However, in 2006, the Ministry of Finance issued the Accounting Standards for Business Enterprises (2006) applicable for listed companies from 1 January 2007; these standards largely follow the International Financial Reporting Standards (IFRS). It is expected that the Accounting Standards for Business Enterprises (2006) will be required for FIEs in the coming years. However, early adoption is encouraged. Statutory requirements Books and records FIEs are required to maintain accounting records and prepare annual financial statements in accordance with China Accounting Standards. The accountancy law stipulates that companies must keep three kinds of primary accounting records: journals, a general ledger and subsidiary ledgers, as well as appropriate
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supplementary memorandum records. Computerised accounting systems, if utilised, can be regarded as the ventures accounting records. All accounting documents, books and statements prepared by a FIE must be written in Chinese, however, they may also be written concurrently in a foreign language. Books and records should be recorded in renminbi (RMB), unless agreed otherwise by relevant authorities and partners. If a foreign currency is used, the financial statements must be converted into RMB at year-end for the preparation and auditing of the annual financial statements. Typically, most foreign-invested enterprises choose to record their books in RMB because their income and expenses are largely denominated in the local currency. All FIEs are required to retain their accounting records, statements and supplementary memorandum for a minimum of 15 years. The Ministry of Finance is responsible for formulating the accounting practices for FIEs operating in China. In July 1992, the Ministry of Finance issued the Accounting Regulations of the Peoples Republic of China for Enterprises with Foreign Investment, which governed all forms of FIEs, including equity joint ventures, cooperative joint ventures and WFOEs. In December 2000, the Ministry of Finance issued the Accounting System for Business Enterprises in a move towards complying with international accounting standards. FIEs were required to adopt these standards effective from 1 January 2002, in replacement of the earlier Accounting Regulations of the PRC for Enterprises with Foreign Investment.
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In 2006, the Ministry of Finance issued the Accounting Standards for Business Enterprises (2006) for application to listed companies from 1 January 2007; early adoption was encouraged for other types of enterprises. It is expected that these new accounting standards may become a standard requirement for FIEs in the next few years. In general, these new standards reflect all IFRS principles, although several differences exist to reflect unique circumstances in China. Audited financial statements FIEs are required to engage a Chinese-registered CPA firm (including an approved Sino-foreign joint venture CPA firm) to audit their statutory annual financial statements. It is generally the duty of the board of directors of a FIE to appoint the auditor. A foreign CPA firm may also be engaged alongside a local CPA firm in performing auditing or related work, but the Chineseregistered CPA firm must issue the report. Audits are required under the company laws, accounting regulations and income tax laws in China, and audited financial statements should be filed with the tax authorities, together with the annual income tax returns. FIEs are required to provide the auditors with all the enterprises documents, books and reports. The accounting statements to be submitted for an annual audit include the balance sheet, income statement, statement of cash flows and relevant supporting notes. The audited financial statements must be submitted to a number of government authorities, including the local offices of the State Administration of Industry and Commerce, the State Administration of Taxation, the local Finance Bureau and the State Administration of Foreign Exchange. Audited financial statements must be submitted to the relevant authorities within four to six months of the year end, depending on local government requirements.
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Accounting profession The national regulatory authority for Chinas CPA profession is the Ministry of Finance. The Chinese Institute of Certified Public Accountants (CICPA), which was established in late 1988, is the organisation that regulates the profession. In addition to licensing CPAs, the CICPAs main functions are as follows: To ensure that all CPAs perform their duties in accordance with the relevant laws and regulations. To promote the development of the profession. To enhance the professionalism of its members and maintain their legitimate professional rights. To promote the exchange of work experiences and business information; and To improve the association between Chinese CPAs and their foreign counterparts. The registration of CPAs in China was discontinued in 1952 and resumed again only in 1980, resulting in a shortage of experienced and qualified personnel and a general unfamiliarity with international practices. However, in recent years, with greater emphasis being placed on accounting education and on encouraging more people to enter the profession, this situation has been improving rapidly. The Ministry of Finance is responsible for approving the qualifications and experience of accountants applying to become CPAs. A national examination for CPAs has been in place since December 1991. With the exception of those with many years of experience, CPAs who qualified after 1 October 1986 are required to take the qualifying examination. Under this revised system, individuals can obtain the CPA qualification only on the basis of their education and experience and upon passing the qualifying examination.
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Only Chinese-registered CPA firms may audit the statutory financial statements of FIEs, certify the capital contributions, certify the accounting statements upon the liquidation and dissolution of a venture and perform other attesting services on financial statements in accordance with Chinese standards. Many of the larger, international accounting firms have established a presence in China through sino-foreign joint ventures and local member firms. These firms generally combine qualified PRC accountants with staff support from the firms overseas offices, particularly offices in Hong Kong, Taiwan and the US. The joint ventures and member firms can, with this support, provide most of the usual auditing, accounting and taxation services offered by international accounting firms elsewhere in the world. Although approved joint ventures and member CPA firms are the only foreign-owned firms able to perform statutory audits in China, other foreign CPA firms may be engaged to perform certain audit and accounting work for accounting and management control purposes. This includes developing accounting and internal control systems, training local accounting personnel, reviewing specific financial information for accuracy and reliability, and performing full or limited-scope audits to meet the audit requirements of the foreign partners parent company. If requested by the foreign partner and with the consent of the Chinese partner, in certain cases they may also perform joint audits with the local CPA firms to ensure that the audits will satisfy both the Chinese and the foreign partners home country auditing standards and requirements.
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Auditing standards The audit requirements for foreign-invested enterprises are contained in the Accounting Law and in the Regulations on Accounting and Financial Reporting. The requirement for annual audits is also contained in the foreign income tax law, which came into effect in July 1991. Rules on the audits of financial statements by certified public accountants were formulated by the CICPA and first published in December 1988. They were subsequently updated in December 1995 before the CICPA issued new auditing standards (in 2006) that are substantially the same as International Standards on Auditing; these standards came into effect from 1 January 2007. A typical unqualified audit report would read as follows: We have audited the accompanying financial statements of ABC Company, which comprise the balance sheet as at [date], and the income statement and cash flow statement for the year then ended and notes to these financial statements. Managements responsibility for the financial statements Management is responsible for the preparation of these financial statements in accordance with the Accounting Standards for Business Enterprises and the Accounting System for Business Enterprises. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation of financial statements that are free from material mis-statement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
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Auditors responsibility An auditors responsibility is to express an opinion on financial statements. An audit should be conducted in accordance with the China Auditing Standards. Those standards require that auditors comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material mis-statement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entitys preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entitys internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. Opinion An unqualified opinion should typically be as follows: In our opinion, the financial statements present fairly, in all material respects, the financial position of ABC Company as of [date], and of its financial performance and its cash flows for the year then ended in accordance with the Accounting Standards for Business Enterprises and the Accounting System for Business Enterprises.
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Chapter 10
Accounting principles and practices
Key messages On 15 February 2006, the Ministry of Finance (MoF) announced new China Accounting Standards (CAS 2006) which themselves form a comprehensive basis of accounting and achieves a substantive convergence with the International Financial Reporting Standards (IFRS). CAS 2006 is effective from 1 January 2007 for all listed companies. In regards to non-listed foreign investment enterprises, CAS 2006 may apply from 1 January 2009. Basic financial statements such as balance sheet, income statement (profit and loss account), cash flow statement, statement of changes in owners equity and notes to financial statements are all required. Accrual basis should be adopted. Accounting year of an enterprise shall start on 1 January and end on 31 December. RMB is normally the recording currency. CAS 2006 focuses on the concept of the power to control in determining whether a parent/subsidiary relationship exists. It in turn determines whether a consolidation is required. Under CAS 2006, where an enterprise has multiple operations or operates in multiple geographical areas, it shall disclose segment information unless otherwise stipulated by laws or administrative regulations. Accounting regulations in China have deviated from tax laws. Separate accounting for book and taxes is warranted.
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Accounting principles The Accounting Law in China defines the role of the government and outlines the general requirements of accounting practice, accounting procedures and accounting supervision. The Accounting Law stipulates that the department of finance under the State Council, i.e., the Ministry of Finance (MoF), shall administer accounting matters throughout the country, including promulgation of uniform accounting regulations. The general accounting principles for business enterprises, including foreign investment enterprises, is currently set out in the Accounting System for Business Enterprises (ASBE), supplemented by 16 specific accounting standards. These 16 specific accounting standards themselves do not form a comprehensive basis of accounting. Although ASBE is generally in accordance with international accounting principles, there are still some deviations in certain areas, for example: The measurement base of fair value is not introduced in ASBE. Under ASBE, assets should be initially recognised at the actual costs, which can be subsequently adjusted only for asset impairment. Otherwise, an enterprise is not allowed to adjust the carrying amounts of assets except as stipulated in specific regulations, such as using the appraised values as deemed costs when re-organising a SOE into a limited liability company incorporated in accordance with the Company Law. Accounting treatments for certain complicated transactions and items are not covered in ASBE, such as the accounting treatment for business combinations, share-based payments, and embedded derivatives.
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On 15 February 2006, the MoF announced new China Accounting Standards (CAS 2006) which themselves form a comprehensive basis of accounting and achieves a substantive convergence with International Financial Reporting Standards (IFRS). CAS 2006 was effective on 1 January 2007 for all listed companies, replacing the ASBE and 16 existing specific accounting standards. It will, in phases, become the only basis of financial reporting for all types of business enterprises, within the next two to three years. FIEs may be required to apply CAS 2006 from 1 January 2009. As of July 2007, CAS 2006 comprises one basic standard and 38 specific standards, with application guidance for 32 specific standards. The structure of CAS 2006 is illustrated below: General standards Basic standard
Inventories, fixed assets, leases, etc.)
38 Specific standards
Industry specific standards

Extraction of oil and natural gas, biological assets, etc.
Application guidance
(including interpretation, chart of accounts and examples of journal entries)
Reporting standards
Presentation of financial statements, cash flow statements, etc.
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In addition, the officials of the Accounting Regulatory Department of the MoF, who were responsible for drafting CAS 2006, formed a team to compile an implementation guidance equivalent book Jiang Jie for CAS 2006 in April 2007, which is one of the major sources for further guidance and interpretation on the implementation of CAS 2006. Compared with ASBE, CAS 2006 has further converged with IFRS, especially in the following areas: Deferred taxation. Business combinations under non-common control. Share-based payment. Financial instruments. Assessment for asset impairment. Segment reporting. While CAS 2006 does not reflect a literal translation of IFRS, it essentially includes all IFRS principles. In addition, they contain interpretive guidance to address accounting for specific types of transactions unique to the Chinese environment (e.g. combinations of companies under common control) and industry accounting issues (e.g. extraction of oil and natural gas). There are still a small number of differences to reflect unique circumstances in China, for example, reversal of impairment loss provided for non-current assets is prohibited. For a comparison of the index of CAS 2006 and IFRS, see Appendix X.
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Form and content of financial statements Unless specified otherwise, the discussion below with respect to the form and content of financial statements is primarily based upon the requirements under CAS 2006. Basic financial statements: Financial statements of industrial (manufacturing) enterprises would generally include the following: Balance sheet. Income statement (profit and loss account). Cash flow statement. Statement of changes in owners equity. Notes to financial statements. For sample financial statements see Appendix IX Notes to financial statements Notes to financial statements should include, at a minimum, the following information: Basis of preparation of the financial statements Statement of compliance with CAS 2006 Description of significant accounting policies, including the measurement bases for items recognised in the financial statements and the basis for selecting those accounting policies Descriptions about the key accounting estimates, including the basis for determining any accounting estimates that may have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next accounting period Descriptions of any changes in accounting policies and accounting estimates, and corrections of errors
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Additional descriptions of significant items presented on the face of the balance sheet, income statement, cash flow statement and statement of changes in owners equity. Disclosure of contingencies and commitments, nonadjusting events after the balance sheet date, related party relationships and transactions. Basis of accounting An enterprise shall adopt the accrual basis of accounting in performing recognition, measurement and reporting for accounting purposes. All income realised and expenses incurred or attributable to the current period should be recognised as income or expenses in the current period regardless of when the income is received or expenses are paid. Income and expenses not attributable to the current period but which have been received or paid during that period should not be recognised as income or expenses in the current period. Accounting period The Accounting Law requires that the accounting year for an enterprise shall start on 1 January and end on 31 December, i.e. the commencement date of the accounting year is not elective. Functional currency An enterprise shall normally choose renminbi (RMB) as its recording currency. For an enterprise where the income and expenses arising on its operations are mainly denominated in currencies other than RMB, it can choose one of those currencies as its recording currency. However, its financial statements prepared shall be translated into RMB.
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Measurement of assets Inventories Inventories are initially measured at cost, including purchase price, related taxes and shipping, handling, insurance and other costs attributable to the acquisition of inventories. An enterprise shall use the first-in first-out method, weighted average cost method or the specific identification method to assign the actual cost of inventories. At the balance sheet date, inventories shall be measured at the lower of cost and net realisable value. If the cost is higher than its net realisable value, a provision for declining value of inventory should be recognised in profit or losses. When circumstances that previously caused inventories to be written down below cost no longer exist, the amount of the write-down is reversed. Account receivables Under ASBE, account receivables are presented at actual amounts net of provision for doubtful debts. Under CAS 2006, account receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. The amount of the provision is the difference between the assets carrying amount and the present value of estimated future cash flows, discounted at the initial effective interest rate. Subsequent recoveries of amounts previously written down are reversed in profit or loss.
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Fixed assets Fixed assets are measured initially at cost. The cost of a purchased fixed asset comprises the purchase price, related taxes, and any costs directly attributable to bringing the asset to working condition for its intended use, such as shipping and handling costs, installation costs and professional fees. The cost of a selfconstructed fixed asset comprises those expenditures necessarily incurred for bringing the asset to working condition for its intended use. An enterprise should choose the depreciation method which can reflect the pattern in which the assets future economic benefits are expected to be consumed. The depreciation can be determined using the straight-line method, the units of production method, the double diminishing balance method or the sum-of-the-digits method. Impairment tests should be carried out when there is an indication that the fixed assets may be impaired. Impairment loss shall be recognised and recorded in profit or loss when the impairment test reflects the fact that the recoverable amount is less than the carrying value. Under ASBE, when there is an indication that the need for an impairment provision recorded in a prior year no longer exists or has decreased, the provision for impairment loss is reversed. Under CAS 2006, once an impairment loss is recognised, it shall not be reversed in the subsequent periods. Intangible assets An intangible asset is an identifiable non-monetary asset without physical substance owned or controlled by an enterprise, such as land use rights, patent, proprietary technology, for example.
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An intangible asset shall be measured initially at cost and shall be amortised over a period in which the assets economic benefits are expected to be realised. Under CAS 2006, an intangible asset with an indefinite useful life shall not be amortised. Under ASBE, expenditure on an internal research and development project shall be recognised in profit or loss in the period in which it is incurred. Under CAS 2006, expenditure on an internal research and development project shall be classified into expenditure in the research phase and expenditure in the development phase. Expenditure in the research phase shall be recognised in profit or loss in the period in which it is incurred. Expenditure on the development phase shall be recognised as an intangible asset only when certain conditions are satisfied. Apart from intangible assets with an indefinite useful life that should be tested for impairment at least annually, the regulations under ASBE and CAS 2006 regarding the impairment test of intangible assets are similar to fixed assets as described above. Revenue recognition Revenue from the sale of goods shall be recognised when significant risks and rewards of ownership of the goods are transferred to the buyer; the enterprise retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; and it is probable that the economic benefit associated with the transaction will flow to the enterprise and the relevant revenue and costs can be measured reliably.
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When the total amount of revenue and costs arising from the provision of services can be estimated reliably, it is probable that the economic benefits associated with the transaction will flow in and the stage of completion of the services provided can be measured reliably. Revenue arising from rendering of services is recognised using the percentage of completion method. Deferred income taxes Under ASBE, an enterprise should adopt either the tax payable method or the tax effect accounting method to account for income taxes. Under the tax payable method An enterprise recognises the income tax payable computed for the current period as income tax expense for the current period, and does not recognise the effect of timing differences. Under this method, the amount of income tax expense is the same as the amount of income tax payable for the current period. Under the tax effect accounting method An enterprise recognises the effect of timing differences on income tax. Timing differences are the differences between accounting profit before tax and taxable income due to different recognition periods for revenue, expenses and losses under tax rules and accounting requirements. Under the tax effect accounting method, it recognises the aggregate of income tax payable for the current period and the amount of income tax affected by timing differences as income tax expense for the current period. The effect on income tax arising from timing differences should be deferred and allocated to subsequent periods.
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Enterprises that use the tax effect accounting method can adopt either the deferral method or the liability method. Under the deferral method, when there are changes in tax rates or imposition of new taxes, no adjustment need be made to the income tax amounts originally recognised in respect to timing differences. Any reversal of the effect on income tax in respect to timing differences should be made at the original tax rate. Under the liability method, when there are changes in tax rates or imposition of new taxes, adjustments should be made to the income tax amounts originally recognised in respect to timing differences. Any reversal of the effect on income tax in respect to timing differences should be made at the current tax rate. Under CAS 2006, deferred income tax shall be provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. At the balance sheet date, deferred tax assets and deferred tax liabilities shall be measured at the tax rates that are expected to apply to the periods when the asset is realised or the liability is settled. Where there is a change in the applicable tax rates, an enterprise shall reassess the recognised deferred tax assets and deferred tax liabilities. An enterprise shall recognise a deferred tax asset for deductible temporary differences, the carry forward of deductible losses and tax credits to subsequent periods, to the extent that it is probable that future taxable profits will be available against which the temporary differences, the deductible losses and tax credits can be utilised.
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Owners equity Owners equity shown in the balance sheet includes paid-in capital, capital reserves, surplus reserve, and undistributed profits. Paid-in capital is the actual amount of capital contributed by the investors in an enterprise in accordance with the memorandum and articles of incorporation/establishment of the enterprise, investment contracts or agreements. Capital contributed by an investor in excess of the investors share of the registered capital is shown as capital reserves. For FIEs, surplus reserves include the following: Reserve fund, being a fund appropriated from net profit in accordance with laws and administrative regulations which, when approved, can be used to offset accumulated losses or to increase capital. Enterprise expansion fund, being a fund set aside from net profit in accordance with the laws and administrative regulations for the purpose of production and development of the enterprise which, when approved, can be used to increase capital. Business combination For a business combination of entities that are not under common control, the purchase method of accounting is used. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the acquirers share of the identifiable net assets acquired is recorded as goodwill. Goodwill is not amortised but should be reviewed for impairment at least annually. If the identifiable cost of acquisition is less than the fair value of the net assets acquired, the difference is recognised directly in profit or loss.
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For a business combination of entities under common control, the pooling-of-interest method shall be applied. The considerations paid and the net assets obtained by the absorbing party shall be measured at the carrying amount. The difference between the carrying amount of the net assets obtained and the carrying amount of the consideration paid for the combination shall be adjusted to equity. Consolidation 1. Subsidiaries Under ASBE, the following investees are defined as subsidiaries and should be consolidated: a) entities over which the parent holds more than 50% (not including 50%) of the registered capital of the investee; or b) entities over which the parent holds directly 50% or less of the registered capital of the investee but, in substance, has control over the investee. Subsidiaries satisfying certain conditions, for example, subsidiaries that are closing down or suspending operation, are not required to be consolidated. In addition, a subsidiary with total assets, revenue and net profits for a current period that are each less than 10% of the corresponding amounts of the group, and subsidiaries in special industries (such as banking or insurance), are not required to be consolidated. Under CAS 2006, it focuses on the concept of the power to control in determining whether a parent/ subsidiary relationship exists. Control is the parents ability to govern the financial and operating policies of a subsidiary in order to obtain benefits from the latters activities. A parent shall include all subsidiaries within the scope of consolidation as long as control exists. If there is evidence demonstrating that the parent cannot control the investee, even when the parent owns, directly or indirectly through subsidiaries, more than half of the voting power of an investee, the investee shall not be regarded as a subsidiary and shall not be consolidated.
2. Associates Associates are entities over which the investor has significant influence but not control, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in associates are initially recognised at cost, and are subsequently accounted for using the equity method of accounting. The investors share of its associates post-acquisition profits or losses is recognised in profit or loss. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the investors share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the investor does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate. Cash flow statement Cash flow statements are to be prepared using the direct method, and a reconciliation of net profit to the amount of cash flows from operating activities should be disclosed in a note to the financial statements. The principal items used to adjust the net profit or loss include the following: Provision for impairment of assets. Depreciation of fixed assets. Amortisation of intangible assets. Amortisation of long-term prepaid expenses. Gains or losses on disposals of fixed assets, intangible assets and other long-term assets. Losses on scrapping of fixed assets. Gains or losses on changes in fair values.
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Financial expenses. Income, gains or losses arising on investments. Deferred tax assets and deferred tax liabilities in relation to income tax. Inventories. Operating receivables. Operating payables. Segment reporting Under ASBE, the requirement for segment reporting is not emphasised. Under CAS 2006, where an enterprise has multiple operations or operates in multiple geographical areas, it shall disclose segment information unless otherwise stipulated by laws or administrative regulations. In disclosing segment information, an enterprise shall identify reportable segments on the basis of business segments or geographical segments. The primary reporting format and secondary reporting format in the disclosure of segment information are identified by the enterprise according to whether risks and returns are affected predominantly by differences in the products and services it processes or by the fact that it operates in different countries or geographical areas. An enterprise shall disclose segment accounting policies, including identification of segments, pricing for intersegment transfers, and allocation basis of segment revenue and expenses. The notes relating to the primary segment reporting shall include the information about segment revenue, segment expenses, segment profit (loss), total segment assets and total segment liabilities.
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Disclosure of related party relationships and transactions Definition of related party Under ASBE, if a party has the power to, directly or indirectly, control, jointly control or exercise significant influence over the financial and operating policies of another party, there is a related party between these parties. If two or more parties are subject to control from the same party, there is also a related party relationship between the controlled parties. Under CAS 2006, if a party has the power to control, jointly control or exercise significant influence over another party, they are regarded as related parties. Two or more parties are also regarded as related parties if they are subject to control, joint control or significant influence from the same party. Disclosure requirements An enterprise shall disclose the following information related to its parent and subsidiaries in the notes, irrespective of whether there have been transactions with those related parties: Names of the enterprises parent and subsidiaries. Nature of business of the enterprises parent and subsidiaries, place of registration and registered capital (or paid-in capital or share capital) and changes therein. Proportion of shareholdings and voting power of the parent over the enterprise, and that of the enterprise over the subsidiaries.
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Where there have been related party transactions between an enterprise and its related parties, the enterprise shall disclose the nature of the related party relationships, the types of transactions and the essential elements of the transactions in the notes. At a minimum, such essential elements shall include: The amounts of the transactions. The amounts of outstanding balances; their terms and conditions; and details of any guarantees given or received. The amounts of provisions for doubtful debts related to outstanding receivables. Pricing policies. Practical considerations Separate accounting for book and tax purpose Accounting regulations in China have deviated from tax laws. With the introduction in 2001 of ASBE, which is more in line with international accounting practices, book and tax differences are becoming more common and inevitable. Separate accounting for book and taxes is warranted. Nevertheless, certain government authorities, especially those tax authorities in less developed cities, may be reluctant to accept differences from books. Difference between accounting principles and tax regulations For the computation of corporate income tax, there are significant differences between the accounting regulations and tax rules, for example: If an entity records a provision for impairment of assets without first obtaining approval from the tax bureau, the amount of the provision must be added back to earnings for the purposes of calculating taxable income.
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Only the straight-line method for depreciation of fixed assets is allowed. In addition, the tax authorities have set minimum depreciation periods for certain assets (see Appendix II). Accelerated depreciation is allowed in special circumstances, as set out in the tax legislation, and with prior approval from the tax authorities. For detailed guidance on the tax rules regarding computation and filing of corporate income tax, see Chapters 12 and 13.
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Chapter 11
Tax system
Key messages Starting from 1 January 2008, a unified tax system is applicable to foreigners, foreign investment enterprises and foreign corporations, as well as domestic enterprises. Tax Resident Enterprises in China and foreign individuals who have a domicile/place of abode in China, or do not have a domicile/place of abode in China but have resided in China for five full consecutive years, are taxed on their worldwide income. Non-tax Resident Enterprises and non-domiciled or non-resident individuals are taxed on their China sourced income generally. Corporate income tax is at a flat rate of 25%. Individual income tax rates are progressive from 5% to 45%. Double taxation relief is offered through credit, exemption or reduction provided under national statutes and tax treaties. Advanced approval may be required to obtain the right to select and change accounting methods and to secure tax filing positions or exemptions. In many cases, filing of required materials and information for documentation purposes may be sufficient. Principal taxes The main applicable taxes when doing business in China are as follows: 1. Taxes on income: a. Corporate income tax; and b. Individual income tax.
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2. Taxes on transactions turnover tax system, comprising: a. Value-added tax; b. Consumption tax; and c. Business tax. 3. Other taxes: a. Customs duties; b. Stamp tax; c. Vehicle and vessel usage and license plate tax; d. Motor vehicle acquisition tax; e. Deed tax; f. Land appreciation tax; g. Resources tax; and h. Cultural business construction fee (applied only to entertainment and advertising businesses liable to business tax). 4. Tax on property: Urban real estate tax or real property tax. 5. Local levies. Legislative framework Statute law Chinas tax laws applicable to enterprises are drafted by the State Administration of Taxation and the Ministry of Finance and then submitted to the State Council, the executive organ of the National Peoples Congress, for discussion and review. Once passed by the State Council, they are then submitted to the National
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Peoples Congress for final approval and promulgation. Implementing rules and regulations are also drafted by the State Administration of Taxation and are submitted to the State Council for final approval. The tax laws normally become effective the day of promulgation with a few exceptions, and, as a general rule, they do not have retrospective effect. On 16 March 2007, the Corporate Income Tax Law (CITL) of the PRC was promulgated and came into effect on 1 January 2008. The CITL represents the consolidation of two separate enterprise income tax regimes for domestic investment enterprises and foreign investment enterprises into a single regime. The CITL also provides for a fundamental change in Chinas tax incentive policy in terms of shaping and directing the future development of the country. With respect to the taxation of individuals, the individual income tax law of the PRC was amended by the National Peoples Congress on 27 October 2005 and minor amendments were made thereafter. These amendments raised the statutory monthly deduction allowable for individual income tax calculation from RMB800 to RMB2,000. Foreign individuals are entitled to an additional allowance of RMB2,800. In addition, it imposed additional reporting obligations on individuals with an annual income over RMB120,000. Case law Tax disputes in China are normally settled through appeals to higher tax authorities rather than through court proceedings. As a result, there is very little published case law. The tax authorities may issue private letter rulings, which confirm the tax treatment.
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Anti-avoidance China has adopted transfer pricing legislation. The first ruling, which requires the use of arms-length prices for business transactions between foreign investment enterprises and their affiliated companies, was issued by the State Administration of Taxation in January 1988. In April 1998 the State Administration of Taxation issued the Regulations and Procedures on Tax Administration of Transactions Between Associated Enterprises (Trial), which was subsequently amended in October 2004 and again in April 2006. The Regulations set out a comprehensive set of transfer pricing guidelines and administrative procedures. Furthermore, in the new CITL, there is a chapter entitled Special Tax Adjustments which deals with tax avoidance and transfer pricing issues by enhancing existing legislation and regulations, introducing new concepts and strengthening enforcement. Form versus substance In comparison with international tax practice, Chinese tax laws often require clarification. Interpretation is the responsibility of the tax authorities, which have the power to require the re-calculation of taxable income on the basis of substance. Clearance procedures There are no general clearance procedures although the tax authorities are always willing to hold discussions on the tax consequences of a contemplated project or transaction. A verbal opinion on the tax status of a project is not binding, so a written ruling should always be obtained from the tax authorities. A ruling is valid and binding until revoked, but only with respect to the enterprise or individual that requested it.
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Income tax Types of taxpayer under the new CITL: Tax Resident Enterprises in China are taxed on their worldwide income. Tax Resident Enterprise refers to an enterprise that is legally established in China or an enterprise that is established in accordance with laws of foreign countries (regions) but its effective management institute is within China. Non-tax Resident Enterprises are subject to corporate income tax only on China sourced income. Non-tax Resident Enterprise refers to an enterprise which is established in accordance with the laws of foreign countries (regions) and its effective management institute is not within China, but it has an establishment or place in China; or an enterprise which, though having no establishment or place in China, derives income that is sourced from China. Types of taxpayer under the Individual Income Tax Law: Individuals who have a domicile or place of abode in China and individuals staying in China for five full consecutive years are taxed on their worldwide income. Individuals staying in China for less than one full year only subject their China sourced income to China individual income tax. Individuals staying in China for more than one full year but less than five full consecutive years are taxed on China sourced income and income borne by an entity or establishment in China (For details, please refer to Chapter 17).
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Taxable income Enterprises The taxable income of an enterprise is defined as the amount remaining from the gross income in a tax year after the deduction of costs, expenses and losses in that year. Individuals Salaries and allowances paid to individuals are considered to be taxable unless specifically exempted. Certain fringe benefits and reimbursement of ordinary business expenses, provided they are reimbursed on a dollar-for-dollar basis and supported by valid invoices or other documents, are generally not taxable. For details of the categories of taxable income in China, please refer to Chapter 17. Tax year The tax year is the calendar year (from 1 January to 31 December). Where an enterprise commences business within a calendar year or has operated for less than 12 months in a calendar year, the actual operating period of the tax year should be taken as a tax year. Tax incentives Under the new CITL, tax incentives are generally offered to enterprises and projects in those industry sectors encouraged and supported by the State. Qualified small and low-profit enterprises and qualified high/ new-tech enterprises are subject to reduced corporate income tax rates. Reduction or exemption may also be available for (1) agriculture, forestry, animal husbandry and fishery projects; (2) basic infrastructure projects; (3) environmental protection projects and energy/water conservative projects; and (4) qualified technology transfer. Please refer to Chapter 5 for details of tax incentives.
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Tax-free zones There were tax incentives offered to enterprises (in most cases, foreign investment enterprises) operating in Special Economic Zones, Economic and Technological Development Zones and Old Urban Districts of the 14 coastal cities, and other special open zones. However, these incentives were removed under the new CITL. Enterprises established before the promulgation date of the new CITL, which may currently enjoy a lower income tax rate, are entitled to a grandfathering period during which a gradual increase of tax rates will occur to the standard rate of 25% within five years starting from 2008. Tax holidays Tax holiday incentives were offered to foreign investment enterprises of a productive nature that expected to operate in China for more than ten years, whereby such foreign investment enterprises could apply to the tax authorities for exemption from income tax in the first two years and for a 50% tax reduction in the subsequent three years, starting from the first profit-making year. However, these incentives were removed under the new CITL. The unused tax holiday of foreign investment enterprises established before the promulgation date of the new CITL is grandfathered until the expiry of the tax holiday. Where the tax holiday has not yet started because of tax losses, it shall be deemed to commence from 2008. International aspects Tax Resident Enterprises in China are taxed on their worldwide income. Double taxation of foreign source income may be avoided by way of a foreign tax credit. Foreign income tax paid abroad in respect of foreign sourced income can be claimed against corporate
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income tax payable in China in respect of the same income, subject to a tax credit limit. The unused foreign tax credit can be carried forward for not more than five years under local tax statutes. Similar relief is provided under the agreements on avoidance of double taxation (see Chapter 19). For foreign enterprises with foreign source income attributable to a permanent establishment or place of business in China, they may apply for similar tax credit treatment as Tax Resident Enterprises. For individuals, since taxpayers considered to be domiciled in China or resident in China for five full consecutive years (although without a domicile in China) are taxed on their worldwide income, whether or not received in China (see Chapter 17), they may claim a tax credit for foreign taxes imposed on their foreign-source income that is also subject to Chinese individual income tax. China has signed agreements/arrangements on avoidance of double taxation with 92 countries or jurisdictions (see Appendix IV). The agreements generally take precedence over the local tax laws.
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Chapter 12
Tax administration
Key messages The tax system is based mainly on self-assessment. Provisional corporate returns are filed on a monthly or quarterly basis; annual returns are due within five months after the end of a tax year. An extension for tax filing may be granted following approval by tax authorities. Individual returns are filed on a monthly basis. In addition, individuals with an annual income over RMB120,000 are obliged to report their annual income in an annual income report. Severe penalties and surcharges are imposed for failure or delinquency in filing returns or paying tax. Withholding of income tax applies to dividends, interest, royalties, and other income. Tax audits are usually lengthy and comprehensive. Tax assessments may be contested and appealed. Administration of the tax system The two main income tax laws governing enterprises and individuals, respectively, are the CITL and the Individual Income Tax Law (IITL) . The tax laws are enforced and administered on a day-to-day basis by one tax bureau (local tax bureau) under the local government, and another tax bureau (state tax bureau) under the State Administration of Taxation (SAT) in Beijing. These tax bureaus are responsible for ensuring that the policies laid down by the SAT are implemented in accordance with local conditions as well as for tax assessments, collecting tax payments, performing tax audits and conducting tax negotiations with taxpayers. The SAT, on the other hand, is responsible for making tax policies for the
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whole country (including drafting new or revised tax laws and regulations) and for acting as the tax appeal body with respect to disputes between the tax bureaus and taxpayers. With the introduction of the amended Tax Administration and Collection Law on 1 May 2001, all relevant government authorities are required to closely cooperate with the tax bureaus to strengthen the administration and collection of taxation. In line with such cooperation, the State Administration of Industry and Commerce is required to regularly inform the tax bureaus about new business registrations. Likewise, banks are required to keep track of a tax-payers tax registration numbers with their respective accounts. Tax authorities are able to access the taxpayers bank accounts or even freeze bank accounts up to the amount of the overdue taxes if necessary. Tax authorities also have the right to obtain relevant information about the taxpayer from any related parties during a tax investigation. Corporate taxpayers Tax returns The tax year for enterprises is the calendar year. Foreign investment enterprises and foreign enterprises are required to file their annual income tax returns and annual financial statements within five months after the end of a tax year, together with an audit report issued by a Chinese-registered CPA firm. Other documents, such as approval documents on the entitlement of tax preferential treatment and supporting documents on deductibility of certain expenses, may also be required at the time of annual tax return filing. There is a late payment surcharge of 0.05% of the unpaid tax balance for each day the income tax is in arrears. If the taxpayer fails to file a return or pay the tax due, an additional fine may be assessed.
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Assessments Enterprises are required to make provisional assessments and file corporate returns on a monthly or quarterly basis. The returns are generally prepared on a self-assessment basis and the provisional payments are reconciled after the year-end in an annual return for final tax settlement. Any tax discrepancy shall be paid within five months after the year-end and any tax overpayment may be refunded upon approval by tax authorities. Appeals If an enterprise disagrees with the tax treatment of the tax authorities, it may apply to a higher-ranking tax authority for reconsideration. However, before submitting the application, the tax payment and related tax payment surcharge, if any, must be made or a corresponding surety must be provided. Applications for reconsideration must be made within 60 days of receipt of the tax payment certificate or other actions taken by the tax authorities. Once an application has been received, the higher-ranking tax authority has 60 days in which to make its decision. If the enterprise is dissatisfied with the decision of the higher ranking authority, it may file legal proceedings with the Peoples Courts. Objections to a sanction or a mandatory measure for retaining tax revenue implemented by the tax authorities can also be taken to a higher-ranking authority or directly to the Peoples Courts. If the enterprise does not take the matter to a higher level or court within the prescribed time limit, but fails to comply with the notice, the tax authorities may pursue enforcement measures according to the relevant provisions or apply to the Peoples Courts for enforcement of the notice. In actual practice, applications to the Peoples Courts are rare.
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Payment and collection Enterprises are required to pay their provisional tax on a monthly or quarterly basis within 15 days after the end of each month or quarter. The provisional payments are reconciled after the yearend in the annual return for final tax settlement. Any tax discrepancy shall be paid within five months after the year-end and any tax overpayment may be refunded upon approval by the tax authorities. Withholding taxes Non-resident enterprises that do not have an establishment or place of business in China, or those that have a permanent establishment or place of business but earn China sourced income such as dividends, interest, rent and royalties, that are not effectively connected with that establishment or place of business, will be subject to withholding tax at a concessionary rate of 10% (though the statutory standard rate is 20%) on such income sourced in China. As withholding agents, the payers who make payments of dividends, interest, rent, royalties or other income to foreign enterprises are required to file a withholding tax return, withhold the proper tax and remit the tax to the tax authorities once payments to foreign enterprises are made or accrued as deductible expenses in the account of the payers for corporate income tax purposes. Under the IITL, all employers should withhold individual income tax from the salaries and wages of their employees, including expatriate and local employees, file tax returns and remit the tax withheld to tax authorities. Individual income tax filing and payment should be made on a monthly basis and completed within seven days after the month end. Registration is required prior to filing of individual income tax.
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Tax audit Under Chinese tax laws, enterprises are required to engage a China-registered CPA firm to conduct annual audits for tax purposes. The tax authorities are authorised to inspect the financial, accounting and tax documents and to check that withholding procedures have been properly carried out. The tax laws require that all accounting books, records and supporting documentation be retained in China for at least 10 years to enable proper computation of taxable income. The tax authorities usually conduct tax audits on a random selection basis. It is also possible that tax inspections/audits are carried out within a specific industry or specific targets, usually according to anonymous letters. The tax audit processes can be lengthy and usually involve the tax authorities initial review of the questionnaires or forms completed by taxpayers at the request of tax authorities; visits to the taxpayers office and examination of financial, accounting, tax and other related documents; discussions and negotiations between the taxpayer and tax authorities regarding the issues raised in the course of the tax audit; internal review and approval by the tax authorities of a proposed settlement or additional assessment, as appropriate; and issuance of a determination notice by tax authorities. If the taxpayer disagrees with the determination notice issued by the tax authorities, it may appeal the notice by going through the processes mentioned in the Appeals section above. Penalties The surcharge for failure to pay income tax within the prescribed time limit or to submit the tax that has been withheld by the withholding agent is 0.05% of the overdue amount for each day the payment is in arrears.
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Any taxpayer or withholding agent that fails to perform tax registration procedures, change or cancel tax registrations, or submit income tax or withholding returns within the required time limit may be subject to a fine of up to RMB2,000. This also applies to taxpayers that fail to establish or keep the required accounting books, vouchers and related documents; that fail to provide the tax authorities with details of their financial and accounting systems, accounting software and all bank account numbers; or that install or use the tax control devices or destroy and modify the tax control devices without authorisation. If the tax authorities set a new time limit and the taxpayer or withholding agent again fails to comply, a fine of up to RMB10,000 will be imposed. Where a taxpayer fails to perform tax registration, even after a new time limit has been set by the tax authorities, the taxpayers business license can be cancelled by the industry and commerce administration authority upon request by the tax authorities. Any taxpayer who fails to use the tax registration certificate according to the regulations or who transfers, lends, alters, damages, sells, purchases or forges the tax registration certificate may be subject to a fine ranging from RMB2,000 to RMB10,000. In serious cases a fine ranging from RMB10,000 to RMB50,000 may apply. Withholding tax agents that fail to establish and keep the accounting books, accounting vouchers and related documents regarding taxes withheld and remitted, and taxes collected and remitted may also be subject to a fine of not more than RMB2,000. In serious cases a fine of up to RMB5,000 will be imposed. Withholding agents that do not withhold tax in accordance with the law may also be subject to a fine ranging from more than 50% to less than three times the amount of tax involved.
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The fine levied for defrauding export tax refunds by making a false declaration of export or other deception, or refusing to pay tax using violence and/or intimidation, ranges from one to five times the tax amount owed. The fine for evading, refusing or hindering tax inspection shall be up to RMB10,000, or between RMB10,000 and RMB50,000 in the case of serious violation. The fine for illegally printing invoices is between RMB10,000 to RMB50,000. In serious cases, it may be regarded as a criminal offence. Statute of limitations Chinas tax law and regulations do not include a statute of limitations but do require enterprises to keep their accounting books, statements and supporting documents for at least 10 years. The Tax Administration and Collection Law, amended on 28 April 2001 (effective 1 May 2001), states that if a taxpayer or withholding agent fails to pay or underpays tax due to a mistake by tax authorities, the tax authorities may require the taxpayer or withholding agent to pay the tax in arrears within three years but may not impose a late payment penalty. If it is a mistake of the taxpayer or withholding agent that results in an underpayment or failure to pay tax, the tax collection period may be extended to five years. In the case of tax fraud, evasion or refusal to pay tax, no time bar is set for tax collection. If a taxpayer has overpaid tax, upon verification by tax authorities, the taxpayer shall be entitled to a refund together with bank interest on the tax overpayment within three years after the tax payment.
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Individual taxpayers Tax returns Individuals are required to submit tax returns to the relevant tax bureau and make tax payments within seven days after each month end. The payments should be computed by reference to monthly compensation. Spouses shall file their returns separately and are separately entitled to a standard monthly deduction. Individuals with an annual income over RMB120,000 are obliged to report their annual income to the designated tax bureau in an annual income report. Tax liability will be assessed on income computed in renminbi. Foreign-currency income will be converted to renminbi at the exchange rates promulgated by the Peoples Bank of China. Tax returns must be timely filed, with extensions granted only under special circumstances. Assessments Monthly returns are computed on a self-assessment basis. Unless special approval has been obtained from the designated tax bureau, provisional assessments do not apply for individual income tax filing. Tax returns should be prepared according to the actual salaries or wages and taxable allowances received. Appeals In the event of a dispute with the tax authorities, taxpayers must pay the assessed tax before an appeal can be made to the higher-ranking tax authorities. The tax authorities are required to issue a decision within 60 days of receiving the notice of appeal. Taxpayers can appeal against the decision of the higher-ranking tax authority to the Peoples Courts. In practice, this rarely happens.
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Tax administration
Payment and collection The tax bureaus under local governments are responsible for collecting individual income tax payments, which are due within seven days after each month end. Withholding taxes All employers should withhold individual income tax from wages and salaries paid to their expatriate and local employees and submit individual income tax returns and tax payments on a timely basis. However, taxpayers have a primary responsibility to report their income to tax authorities under the following scenarios: 1. Taxpayer having income derived from more than one source; or 2. Taxpayer having income derived in China without any withholding agent. Tax audit The tax authorities are entitled to conduct investigations in respect of individual income tax payments. The law requires that taxpayers and withholding agents provide the tax authorities with accurate and factual information and that all income be reported. Penalties For delinquent tax payments, the withholding agent or taxpayer is required to pay a surcharge of 0.05% of the outstanding tax for each day the payment is in arrears. Penalties may be imposed for non-compliance with the law. The provisions regarding penalties stipulated in the Tax Administration and Collection Law of the Peoples Republic of China also apply to individuals. See Penalties under Corporate taxpayers above.
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Tax administration
Statute of limitations The provisions regarding the non-payment or underpayment of tax contained in the Tax Administration and Collection Law also apply to individuals. See Statute of limitations under Corporate taxpayers above. Exit permits The regulations provide that individuals subject to income tax must pay their outstanding tax liability to the tax authorities before leaving the country.
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Chapter 13
Taxation of corporations
Key messages Tax resident enterprises, which include enterprises incorporated in China and foreign enterprises whose effective management institute is based in China, are liable for corporate income tax on worldwide income. Accelerated depreciation is acceptable under certain circumstances. Amortisation of intangible assets is allowed. In principle, the accrual method of accounting is required. Income tax is levied at a flat rate of 25%. Dividends paid between qualified tax resident enterprises are exempt from corporate income tax. Foreign tax credits are available. Qualified high and new technology enterprises are eligible for a reduced tax rate of 15%. Other forms of tax incentives are also available for enterprises that are engaged in encouraged industries or which invest in R&D and specific equipment. New qualified high and new technology enterprises established in special areas in China may enjoy other preferential income tax treatments for a period of time. Arms length prices must be used for transactions conducted between related parties. Corporate income tax system Corporations and shareholders China has two different enterprise income tax regimes: one is applicable to foreign investment enterprises (i.e. equity joint ventures, limited liability co-operative/ contractual joint ventures and wholly foreign-owned enterprises) and foreign enterprises; and the other is applicable to domestic enterprises.
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On 16 March 2007, Chinas top legislature passed the new Corporate Income Tax (CIT) Law of the Peoples Republic of China which consolidates the two separate enterprise income tax regimes into a single one. The new CIT Law has come into effect from 1 January 2008. As the new CITL mainly provides a framework of general tax provisions, important details on the definition of numerous terms as well as the interpretation and specific application of various provisions are left to the detailed implementation regulations and supplementary tax circulars formulated by the State Council. Unless specifically indicated therein, references in this chapter are made to the CIT treatments of tax resident enterprises under the new CITL (see Residence concept below for definition of a tax resident enterprise). For CIT positions related to foreign enterprises that are non-tax resident enterprises in China, see Chapter 14. Residence concept Enterprises incorporated in China are always tax resident enterprises. A foreign enterprise with an effective management institute based in China is also regarded as a tax resident enterprise. Tax resident enterprises are subject to CIT on worldwide income. A non-tax resident enterprise, which has an establishment or place of business in China is subject to CIT on the income derived by such establishment or place of business. For a non-tax resident enterprise that has no establishment or place of business in China, or that has an establishment or place of business in China but income derived therefrom is not effectively connected with such establishment or place of business, is subject to withholding CIT on China source income (often referred to as passive income that includes dividends, interest, royalties, rental income, capital gains, for example).
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To lessen the double taxation of foreign sourced income, a foreign tax credit is allowed for income taxes paid to other countries on foreign-sourced income. Taxable entities Except for individual enterprises and partnership enterprises, which are excluded from the scope of the CITL, nearly all types of companies, enterprises, institutions and organisations incorporated in China are taxable entities. Foreign enterprises, which derive China sourced income will also be taxable entities. Equity joint ventures An equity joint venture is a Chinese legal entity that takes the form of a limited liability company established in China. The partners have joint management of the company, and the profits and losses are distributed according to the ratio of each partners capital contribution. Capital repatriation before the termination of the equity joint venture is not allowed. Co-operative/contractual joint ventures A co-operative/contractual joint venture can operate as a partnership, although the parties to the venture may apply for approval to have the company structured as a separate legal entity with limited liability. The investing parties may make in-kind capital contributions. Sharing of profits and losses may be agreed between the investing parties separately from the proportion of capital contributions. If all assets revert to the Chinese partner at the termination of the venture, capital repatriations of the foreign partner are permitted over the life of the co-operative/contractual joint venture, with appropriate guarantees from the local tax authorities where the partner wishes to secure the repatriation and approval.
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Wholly foreign-owned enterprises WFOEs are those established exclusively with the foreign investors capital. However, subject to WTO agreement, there are still a few industries restricted to joint venture and in which WFOEs are not allowed to invest. Domestic enterprises Domestic enterprises include all types of enterprises, companies, institutions and other income generating organisations, which are incorporated in China and without foreign investment. Foreign enterprises with effective management institutes in China Effective management institutes, in the context of the CITL, refers to an establishment that exercises, in substance, overall management and control over the production and business, personnel, accounting, properties, among other factors, of an enterprise. Gross income Accounting period The tax year is the calendar year. An enterprise that commences business in the middle of a tax year or has operated for less than 12 months in a tax year is to treat the actual operating period as the tax year. The liquidation period is considered the final tax-reporting period. Accounting method Unless otherwise prescribed in tax laws or regulations, the accrual method of accounting is required for all enterprises. The enterprises income may be stated in renminbi or foreign currency.
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The accounting records and reports should be maintained in Chinese or in both Chinese and a foreign language. In addition, according to the Tax Administration and Collection Law, all accounting books, records and supporting documents must be kept in China for at least 10 years. Business profits Income tax is assessed on taxable income, which is defined in the CITL as the amount remaining from an enterprises gross income in a tax year after deduction of non-taxable income, tax-exempt income, various deductions and allowable losses brought forward from previous years. Intercompany transactions In principle, the CITL requires an enterprise to conduct business transactions with its related parties in accordance with the arms length principle. If a related party transaction is not conducted at arms length and there is a reduction of gross income or taxable income, the Chinese tax authorities are authorised to make the appropriate tax adjustment. Inventory valuation The taxpayer may select one of the following calculation methods: First-in first-out method; Weighted average method; or Some other specific identification method. Capital gains, interest, royalties and dividends Capital gains, interest and royalty income derived by a tax resident enterprise are taxable as ordinary income. The aforesaid capital gains refers to the gains from the
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disposition of property, including residential property, buildings, structures, and attached facilities located in China, and from the assignment of land-use rights and the transfer of equity investments. For any gain derived from the transfer of land-use rights, buildings and premises and related facilities attached thereto, a land appreciation tax is also levied (see Chapter 18 Indirect taxes). Dividends paid between qualified tax resident enterprises are exempt from CIT under the new CITL. Service fees Service fees generated from consultation, management, training and other labour services by a tax resident enterprise are taxable as part of worldwide income, irrespective of the locality in which the services are performed. Exchange gains and losses Exchange gains and losses incurred during business transactions and year-end transaction gains and losses in respect of assets and liabilities should generally be accounted for in the current year. Donation and debt forgiveness Unless otherwise prescribed in the tax regulations, tax resident enterprises should include donations received and releases from debt as taxable income. Non-taxable income Fiscal appropriation, governmental administration charges and governmental funds that are collected and administered as treasury management of the state are non-taxable income under the CITL.
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Tax-exempt income Tax-exempt income includes: interest on state treasury bonds; dividends paid between qualified tax resident enterprises; dividends derived by a non-tax resident enterprise which has an establishment or place of business in China from a tax resident enterprise and the said dividends are effectively connected with the establishment or place of business; and income derived by qualified non-profit-seeking organisations. Deductions Business expenses In principle, unless specifically excluded under the CITL and other tax regulations, reasonable business expenditures including costs, expenses, taxes and losses, that are actually incurred by a tax resident enterprise and relevant to the generation of income, are deductible. Depreciation The straight-line method of depreciation is allowed. However, for reasons including technological advancement, fixed assets may be depreciated over a shorter period or under accelerated depreciation methods. Leasing agreements CIT treatments of leased fixed assets are generally consistent with the accounting treatments under Chinas general accounting standards. Depletion As the CITL is silent on the issue, tax treatment for costs incurred on oil/gas fields during the exploration and development stages will be laid down in subsequent regulations.
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Interest In principle, interest on working capital is tax deductible. Interest related to capital expenditure on assets before they are put into use should be capitalised, while interest incurred subsequently is deductible in the current period. Royalties and service fees Royalties and service fees paid by tax resident enterprises are generally allowed as a deduction, provided they are of a reasonable amount. Employee remuneration Remuneration for employees of a reasonable amount can generally be deducted as an expense. Staff welfare expenses Expenses incurred for contribution to some prescribed statutory social welfare funds for local Chinese staff (including medical, pension and housing funds), labour union fees and educational fees, subject to caps stipulated by the government, are allowable deductions in calculating CIT liabilities. Insurance premiums Insurance premiums paid for life and asset protection, for example, for the benefit of investors or employees of enterprises, are generally not deductible with a few exceptions. Inter-company charges Reasonable inter-company charges that represent specific and active services provided by affiliated companies for the day-to-day operations of an enterprise in China are generally deductible, but subject to certain restrictions.
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Cost sharing The CITL allows cost sharing arrangements. A cost sharing arrangement is an arrangement between two or more associated enterprises to share the costs and risks of developing or obtaining intellectual property and/or providing or receiving services for an agreed scope in exchange for a specified interest in the projects results. However, the Chinese tax authorities may not yet be experienced in dealing with cost sharing arrangements. The common issues involved are the nature of services, cost allocation methodology, reasonableness of the cost shared, as well as the taxation on service providers. Other deductions Business entertainment expenses. Only 60% of actual incurred business entertainment expenses is deductible for CIT purposes. In addition, the total amount is capped at 0.05% of the total sales (business) revenue of the subject tax year. Bad or doubtful debts. It is likely that enterprises other than financial institutions are not allowed to make bad debt provisions for CIT purposes. Bad debt losses are deductible only when the loss is actually incurred. Amortisation of intangible assets. The straight-line method is allowed for amortisation of intangible assets with a minimum amortisation period of not less than 10 years. Advertising and promotional expenses Except as stipulated by the regulations otherwise, the deduction of advertising and promotional expense is limited to 15% of the annual sales revenue. Excess portion is allowed to be carried forward and deducted in future years.
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Research and Development (R&D). A tax resident enterprise that incurs R&D expenses for the development of new techniques, new products and new craftsmanship is entitled to an extra 50% deduction of the R&D spending. Non-deductible items The CITL states that the items listed below are nondeductible in calculating the taxable income of a tax resident enterprise: 1. Payment in the nature of equity investment returns to investors such as dividends and bonuses. 2. Corporate income tax payments. 3. Tax surcharges. 4. Penalties, fines and losses due to the confiscation of property. 5. Donations to institutions other than qualified charitable institutions. 6. Sponsorship expenditures. 7. Provisions that have not been verified. 8. Other expenditure that is irrelevant to the generation of income. Losses Tax loss Tax losses incurred by a tax resident enterprise may be carried over and deducted from the succeeding five years taxable income.
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Tax carry-back is not allowed Property loss Under the CITL, property losses that include losses in stock count, damage or obsolescence of fixed assets or current assets, bad debts and extraordinary losses suffered as a result of a natural disaster, for example, will be deductible after verification by the tax authorities. Tax computation Taxable income Taxable income is defined as the amount from the gross income in a tax year after deduction of non-taxable income, tax exempt income, various deductions and allowable losses brought forward from previous years. See Appendix III for sample calculations. Taxable income in foreign currency should be converted into renminbi to come up with the tax payable. Tax rates The corporate income tax rate is standardised at 25% for all tax resident enterprises and non-tax resident enterprises, which derive income that is effectively connected with their establishments or places of business in China. Also see Appendix I. Tax credits For a tax resident enterprise that generates foreign source income or a non-tax resident enterprise that derives foreign sourced income that is effectively connected to its establishments or places of business in China, it may deduct the foreign income tax paid on such income sourced outside China from the amount of tax payable. However, the deductible amount may not exceed the amount of Chinese income tax otherwise payable in respect of the foreign source income.
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If the foreign income tax paid on foreign sourced income is less than the credit limit, the foreign tax can be credited against the Chinese tax payable. If the foreign tax exceeds the limit, the unrelieved balance of the foreign tax paid may be offset against the tax payable in subsequent years, up to a maximum of five years. An enterprise applying for a foreign tax credit must submit the original tax receipts of the relevant tax authorities to support its claim for a foreign tax credit. In addition, the CITL also provides that if a tax resident enterprise derives dividends distributed from its directly or indirectly owned foreign enterprises, it is allowed to treat the foreign tax paid by the overseas enterprises in association with the received dividends as its own creditable foreign tax. Consolidation A tax resident enterprise should make combined CIT filings for its branches. Except for rules otherwise prescribed by the State Council, affiliated companies are not permitted to file consolidated returns on a group basis. Income tax incentives Preferential tax rates Qualified small and low-profit enterprises are eligible for a reduced tax rate of 20%. Qualified high and new technology enterprises are eligible for a reduced tax rate of 15%. Tax reduction and deduction Tax reduction and exemption treatments are targeted primarily towards (i) agriculture, forestry, animal husbandry and fishery projects; (ii) basic infrastructure projects; (iii) environmental protection projects and energy/water conservation projects; and (iv) qualified technology transfers.
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Extra deduction A 50% extra deduction is allowed if an enterprise incurs R&D expenditure for the development of new techniques, new products and new craftsmanship. In addition, a 100% extra deduction is allowed for salary expenses related to the employment of the handicapped and other employment encouraged by the State Council. Reduction of taxable income Taxable income may be reduced by a deemed deduction calculated as a percentage of investment amount (i.e. 70%) for venture capital businesses investing in small and medium sized high and new technology enterprises for at least two years. Reduction of revenue A reduction allowance amounting to 10% of total revenue may be allowed for revenue earned from products manufactured with comprehensive resources pursuant to state industry policies. Investment tax credit A tax credit amounting to 10% of qualifying expenditures on plants and machinery for environmental protection, energy and water conservation and production safety is available. Geographical tax incentives After the enactment of the CITL, newly established qualified enterprises that are engaged in high and new technology industries encouraged by the State and which are located in Special Economic Zones and the Shanghai Pudong New Area may still enjoy transitional preferential treatment.
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Enterprises engaged in encouraged industries located in the Western regions continue to enjoy the existing tax incentives until expiry. Other grandfathering measures Enterprises which were approved and established prior to publication of the CITL and which were entitled to preferential treatment in the form of reduced tax rates (e.g. 15%) according to the tax laws and administrative regulations enacted before 2008 may apply for grandfathering measures. Accordingly, their applicable CIT rate will gradually be increased to 25% within five years starting from 2008. Where they were entitled to preferential treatment in the form of a tax holiday, they may continue to enjoy the tax holiday until expiry pursuant to the rules stipulated by the State Council. However, where they have not yet triggered the tax holiday due to a cumulative loss position, the tax holiday shall be deemed to begin from 2008. Anti-avoidance measures General anti-avoidance rule With the introduction of the general anti-avoidance provision, the Chinese tax authorities are empowered to make adjustments to the taxable income of a taxpayer where business transactions are regarded as arranged without reasonable commercial substance. Controlled foreign corporation rule Where a tax resident enterprise controls, or where a tax resident enterprise and a Chinese individual jointly control a foreign corporation that is located in a low tax jurisdiction, if the profit is not distributed or is underdistributed without reasonable operational needs, the undistributed profit may be taxed in China as a deemed distribution.
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Chapter 14
Taxation of foreign enterprises
Key messages Starting from 1 January 2008, foreign enterprises are governed by Chinas new CITL. Under the CITL, a foreign enterprise with its effective management institute based in China is a tax resident enterprise and should be taxed in the same way as an enterprise established in China (see Chapter 13). Non-tax resident foreign enterprises are taxed only on their China sourced income and foreign sourced income that is attributable to their establishments or places of business in China. Resident representative offices of foreign enterprises acting as agents or consultants and rendering services to enterprises are subject to CIT and business tax (BT). Income that is earned by a foreign enterprise and that is attributable to its establishments or places of business in China is treated as ordinary income and taxed at the flat income tax rate of 25% starting from 1 January 2008. BT is assessed on the gross amount of China sourced income at various rates. Other income is subject to withholding tax. The statutory standard withholding corporate income tax rate is 20% while a concessionary rate of 10% is available. In addition, further reduced rates may be provided under some tax treaties.
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Tax residence concept Foreign enterprises have been governed by the new CITL starting from 1 January 2008. Unless specifically indicated therein, references under this chapter regarding CIT treatments are made to those under the new CITL. Enterprises incorporated in China are always tax resident enterprises. A foreign enterprise with an effective management institute based in China is also regarded as a tax resident enterprise. Tax resident enterprises are subject to CIT on worldwide income. In respect of CIT treatments for tax resident enterprises, please see Chapter 13. A non-tax resident enterprise that has an establishment or place of business in China is subject to CIT on income derived by such establishment or place of business. Such income is subject to a CIT of 25% and reasonable expenses incurred by the establishment should be deductible in calculating taxable income. A non-tax resident enterprise that has no establishment or place of business in China, or that has an establishment or place of business in China but income derived therefrom is not effectively connected with such establishment or place of business, is only subject to withholding CIT on China sourced income. Such China source income may be termed passive income and includes interest, rental income, royalties, dividends, capital gains, for example. The statutory withholding CIT rate is 20%, which has been reduced to 10% under the implementation rules of the CITL. Further reduced rates may be available for certain income items under some tax treaties.
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Resident representative offices Except for representative offices engaged in consulting businesses such as accounting, tax, law and audit, representative offices are generally not permitted by law to conduct direct profit-making activities, such as negotiation and conclusion of sales contracts with Chinese customers. Accordingly, a number of foreign companies have established representative offices in China for the purpose of conducting market research activities and other preparatory and auxiliary activities. A resident representative office that performs only preparatory and liaison services for and on behalf of its immediate head office may be exempt from China corporate taxation. The term immediate head office has a very narrow definition and refers to the legal entity that directly owns the resident representative office in China, excluding affiliate companies within the same group. To maintain tax-exempt status it is necessary to restrict the liaison services of the resident representative office to its immediate head office. In addition, the representative office must not be involved with the negotiation or conclusion of contracts involving its immediate head office. Increasingly, the China tax authorities will only consider a representative office as qualifying for tax-exempt status if its immediate head office is a non-profit-seeking organisation or is a principal manufacturer. As a result, when applying for tax-exempt status, a representative office must furnish a significant amount of information with respect to its head office, including such details as licences, patent rights of its products, and more. Subject to conditions, representative offices of certain financial institutions (such as insurance companies and banks) may be eligible for tax-exempt status.
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The corporate taxation of a resident representative office may be calculated using the following methods: 1. Actual income/actual profit method. 2. Actual income/deemed profit method. 3. Operating cost-plus method. Such income is subject to both CIT and BT. Contractors and subcontractors It is important to know about the concepts of establishment or place of business. Under the CITL they refer to establishments and places of business in China that engage in production and business operations, including: 1. Management organisations, business organisations and representative offices. 2. Factories, farms and locations where natural resources are exploited. 3. Places of business where labour services are provided. 4. Places of business where contractor projects, such as construction, installation, assembly, repair and exploration, are undertaken. 5. Other establishments or places of business where production and business activities are undertaken. If a non-tax resident enterprise commissions a business agent to carry out production and business activities within China, including commissioning an enterprise or individual to regularly sign contracts, store and deliver goods, for example, on its behalf, the said business agent shall be considered an establishment or place of business of the non-tax resident enterprise in China.
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In general, establishments or places of business may also refer to a physical site through which a foreign corporation engages in business, such as construction, assembly or installation projects and the provision of services. Contractors and subcontractors are considered to have an establishment or place of business once activities commence in China and thus are subject to both CIT and BT. Foreign corporations from most treaty countries that are engaged in construction, assembly and/or installation may enjoy a six month grace period before a permanent establishment is deemed created in China. In addition, under some tax treaties signed by China, a foreign corporation engaged in the provision of services will not be deemed as having created a permanent establishment in China triggering CIT unless it renders services within China for aggregating more than six months within any 12 month period. The same protection is not afforded with respect to BT. Most foreign contractors and subcontractors do not keep accounting records in China. Therefore, with the approval of the China tax authorities, they are taxed on a deemed profit basis. The deemed profit rate ranges from between 10% to 40%. Except for certain industries such as hotel management where the deemed profit rate may be 40%, the applicable rate is usually between 15% and 30%. In other words, 15% to 30% of the gross contract sum is treated as the deemed profit of the project in China. The following elements may be deducted from the gross contract sum before computing the tax payable: 1. Outward subcontracting of parts of the contract, whether to Chinese or overseas subcontractors. 2. Supply of machinery and equipment. 3. Fees for separate data and information analysis performed outside China.
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Where the deemed profit rate of between 15% and 30% is applied to the net contract sum to arrive at the taxable income, this income is then subject to CIT at the rate of 25%. BT is payable at 3% or 5% depending on the type of services rendered, or 20% (for certain entertainment services) on the net contract sum after the deduction of the above items 1 to 3, provided certain criteria have been fulfilled. The subcontractors are responsible for performing tax registration, filing and payment of tax liabilities to the tax authorities. However, in some situations, the main contractor may be required to act as a withholding agent and pay the appropriate taxes to the tax authorities for and on behalf of the subcontractors in order to ensure compliance with the regulations. Branch operations The Company Law of the PRC allows foreign companies to establish branches within China that may engage in production and operational activities. However, in practice approval to establish branches has so far only been granted to financial institutions and oil and gas companies. Branches established in China by foreign banks and insurance companies are subject to both BT and CIT under the same sets of tax laws and regulations as tax resident enterprises. Prior to 2008, withholding income tax was temporarily waived on interest income derived from China through inter-bank borrowings. However, as of the date of publication, it is uncertain whether such treatment will survive the new CIT regime.
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Other income Passive income derived by a foreign enterprise without any place of business or establishment in China will trigger withholding CIT and, in some cases, BT. The statutory standard withholding CIT rate is 20% but this was reduced to 10% under the implementation rules of the CITL. Dividends Dividends payable to a foreign parent company by a resident enterprise in China are subject to the same withholding CIT treatment stated above. However, a reduced withholding CIT rate may be available under certain tax treaties. Interest Interest payable to a foreign parent company by a resident enterprise in China is subject to the same withholding CIT treatment stated above. However, a reduced withholding CIT rate may be available under certain tax treaties. Foreign enterprises with no establishment or place of business in China but deriving interest income from sources in China might also be subject to BT at the rate of 5%. Royalties Royalties are liable to withholding CIT in the same way as interest income. Certain royalties may be exempt from CIT. In addition, royalties are also subject to BT at the rate of 5%. Subject to certain procedures to be fulfilled by the payer, BT may be exempted if the underlying intellectual property is of a technical nature.
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Rentals Rental income should be subject to withholding CIT at the rate of 10%, with the possibility of a reduction to a lower rate under some tax treaties. The withholding CIT rate of 10% is also applicable to rental income derived by foreign enterprises with no establishment or place of business in China in respect of immovable property situated in China. However, if these foreign enterprises have appointed China-based real estate management companies or dependent agents to carry out management services, the foreign enterprises may be considered to have created a permanent establishment in China, and thus the rental income will be subject to ordinary CIT instead of withholding CIT. In addition, rental income from immovable property is subject to BT at the rate of 5%. It is likely that rental income from movable property situated in China will also be subject to BT at 5%. BT can be deducted from the gross rental income before determining the amount of income tax payable. Capital gains Capital gains earned by foreign enterprises without a permanent establishment in China are subject to withholding CIT at a rate of 10%. Gains from the transfer of real estate In addition to the withholding CIT and BT, gains (whether capital or trading gains) from the sale or transfer of real estate or land use rights are subject to land appreciation tax (see Chapter 18).
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Chapter 15
Taxation of shareholders
Key messages Prior to 2008, China had two different enterprise income tax regimes: one, the Foreign Enterprise Income Tax Law (FEITL), was applicable to foreign investment enterprises and foreign enterprises, while the other, the Enterprise Income Tax Regulation (EITR), was applicable to domestic enterprises. The new CITL consolidated the two separate enterprise income tax regimes. In the past, dividends derived by a foreign investment enterprise from its investment in another foreign investment enterprise in China were excluded from its taxable income. Under the new CITL, dividends paid between qualified tax resident enterprises are exempt from CIT (see tax residency concept in Chapter 13 for the definition of tax resident enterprises). Similarly, in the past, dividends to foreign shareholders were not subject to income tax. Under the new CITL dividends paid by a resident enterprise in China to its foreign investors will be subject to 10% withholding CIT. Foreign investors are subject to withholding tax on capital gains. Domestic shareholders Prior to 2008, dividends and capital gains received by Chinese shareholders of an enterprise (i.e. domestic enterprises) were taxed in accordance with the EITR. On the other hand, dividends received by a foreign investment enterprise from equity investments in China, were exempt from income tax and the relevant investment expenses and losses were not deductible. Following the enactment of the CITL dividends paid between qualified tax resident enterprises are exempt from CIT.
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Taxation of shareholders
Foreign shareholders Dividends Prior to 2008, dividends paid by a foreign investment enterprise to foreign shareholders (corporate and individual) were specifically exempt from income tax in China. After the enactment of the CITL, dividends received by a non-tax resident foreign enterprise from a tax resident enterprise in China are subject to withholding CIT. The previous withholding CIT rate was 20% but was reduced to 10% under the implementation rules of the CITL. Further reductions may also be possible under some tax treaties. Capital gains Foreign shareholders, both corporate and individual, are taxed on capital gains from the sale of their investments in foreign investment enterprises by way of withholding CIT at 10% unless further reduced under a tax treaty. For certain foreign investment enterprises (such as those listed as B shares on a China stock exchange), foreign shareholders, both corporate and individual, are temporarily exempt from taxation on capital gains from the sale of their investments. Reorganisations Under the FEITL regime, where the transfer of equity interest of a foreign investment enterprise was a result of group reorganisation, the transfer could be effected at cost if certain stipulated conditions were fulfilled and, accordingly, there would not be any income tax implications. However, this tax free reorganisation treatment is likely to be subject to more restrictions under the CITL regime. Details are not yet available as of the date of publication of this Guide.
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Chapter 16
Partnership enterprise
Key messages A partnership enterprise in China refers to a general partnership enterprise or a limited partnership enterprise established by natural persons, legal persons or other organisations within China. General partners and limited partners may undertake different levels of liability. A partnerships profits flow through to each partner and are taxed at the partners level for CIT purposes. Due to the absence of detailed tax rules for partnership enterprises, extensive analysis and due judgement is necessary when considering adoption of the partnership model. Partnership enterprise Partnerships have traditionally not been commonly used in China. The first version of the Partnership Enterprise Law came into effect on 1 August 1997. In August 2006, the law was revised, coming into effect on 1 June 2007. According to the 2006 version of the Partnership Enterprise Law, a partnership in China is a general partnership enterprise or a limited partnership enterprise established by natural persons, legal persons and/or other organisations within China. The profit distribution or loss allocation of the partnership enterprise is made according to the partnership agreement or as regulated by the Partnership Enterprise Law. The 2006 version of the Partnership Enterprise Law allows foreign enterprises and individuals to establish Foreign Invested Partnership Enterprises (FIPEs). The Ministry of Commerce issued draft administrative measures for FIPEs (see January 2007 Draft Administrative Measures for FIPEs) to various ministries and governmental bodies at State level for comment in January 2007. As of the date of publication of this Guide, the final administrative measures have not yet been issued.
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Limitation on liabilities The 2006 version of the Partnership Enterprise Law introduced three kinds of partnership enterprises: 1. General partnership enterprises whose partners are all general partners who undertake unlimited liability. 2. Limited partnership enterprises whose partners are comprised of both general partners who undertake unlimited liability and limited partners who undertake limited liability to the extent of the original capital contribution. 3. Special general partnership enterprises (generally applicable to professional firms) whose general partners undertake liability in accordance with special terms in the Partnership Enterprise Law. The various limitations on liability available under the Partnership Enterprise Law provide additional alternatives to partners from an investment perspective. Form of capital contribution For general partnership enterprises, the partners may make capital contributions using cash, in-kind, intellectual property, land use or other property rights, or labour services. The requirements for limited partnership enterprises are the same as for general partnership enterprises except that limited partners are not allowed to contribute capital in the form of labour services. Taxation of partnership enterprises CIT is not imposed on partnership enterprises. Instead, the partnership enterprises profits flow through to each partner and are taxed at the partners level for CIT purposes. However, as there are to date no final administrative measures in place, nor detailed tax
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rules for partnership enterprises, there remains much uncertainty with respect to the taxation of partners (foreign and domestic, corporate and individual) in a partnership enterprise. Features of limited partnership enterprises The latest version of the Partnership Enterprise Law introduces the model of limited partnership enterprises with the following features: General partners and limited partners undertake liabilities at different levels, namely general partners undertake unlimited liability, while limited partners undertake limited liability to the extent of the original capital contribution. Limited partnership enterprises, may be established by as few as two and up to 50 partners, with at least one general partner required. There are limitations on the rights of limited partners. For example, they are not allowed to contribute capital in the form of labour service, nor are they allowed to execute partnership affairs or represent the limited partnership in front of a third party. The protection of limited partners from unlimited liabilities is nullified in certain situations. Features of FIPEs (based on the January 2007 Draft Administrative Measures) The January 2007 Administrative Measures for FIPEs revealed the following major features of FIPEs currently being considered: FIPEs may be established by at least two partners who may all be foreign partners, subject to prescribed national industrial restrictions.
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There are limitations on the rights of foreign partners. For example, they are not allowed to contribute capital in the form of labour service. They must also submit a list of assets and proof of ownership to Chinese authorities for approval and registration authorities for public consultation. The establishment and operation of FIPEs shall comply with the foreign investment industrial policies of the Chinese government. FIPEs shall be the withholding agent of their partners for income tax purposes. FIPEs are subject to tax (other than corporate income tax) and customs duties, and are eligible for incentives as provided in tax and customs regulations. FIPEs may open foreign currency and RMB bank accounts, as well as foreign currency bank accounts (foreign currency receiving account) for their foreign partners with banks in China. FIPEs may apply for conversion to a foreign investment enterprise. Foreign invested holding companies and foreign invested venture capital companies may be foreign partners in FIPEs. Note that the above features may or may not become part of the final administrative measures for FIPEs.
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Chapter 17
Taxation of individuals
Tax planning for foreign individuals The present PRC IITL came into effect on 1 January 1994. It covers the taxation of both foreign individuals and local individuals. China taxes all income derived within its borders except items specifically exempted by statute. This applies to both residents and non-residents. Local taxpayers are entitled to a standard monthly allowance of RMB2,000; foreign individuals can enjoy an additional allowance of RMB2,800. Tax assistance is accounted for on an infinite gross up basis; hypothetical tax deduction is generally recognised. Tax rates are progressive. Tax credit is available only for income tax paid to foreign jurisdictions with respect to foreign-sourced income. Restructuring of remuneration packages may improve tax efficiency, because some in-kind fringe benefits, if structured properly, are non-taxable. China IIITL addresses residence rules that may provide planning opportunities to some foreign individuals by appropriate timing of arrival in and departure from China. Dual employment contracts may be effective for those foreign individuals who hold positions inside and outside China, if careful structures are adopted. Any income received by a foreign individual prior to assignment is not taxable in China if such payment is received for services before the assignment plus the cost of it is not borne by an entity in China. However, income received by a foreign individual for services rendered in China, even if paid outside or after assignment in China, is generally taxable in China.
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Territoriality and residence The present Chinese government IITL, promulgated on 31 October 1993, came into effect on 1 January 1994. The detailed rules and regulations for the implementation of the IITL were subsequently promulgated on 28 January 1994. These regulations are supplemented by various administrative rulings of the Ministry of Finance and the State Administration of Taxation, which, although not codified, have the force of law. The law is applicable to foreign individuals, local residents and entrepreneurs. The sourcing rules set out in the law and its detailed rules and regulations can be categorised as follows: 1. Individuals who have a domicile or place of abode in China are subject to individual income tax on their worldwide income. Individuals who have a domicile or place of abode are those who maintain a residence in China because of their legal residency status, family or economic ties and who habitually reside in China. 2. Individuals who do not have a domicile or place of abode in China are taxed in accordance with their length of residency in China, as follows: a) Non-residents and residents in China for not more than one year will be subject to tax only on their China-sourced income. b) Residents in China for more than one but less than five full years are subject to tax on both their China-sourced income and their foreignsourced income. However, upon application to and approval from the relevant tax authorities, the chargeable scope can be limited to the foreignsourced income that the individual receives from China enterprises, China economic organisations or other China individuals.
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c) Residents in China for five consecutive full years or more are subject to tax on their worldwide income (commonly known as the five-yearresidence rule). The following categories of income, regardless of whether payments are made within China, are considered Chinasourced income: 1. Income derived from employment or contracted labour services performed within the territory of China. 2. Income derived from the leasing of property to others for use within the territory of China. 3. Income derived from the transfer of real property, land-use rights or other property within the territory of China. 4. Income derived from the granting of various franchises to be used within the territory of China. 5. Income derived from interest, dividends and bonus dividends from companies, enterprises and other economic organisations or individuals within the territory of China. Special provisions Residence rules for employment income Foreign individuals deriving income from an overseas employer with no permanent establishment in China for actual employment services rendered in China will be tax exempt if the individual does not physically stay in China, whether consecutively or cumulatively, for more than 90 days in a calendar year. This 90-day test is generally extended to 183 days during a calendar year or any 12-month period (depending on the applicable tax treaty) if the individual is a resident of a country with which there is a tax treaty (e.g. Australia, Japan, the United Kingdom, the US).
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To avoid taxation on worldwide income, foreign individuals who fail to comply with the five-yearresidence rule should avoid staying in China for a full year from the sixth year onward. Dual employment contracts By reference to a notice issued by the State Administration of Taxation in 1995, all the income derived by an individual from different employments, whether within or outside China, should be reported for individual income tax purposes. Time apportionment may be allowed to determine the part of the tax liabilities that could be exempted in respect of the non-China-sourced income. Therefore, dual employment contracts may still be effective for individual income tax planning if careful structures are adopted. However, the current assessment practice of different local tax authorities in this respect is not uniform. Tax reduction for employment income No tax reduction for employment income is allowed. Dividend and profit distribution Income from dividend and profit distribution received by individuals in China is subject to tax at a flat rate of 20%. Gross income Article 2 of the IITL provides that the following categories of income are subject to individual income tax: 1. Wages and salaries. 2. Income from the production and operation of a private business. 3. Income from operation of a business or institution on a contract or lease basis. 4. Payment for labour services.
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5. Authors remuneration. 6. Royalties. 7. Interest, dividends and profit distribution. 8. Rental income. 9. Income from transfer of property. 10. Contingent income. 11. Other income subject to tax as determined by the Ministry of Finance of the State Council. The classification of income is important, because both the tax rates and the allowable deductions vary according to the category of income. Employment services Employment income received by foreign individuals is taxable in China if it is sourced in China, the location of employment is in China, the employment income is borne by a permanent establishment in China, or the employment services are actually rendered in China. The country of the employer, payment and beneficiary of the employees services are all irrelevant. The categories of taxable income for employment include the following: Base salary. Cash allowances and incentives, including overtime, bonuses, foreign service premiums, hardship allowances, and other incentive payments. Housing allowances in excess of actual residential rental of the employee. Per day payments for living expenses in China. Stock option benefits.
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Directors fees and dividends that are effectively compensation for employee services in nature. Payments (employers contribution) to overseas insurance institutions for retirement pension, savings, unemployment protection, medical and accident insurance or the like, except for those mandatory government plans, which may be exempt with the approval of the tax authorities when the required conditions can be met. Tax assistance to the employee, whether a net-oftax package, tax equalisation or a tax protection arrangement. Long service awards. Severance payment. Other income related to employment. In China the income tax calculation for tax assistance provided to an employee by an employer is based on the infinite gross up method, that is, the benefit is grossed up in the same tax period, using the tax-on-tax calculation. Capital gains Capital gains derived from the sale of property are subject to tax in China at a flat rate of 20%. Gains from the transfer of real estate In addition to income tax levied at a flat rate of 20%, gains (whether capital or trading gains) from the transfer of real estate are subject to land appreciation tax (see Chapter 15).
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Other income As mentioned above, other items of taxable income include compensation for personal services, royalties, rentals, passive income, and other specified transactions. The current law and regulations include an increasing number of fringe benefits as income subject to individual income tax, such as overseas insurance benefits. Non-taxable income Items of income that are tax exempt include the following: Employment Benefits 1. Housing received in a non-cash form or on a reimbursement basis. 2. Two round trips home-leave airfare for the individual him/herself from China to the foreign individuals home (or the home of the spouse or their parents) per calendar year. 3. Reasonable relocation/moving costs incurred upon commencement or cessation of China assignment. 4. Reasonable language training for an individual and childrens education in China. 5. Overseas mandatory insurance payments made by employer for employees social security in accordance with the employees home jurisdiction, given that the employer does not claim deduction of the same for China corporate tax purposes, and that approval of the tax authorities is given. 6. Reimbursement of reasonable meals and laundry expenses. 7. Reimbursement of reasonable business-related expenses. 8. Automobile provided by employer.
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Other income 1. Dividends from B shares and overseas shares in Chinese/foreign investment enterprises (temporary exemption) received by foreigners. 2. Gains from transfer of B shares and overseas shares in Chinese/foreign investment enterprises (temporary exemption) received by foreigners. 3. Interest on government bonds and finance bonds issued by the government. 4. Income of diplomatic representatives, consuls and other personnel of foreign embassies and consulates. 5. Income exempt from tax under any international convention in which China participates and any agreement that China has signed. 6. Income exempt from tax as determined or approved by the Ministry of Finance of the State Council. Closely held companies If a foreign individual is an equity owner of a foreign investment enterprise, the profit distributed will be tax exempt. There are incentives for those individuals who actively manage these enterprises to minimise the individual income tax burden by classifying income that would otherwise be salary as dividends. However, a notice issued by the State Administration of Taxation requires those individuals to differentiate between the profits received from the enterprise and the income earned as a result of providing their services.
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Deductions The Chinese IITL allows deductions from certain categories of income in computing the individual income tax of taxpayers. All individuals are allowed a standard allowance (deduction) of RMB2,000 a month from wages and salaries. In addition, foreign individuals, which are defined to include Hong Kong, Macau and Taiwan compatriots, are entitled to an additional allowance of RMB2,800 per month. The monthly personal allowance available to foreign individuals working in China is thus RMB4,800. Spouses are taxed separately and entitled to their own standard monthly allowance. No allowances are granted for children, parents or other dependants of the taxpayers. For income from compensation for personal services, authors remuneration, royalties, or lease of property, residents receive a standard deduction of RMB800 in lieu of expenses if the amount received in a single payment is less than RMB4,000. If a payment is more than RMB4,000, a deduction equal to 20% of the payment will be allowed. The economic substance of a transaction will determine whether income received in several installments of not more than RMB4,000 each (and thus eligible for multiple RMB800 standard deductions) will be treated as a lump sum. If the installment payments are the result of a single economic transaction, they will be treated as a lump sum (also see Appendix VIII). Actual expenses are not deductible against compensation for personal services and royalties. Interest, dividends, bonuses on investments, contingent income, and other kinds of income are taxed on the gross amounts received, without deductions. There is an exception for leased property, whereby actual repairs and maintenance expenses may be deductible, subject to a maximum limit of RMB800 per month. The unclaimed
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balance can be carried forward to the next month. Taxable income from sales of property is defined as the balance of the payment received after deducting the original purchase price of the property and all reasonable expenses incurred. In addition, donations made by individuals to qualified educational institutions and other public welfare organisations can be deducted from taxable income pursuant to the regulations promulgated by the State Council. Double taxation relief If an individual does not have a domicile or place of abode in China or resides in China for less than five full years, foreign-sourced income will not be subject to tax in China upon approval from the local tax authorities. Wages and salaries attributable to services performed in China will be considered China-source income, regardless of where they are paid. Under the agreements for the avoidance of double taxation that China has signed with various countries, a longer grace period is given before individuals are taxed on their China-sourced income. Individuals residing in China for more than five full years are taxed on their worldwide income. (See Territoriality and residence in this chapter.) Tax computation Taxable income (wages and salaries) Where an individuals China tax is borne by the employer, the individuals tax liability is calculated on an infinite grossed-up basis, i.e. tax on tax. The employer may bear the entire tax liability, a fixed sum of the tax liability or a fixed proportion of the total tax liability of the employee. If the employer adopts a tax equalisation scheme whereby the employer will reimburse the actual
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China tax paid in excess of a hypothetical tax, the hypothetical tax can generally be deducted from the gross wages, and the China individual income tax is calculated on the net wages, using the gross-up method. A comparison of the taxable gross-up income and the taxable income (i.e. including the hypothetical tax and excluding the standard monthly allowance of RMB4,800) must be made before determining the tax liability. If the latter is greater than the former, the gross income will be used to calculate the tax liability. A sample tax calculation is shown in Appendix IX. Tax rates Wages and salaries are taxed at progressive rates that range from 5% to 45% (see Appendix VII). Income from other sources, such as compensation for personal services, is generally taxed at a flat rate of 20%. Tax credits Individuals subject to China individual income tax who receive foreign-sourced income may deduct any income taxes paid on such income in a foreign jurisdiction. The foreign tax credit is calculated separately for each jurisdiction and for each category of income. The credit limitation for each jurisdiction is the aggregate of the amounts of tax payable under different categories of income within that jurisdiction. However, this deduction should not exceed the amount of tax that would have been paid on such foreign-sourced income in China. Evidence of tax payments must be submitted to the tax authorities if the payments are to qualify for the foreign tax credit.
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Exchange rate for tax purposes As previously noted, the name of the currency in China is the renminbi (RMB). Monthly income in foreign currency should be converted into RMB according to the foreign exchange rate quoted by the state exchange control authorities on the last day of the previous month before the tax payment receipt is issued. Other taxes Local taxes on income Local governments do not impose any tax on individual income. Wealth tax/gift tax/inheritance tax Currently, there are no wealth, gift or inheritance taxes in China.
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Chapter 18
Indirect taxes
Key messages Nearly all transactions in China are subject to a turnover tax, either VAT or BT. Certain categories of consumable goods are also subject to consumption tax, with rates ranging from 3% to 45%. The standard rate of VAT is 17%. Reduced rates and exemptions are available. BT rates range from 3% to 20%. Stamp tax is levied on business documents signed and or executed within China. Property transactions are subject to land appreciation tax (LAT), with rates ranging from 30% to 60%, and deed tax, with rates ranging from 3% to 5%. Properties are subject to real estate taxes. Taxes on vehicle and vessel usage and license plates are imposed by the tax authorities. Customs duties are levied on the importation of goods. Exemptions are available. Resource tax is levied on extraction of mineral products and production of salt. Turnover tax On 1 January 1994, China introduced a turnover tax system consisting of a VAT, business tax and consumption tax (also known as excise tax) to replace the old system, that included the consolidated industrial and commercial tax (CICT), product tax and the old VAT.
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Indirect taxes
Value-added tax Scope The sale of taxable goods and the provision of labour services in relation to the processing of goods and of repair and replacement services within China are subject to VAT under the new regime. Taxable goods refers to tangible goods as well as certain utilities such as electricity, thermal power and gas, but the term excludes real estate properties. VAT is also levied on the import of taxable goods into China unless the imports are specifically exempt under special rules. In general, exports are zero-rated (with the exception of certain categories of goods for which VAT would be due under the deemed domestic sales rules), and related input VAT could be fully or partially refunded, depending on the categories of goods. The non-refundable portion would be absorbed as cost of export. Rates VAT rates range from 0% to 17%. The standard rate is 17%, and it applies to most taxable goods and services. Certain goods are taxed at a lower rate of 13% or are exempt from VAT (see Appendix VIII). Exports are zero-rated (with the exception of certain categories of goods for which VAT would be due under the deemed domestic sales rules). Registration Enterprises that make sales that are taxable for VAT purposes in China should voluntarily register for VAT with the local tax authority. VAT payers are generally classified into two categories: general VAT payer and small-scale VAT payer.
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Indirect taxes
Basis of taxation VAT is levied and collected on the basis of the value added to the taxable goods or services at each stage of a production chain, i.e. from the acquisition of raw materials by producers to the purchase of finished goods or services by consumers. At each stage, VAT on sales (output tax) is collected by the seller from the purchaser on behalf of the tax authorities. With the support of a valid VAT invoice, the general VAT payer can generally deduct the VAT that has been paid on the purchase of materials and certain overheads that are used for the taxable sales (input tax) and account for the difference to the authorities, as illustrated below: VAT payable = Output tax Recoverable Input tax Input tax includes VAT paid upon importation. Output tax and input tax should both be calculated on the basis of the tax-exclusive price, i.e. price exclusive of VAT. The following formula is applicable to the small-scale VAT payer in calculating VAT liability: VAT payable = turnover X 6%1 VAT paid upon the acquisition or importation of fixed assets is not recoverable as input tax. However, there is a special relief under which equipment and machinery imported by FIEs (in industries listed as encouraged or restricted class in the 2004 foreign investment catalogue) for production purposes, using funds that form part of the FIEs total investment, would qualify for import VAT exemption. Other reliefs that enable input VAT recovery may also be applicable to certain Made in China machinery and equipment or certain fixed assets acquired by specific industries in certain geographic regions in China.
1
4% for commercial enterprises
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Indirect taxes
VAT on exports In general, export sales are zero-rated (with the exception of certain categories of goods for which VAT would be due under the deemed domestic sales rules) from VAT. The related input VAT may be refunded fully or partially. However, the refund rate is generally reduced. Starting from 1 January 2001, the exempt, credit and refund method became applicable to all enterprises in China in calculating VAT refund on exported goods. In effect, when a certain portion of input VAT may not be refunded or credited against output VAT, it may have to be charged to cost of sales. Further, under a bonded contract processing arrangement, an enterprise is temporarily exempt from VAT on import of raw materials, export of finished goods and fees earned for processing services. Business tax Scope Business tax applies to the provision of services (excluding processing services and repair and replacement services, which are taxed under the VAT regime). It also applies to the transfer of intangible assets such as goodwill, patents and the sale of real estate properties in China. Business tax and VAT are mutually exclusive. Rates The tax rates range from 3% to 20% (see Appendix VIII). Registration Enterprises that provide services or sell goods within the scope of business tax should voluntarily register for business tax with the local tax authority.
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Indirect taxes
Basis of taxation Unlike VAT, business tax is not a creditable tax. It follows that taxpayers registered for business tax cannot recover VAT or business tax as input tax. Neither can VAT-registered taxpayers recover business tax as input tax. Business tax is imposed on the basis of turnover, as follows: Business tax payable = Turnover x Applicable tax rate Consumption tax Scope Consumption tax is levied on the importation, production and processing of 14 categories of consumable goods, including tobacco, alcoholic drinks and alcohol, cosmetics, precious jewellery, precious jade and stones and jewellery made with gold, silver and gold and silver mixed with alloys, firecrackers and fireworks, motor vehicle tyres, motorcycles, motor cars, golf balls and golf equipment, luxury watches, yachts, disposable wooden chopsticks, wooden floorboards and product oils. Rate See Appendix VIII. Stamp tax From 1 January 1994, all enterprises became subject to stamp tax on all taxable documents listed in the Stamp Tax Regulations. Stamp tax is levied on the execution or receipt in China of certain documents, including contracts for the sale of goods, the undertaking of processing work, the contracting of construction and engineering projects, leases, loans, and agency and other non-trade contracts. Stamp tax is also levied on documentation effecting the transfer of property, business account books and certification in evidence of rights and licenses.
Indirect taxes
The rates of stamp tax vary (see Appendix VIII). The maximum rate is 0.1%. Stamp tax is assessed on the value of each element in the document if it contains various elements that are taxable at different rates. If no separate value is assigned, tax is assessed on the entire contract value at the higher rate, and if no value is assigned, tax is assessed according to the listed or market value. Land appreciation tax (LAT) LAT is levied on gains realised from real property transactions at progressive rates from 30% to 60%, based on the land value appreciation amount, which is the excess of the consideration received from the transfer or disposition of real property over the total deductible amount. Land value appreciation amount Not more than 50% 51% to 100% 101% to 200% Over 200% % 30 40 50 60
The total deductible amount includes the following: The amount spent on obtaining the land use right. Costs of land development, the construction of building and supplementary facilities. Expenses of the construction of new buildings and supplementary facilities such as finance charges. Taxes in connection with the transfer of real property (generally business tax and stamp tax). Other deductions as determined by the Ministry of Finance.
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Indirect taxes
For taxpayers engaged in the real estate development business, an additional deduction equal to 20% of the sum of the first two costs noted previously is allowed. Finance expenses, such as interest, may be deducted in certain circumstances. Other real property development expenses (e.g. selling and administrative costs) are limited to 5% of the total amount expended to acquire the land use rights and the costs of land development and construction. Deed tax The deed tax provisional regulations were introduced in April 1997 and became effective from 1 October 1997. Deed tax is levied on the purchase or sale, gift or exchange of ownership of land use rights or real properties. The transferee/assignee is the taxpayer. Generally, the rates range from 3% to 5%. Real estate taxes Urban real estate tax The Ministry of Finance is responsible for designating the cities in which urban real estate tax is levied. Urban real estate tax is payable by the foreign enterprise (FE), foreign investment enterprises (FIE) and foreign individuals that own properties. In general, urban real estate tax is levied annually at the rate of 1.2% on the original value of the property. Most cities also grant tax relief and allow a 10% to 30% discount of the amount calculated as indicated above. The specific discount rate is decided by the respective local peoples government. Urban real estate tax is a deductible expense for income tax purposes. Certain exemptions from urban real estate tax are permitted. A tax holiday of three years may sometimes be granted for newly constructed buildings.
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Indirect taxes
Real estate tax Real estate tax is levied in cities, county towns, town/ bases operated under an organisational system and industrial and mining districts. Real estate tax is payable by domestic enterprises that own properties. Real estate tax is levied annually at the rate of 1.2% on the residual value of the property or on the rental income derived from the property at a rate of 12%. The residual value is calculated by applying a discount ranging from 10% to 30% of the original value of the property. The above discount rate is decided by the respective local peoples government. Real estate tax is a deductible expense for income tax purposes. Specific discounts and exemptions from real estate tax are permitted. Real estate tax is payable at the taxpayers local in-charge tax office. Land use tax in cities and towns (LUTCT) Land use tax is levied on the use of land within the boundaries of cities, county towns, town/bases operated under an organisational system, and industrial and mining districts. Land use tax is payable by the FIEs, FEs and domestic enterprises using the land. In general, land use tax is levied annually at rates ranging from RMB 0.6 to RMB 30 per square metre of actual area of land used by the taxpayer. The work of measuring land in use shall be determined by respective local municipalities. Specific discount up to 30% may be applicable. This would be decided by the respective local Peoples government. Land use tax is a deductible expense for income tax purposes. Specific exemptions from land use tax are permitted.
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Indirect taxes
Vehicle and vessel taxes Vehicle and vessel tax This tax is levied on the owners or persons responsible for managing vehicles and vessels within China. The tax is applicable to vehicles and vessels subject to registration with the Vehicle and Vessel Administration Department. Certain categories of vehicles and vessels are exempt from this tax, as listed in the governing regulations. Periodical tax reduction or exemptions may be granted to vehicles and vessels for public transportation in cities and the countryside on the basis of the actual local conditions by individual provincial governments. The time at which the tax obligation arises is the month of the date indicated in the vehicle or vessel registration certificate or license for operation issued by the vehicle and vessel administration department. Rate See Appendix VIII. Motor vehicle acquisition tax (MVA Tax) Effective 1 January 2001, the purchase and importation of the following types of transportation vehicles were subject to MVA tax: Cars Motorcycles Trams Electric buses Carts Certain types of trucks
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Indirect taxes
Manufacture of the above vehicles for self use or receipt of the above in the form of a gift or lottery win, and so forth, would also be subject to MVA tax. The MVA tax rate is fixed at 10% of the taxable consideration which could be the purchase price (including any miscellaneous charges or expenses but excluding VAT), the composite importation price (i.e. the total of CIF price, customs duty and consumption tax) or a deemed price in the cases of self-manufacture, gift, lottery or others. The MVA tax should be paid within 60 days from the date of the purchase, importation or use. The following are specifically exempted from MVA tax: purchase of a motor vehicle which has already been subject to the MVA tax; purchase by an officer of an embassy, consulate or international institution in China; purchase by the PRC Liberation Army; purchase of a motor vehicle with a position-fixing appliance, which is not used for transportation; and other situations explicitly stipulated by the State Council. Customs duties Please refer to Chapter 7 for Customs duties. Resource tax Resource tax may be levied on natural resources, generally on a tonnage or volume basis, at rates specified by the Ministry of Finance in consultation with relevant ministries of the State Council. The resources taxed include crude oil, natural gas, coal, other raw non-metallic minerals, raw ferrous metals, non-ferrous metallic minerals, and salt (including solid and liquid salt). In lieu of the resource tax, mine area usage fees are collected from joint ventures exploiting crude oil or natural gas. For rates see Appendix VIII.
Chapter 19
Tax treaties
Investor considerations The primary purpose of tax treaties is the avoidance of double taxation. Tax treaty provisions take precedence over Chinese domestic tax laws. Relief from double taxation is given by way of tax exemption or reduction and by tax credit for foreign taxes paid. Chinese tax treaties provide for a reduced withholding tax rate on royalties and certain other income. Tax treaty policy China has signed bilateral tax treaties with over 90 countries/regions (see Appendix IV), including developed industrialised countries, developing countries and some eastern European countries. China has also signed comprehensive double taxation arrangements with the Hong Kong Special Administrative Region and the Macau Special Administrative Region. The treaties are primarily aimed at avoiding double taxation and preventing tax evasion. The tax treaties generally follow the model treaty of the Organisation for Economic Cooperation and Development (OECD) and the model treaty of the United Nations. Tax treaty provisions Taxes covered The treaties cover Chinese taxes, including Individual Income Tax and Corporate Income Tax, but not turnover taxes.
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Tax treaties
Residence The treaties apply to persons who are residents of one or both of the contracting states. A resident of a contracting state, for purposes of the treaties, means any person liable for tax by reason of domicile, residence, place of head office, for example. In China, tax resident enterprise refers to an enterprise that is established in accordance with the laws of China, or an enterprise that is established in accordance with the laws of a foreign country (region) but with a place of effective management located within China. Individuals, on the other hand, are taxed either on the basis of residence in China or because they are paid by an enterprise that has an establishment in China. Permanent establishment When an enterprise of one contracting state carries on business in the other contracting state, the treaty provides a two-part test as to whether the latter state may levy an income tax on the enterprise. Tax is payable if an enterprise (1) has a permanent establishment in a contracting state and (2) has profits in the contracting state attributable to that permanent establishment. The definition of establishment for purposes of Chinas CITL is somewhat different from the definition of a permanent establishment as set out in the tax treaties. An establishment under the China CITL refers to establishments or places of business in China engaging in production and business operations, including: (i) Management organisations, business organisations and representative offices. (ii) Factories, farms and locations where natural resources are exploited.
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Tax treaties
(iii) Places of business where labour services are provided. (iv) Places of business where contractor projects, such as construction, installation, assembly, repair and exploration, are undertaken. (v) Other establishments or places of business where production and business activities are undertaken. In addition, a business agent who carries out production and business activities in China, regularly signs contracts, stores and delivers goods, for example, on behalf of a non-resident shall be considered as the establishment or place of business of the non-resident in China. Shipping and aircraft Chinas tax treaties with several countries including, for example, the United Kingdom and Japan, provide for a reciprocal tax exemption on international shipping and/ or aircraft operating profits, while other countries have a separate agreement dealing with this subject. A similar tax exemption in the double taxation arrangement with the Hong Kong Special Administrative Region also includes business tax in China. Withholding taxes Dividends Under Chinas corporate income tax law, the statutory withholding tax rate is 20%. However, this is reduced to 10% under the detailed implementation regulations of the corporate income tax law. The 10% rate is also generally the dividend withholding tax rate pursuant to most of the treaties signed by China.
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Tax treaties
Interest The statutory withholding rate of 20% on interest payments is reduced to 10% under the detailed implementation regulations. This rate is also generally the interest withholding tax rate pursuant to most of the treaties signed by China. Chinas tax treaties with certain other countries such as Japan, the United Kingdom and the United States, include a sourcing provision to determine the rights of the source country to tax interest income. Interest is deemed to arise in a contracting state if the payer is the government or a resident of that contracting state or if a permanent establishment or fixed base within the contracting state bears the cost. Royalties The statutory withholding tax rate is 20% on royalty payments. This is reduced to 10% under the detailed implementation regulations. The treaties generally provide for reduced withholding rates on royalties of 6%, 7% or 10%, depending on the country and the type of royalty payment. Chinas CITL may provide for exemption from withholding tax for certain technology or know-how provided by a foreign enterprise, subject to the State Councils approval. Certain treaties, such as those with Japan, the United Kingdom and the United States, contain a sourcing provision with regard to royalty payments made by a company with a permanent establishment or fixed base in China. Even if such payments are not made from China to a treaty-country enterprise, withholding tax will be payable if the permanent establishment in China can be said to have borne the cost. Examples of the withholding tax rates for treaty countries are shown in Appendix IV.
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Tax treaties
Personal services Individual services Individuals are taxed on the basis of residence in China or as a consequence of working in China and being paid by an enterprise with an establishment in China. Residence is usually considered to be a stay of 90 days or more (see Chapter 17). The tax treaties provide that salaries, wages and other similar remuneration derived by a resident of one contracting state are taxable only in that state in respect of employment exercised in the other state if all of the following conditions are met: 1. The recipient is present in the other contracting state for a period or periods not exceeding 183 days in the calendar/fiscal year or a 12 month period; 2. Compensation is paid by or on behalf of an employer that is not a resident of the other contracting state; and 3. Compensation is not borne by a permanent establishment or a fixed base that the employer has in the other contracting state. Professional services The tax treaties provide that professional services rendered by individuals are normally taxable in the country of residence of the individual providing such services. The only exceptions occur in the following cases: 1. The individual has a fixed place of business available in the other contracting state; or 2. The individual is present in the other contracting state for a period exceeding (in the aggregate) 183 days in the calendar year or a 12 month period.
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Tax treaties
Exchange of information The tax treaties provide the competent authorities to exchange such information as is necessary for carrying out the provisions of the treaty and for the prevention of fraud or fiscal evasion. The treaties contain a variety of restrictions as to the treatment and the type of information that can be exchanged. Competent authority The treaties contain a provision under which a taxpayer of a contracting state may present a case to the competent authorities in the taxpayers country of residence if the taxpayer considers that the action of the tax authorities taken in one or both of the contracting states will result in taxation not in accordance with the tax treaty. If the taxpayers claim is considered to have merit, the competent authorities in the taxpayers country of residence will attempt to reach an agreement with the other country to avoid double taxation.
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Chapter 20
Transfer pricing
Key messages Burden of proof rests with the taxpayer. The new CITL provides for contemporaneous documentation requirements. Taxpayers are required to provide information relating to transfer pricing methodologies, costing bases, resale price information and other detailed information. There is a special interest levy for transfer pricing tax adjustments. Transfer pricing adjustments may be made on a retroactive basis for up to 10 years as a result of a transfer pricing audit. Advance pricing arrangements are becoming a popular alternative for taxpayers who seek to minimise uncertainties in tax consequences related to their transfer pricing policies. General environment Transfer pricing has become an important area for all enterprises in China dealing with intra-China and crossborder transactions and, consequently, for the Chinese tax authorities. With the passing of the new CITL, domestic enterprises (DEs) and FIEs are now subject to the same statutory rules which seek to apply arms length pricing between associated enterprises. Audit procedures are strictly laid down and the burden of proof lies with the taxpayer. On 6 December 2007, the State Administration of Taxation (SAT) issued the Detailed Implementation Regulations (DIR), which provide some guidance to the interpretation of the CITL, including those related to transfer pricing.
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Transfer pricing
Statutory rules in transfer pricing Promulgated in 1991, the Income Tax Law for Foreign Investment Enterprises and Foreign Enterprises (FEITL) adopts the arms length principle for transactions with FIEs and foreign enterprises (FEs). Under Article 13 of the FEITL, the tax authorities are authorised to adjust an FIEs or FEs taxable income where it has been reduced as a result of non-arms length pricing. Similar rules apply to transactions between DEs and the rules are included in Article 10 of the Provisional Rules on Enterprises Income Tax enacted in 1993. The Detailed Implementation Rules of Tax Collection and Administration Law (Tax Collection and Administration Law), first introduced in 2002, make it possible for taxpayers to enter into an advance pricing arrangement (APA) with local Chinese tax authorities. Chapter 6 of the new unified CITL, titled Special Tax Adjustments, specifically deals with tax avoidance and transfer pricing issues by enhancing legislation and regulations, introducing new concepts and strengthening enforcement by the SAT. Rulings and regulations in transfer pricing In November 1990, the SAT issued a set of provisional rules regarding the administration of the taxation of transactions between FIEs and their associated enterprises. These rules set out general guidelines on the transfer prices of these transactions and thus provide the basis for the subsequent legislation. Two important rulings on transfer pricing were issued on 29 October 1992: Guoshuifa [1992] No. 237 and 242. The former provides a definition for related party transactions and states the requirement for companies to disclose details of their related party transactions in their annual income tax returns. The latter is an
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Transfer pricing
internal document for the tax authorities, which sets out procedural aspects of dealing with transfer pricing, such as the selection of targets to be investigated and the methods to be used when conducting an investigation and adjusting prices. China is the second country in Asia to pass detailed transfer pricing and APA regulations. In 1998, the SAT issued a detailed transfer pricing audit directive, Guoshuifa [1998] No. 59, which consolidates previous transfer pricing legislation and rulings. This is equivalent to Chinas first transfer pricing master guide and marks the beginning of popular transfer pricing in China. In addition to detailing the methodologies for tax authorities to follow when carrying out transfer pricing audits, Guoshuifa [1998] No. 59 also defines the term associated enterprises for transfer pricing, procedures for examination, pricing adjustments, and information disclosure. Thereafter, Guoshuifa [2002] No.128 set out guidelines with respect to the arms length principle for the provision of services between Chinese holding companies and their associated companies in China. The SAT was empowered to interpret tax legislation and frequently issues interpretative notices/rulings. Although these rulings do not have the force of law, they are in practice respected as such and, in fact, there have been no reported court decisions that contradict them. In view of the series of transfer pricing related regulations issued in China since the introduction of Guoshuifa [1998] No. 59, the SAT introduced several changes in 2004 under the cover of Guoshuifa [2004] No. 143 to clarify and provide further detailed instructions for transfer pricing enforcement. That year also saw the issuance of the first APA circular, Guoshuifa [2004] No.118, which provided a set of detailed process guidelines for local tax authorities to follow when conducting APAs.
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Transfer pricing
In the following year, Guoshuifa [2005] No. 239 set out measures for strengthening anti-avoidance practices in China on transfer pricing investigations and monitoring. This ruling also facilitates the centralisation of antiavoidance management in the SAT, requiring approval from the SAT before commencement and conclusion of any transfer pricing audit case. With the issuance of Guoshuihan [2007] No. 363 by the SAT on 27 March 2007, Chinese tax authorities are placing more significant emphasis on transfer pricing enforcement. Arms length principles The Chinese tax authorities require transactions between related parties to be carried out in accordance with the arms length principle. In China, this requirement was first introduced by the Income Tax Law of the Peoples Republic of China on Enterprises with Foreign Investment and Foreign Enterprises (under Article 13). This was issued by the National Peoples Congress on 9 April 1991 and came into force on 1 July 1991. The arms length principle requires that associated enterprises should deal with each other as if they were third parties. Under Guoshuifa [1998] No. 59, relevant inter-company transactions include: 1) purchase and sale of products; 2) transfer and use of intangible properties; 3) provision of services; and 4) financing. Burden of proof Guoshuifa [1998] No. 59 stipulates that the taxpayer in question is obligated to provide documentation showing that the transactions being investigated are reasonable and in accordance with the arms length principle. Article 114 of the DIR, released on 6 December 2007, stipulates that contemporaneous documentation and other related details in respect of related party transactions will be required to be submitted with the taxpayers corporate income tax return to the tax authorities.
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Transfer pricing
Such other details may include the following: 1. The relevant information in respect of the resale (or transfer) prices or ultimate sale (or transfer) prices of properties, rights to use of the properties and labour services, for example, involved in business transactions with related parties. 2. Information on product price, pricing methods and profit levels, for example, comparable to the taxpayer. 3. Other relevant information on the related party transactions. While details of the contemporaneous transfer pricing documentation requirements have not been released as at the date of this publication, they should be released by the SAT later in 2008. It would therefore be advisable for enterprises to prepare documentation for China as a good risk management measure to prove the reasonableness of their transfer pricing policies. Audit targets Article 12 of Guoshuifa [1998] No. 59 identifies the 10 key criteria for selecting audit targets. These criteria include: FIEs that have incurred losses for more than two consecutive years. FIEs that are involved in transactions with associated enterprises incorporated in tax haven countries/ regions. FIEs that make a profit and loss in alternate years or whose profitability does not appear normal. FIEs with profitability that is lower than that of other enterprises in the same industry. FIEs with profitability that is lower than that of other enterprises in the same corporate group.
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Transfer pricing
FIEs with production and operational management that are controlled by associated enterprises. FIEs that have expanded operations but reported losses or marginal profits for an extended period. FIEs that have significant transactions with associated enterprises. FIEs that pay associated enterprises unreasonable fees. FIEs that have a significant drop of profit after the expiration of tax holidays. The tax authorities are required to audit no less than 30% of the designated audit targets each year. More recently, the SAT has moved towards a national audit approach, focusing on both intra-China and crossborder related party transactions. The authorities seek to identify MNCs with a number of subsidiaries with operations across China as targets for national audits. Due to Chinas unique feature whereby Chinese entities of the same group are not permitted to file consolidated income tax returns and group companies in China may be subject to various corporate tax rates, MNCs in China can be subject to multiple transfer pricing audits. Audit procedure and adjustments Transfer pricing in China is the responsibility of one of the many local tax authorities. Tax audits in China may be conducted either at the office of the taxpayer or at those of the tax authorities. A transfer pricing audit usually starts with the issuance of an information request to a taxpayer after performing a desktop review. If the local tax authority wishes to pursue the matter further, it will carry out fieldwork at the taxpayers site. The audit processes include rounds of information requests and
206
Transfer pricing
negotiations between the tax auditors and the taxpayer. The tax auditors will then analyse the findings and report them to the SAT, which will give the local tax authority clearance before a final decision is issued to the taxpayer. The transfer pricing audit can be lengthy depending on the complexity of the case. When it is ascertained that transactions are not conducted at arms length, the tax authorities are empowered to adjust the enterprises income, based on various methods prescribed in Guoshuifa [1998] No. 59. For transfer of tangible properties, the following methods may be used: Pricing for the same or similar business transactions between independent enterprises (comparable uncontrolled price). Profit margins obtainable from reselling the goods to a non-affiliated third party (resale minus method). Cost plus a reasonable profit margin (cost plus method). Other appropriate methods including, but not limited to, the comparable profits method, profit split method and transactional net margin method. For financing transactions, adjustments will be made on normal commercial interest rates. For services, adjustments will be made on normal and standard fees for similar services. For leasing transactions, adjustments will be made according to an analysis of pricing between non-related enterprises for similar transactions, which may involve looking at cost plus a reasonable profit, or depreciation plus cost and reasonable profit. For transfer of intangible properties, adjustments will be based on transactions between non-related enterprises. Transfer pricing adjustments made can be punitive.
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Transfer pricing
Settlement is often achieved through negotiation. While the conduct of the taxpayer should not significantly affect the outcome, a friendly working relationship with the tax authorities is always to the taxpayers advantage as Chinese tax legislation gives a broad measure of discretion to tax authorities. Statute of limitations The Statute of Limitations for transfer pricing investigations in China is up to 10 years. The Chinese tax authorities generally investigate a companys transfer pricing position for all of the years starting from the commencement of its operations, up to the 10-year limit. Special interest levy on tax adjustment Article 48 in the CITL introduces the imposition of a special interest levy on anti-avoidance tax adjustments made by the tax authorities. Prior to enactment of the CITL, there was no penalty for transfer pricing adjustments made by authorities in China, except for the tax on the adjustment itself. This limited compliance incentives for the taxpayer until it faced a transfer pricing review or audit situation. The implementation of the special interest levy will significantly increase the financial costs associated with any anti-avoidance tax adjustment and will no longer be limited only to the transfer pricing tax adjustments. According to Article 122 of the DIR, the special interest levy shall be determined based on the renminbi loan base rate applicable to the relevant period of tax delinquency as published by the Peoples Bank of China in the tax year to which the tax payment is related, plus a penalty component of 5%. The interest levy will be calculated based on the underpaid tax compounded on a
208
Transfer pricing
daily basis, starting from 1 June of the tax year following the year to which the tax payment is related till the day when the tax underpaid is settled. If an enterprise provides relevant information, it may avoid the imposition of the punitive interest component of 5% when the special interest is levied. Since the SAT can make adjustments going back as far as 10 years, the cost to the taxpayer will increase substantially with the interest levy on transfer pricing adjustments. The special interest levy on tax adjustments, therefore, adds an incentive for taxpayers to institute good transfer pricing policies and to maintain proper documentation to mitigate any associated adjustments and interest/penalty risks. Advance pricing arrangements (APA) In China, more and more corporations use the APA to reduce transfer pricing risks. Since the introduction of the APA concept in 1998, and up to the end of 2007, under Guoshuifa [1998] No. 59 roughly 200 APAs, of which four cases are bilateral, have been concluded so far. The first bilateral APA, between Japan and China, was concluded in April 2005. The second bilateral APA, between the US and China, was concluded in January 2007 and the third and fourth bilateral APAs, between Korea and China, were concluded in November 2007. There are currently many unilateral and more than 10 bilateral APAs under discussion. The surge in demand by taxpayers for APAs called for uniform implementation guidelines. In order to standardise the application procedures so as to avoid local variations among different local tax authorities, the SAT released Guoshuihan [2005] No. 1172 in December 2005, further clarifying and reinforcing the formal APA ruling. All APA applications must be approved by the SAT.
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Transfer pricing
Article 42 of the CITL evidences strong support from the central government and potentially enhances the application procedures at the local level. This development could make both the unilateral and bilateral APA processes more attractive, especially given the growth in Chinas cross border transactions. The APA programme in China is generally well received by both taxpayers and tax authorities as a useful option to resolve transfer pricing disputes. Under current APA regulations, an APA can only be retrospectively applied to the year of application. Hence, the APA would not cover the companys transfer pricing issues in previous years. The same idea is also echoed in Article 113 of the DIR. However, the Chinese tax authorities usually require companies to resolve their historical transfer pricing issues before accepting an APA application. Transfer pricing documentation Article 43 of the CITL requires taxpayers to attach a related party transaction report to their annual CIT return. Under current practice, FIEs need to report the transactions that they had conducted with their related parties during the year on either Schedule A-13-A or Schedule A-13-B. The forms are two of the supporting schedules that FIEs must submit to the tax authorities together with their annual corporate income tax returns. Schedule A-13-A is applicable to enterprises that have conducted only a single category of related party transactions during the year. Schedule A-13-B applies to enterprises that have conducted multiple categories of related party transactions during the year. The CITL also authorises the tax authorities to deem a taxpayers taxable income if the taxpayer fails to provide required documentation or provides false or incomplete documentation. This provides further legal basis for
210
Transfer pricing
Chinas contemporaneous documentation rules, which are expected to be issued shortly by the SAT. Until specific documentation requirements are released, however, it is recommended that taxpayers prepare documentation for China either in accordance with their home country requirements or follow the Organisation for Economic Cooperation and Development Guidelines. Thin capitalisation Article 46 of the CITL introduced the thin capitalisation rule, which disallows interest deductions on borrowing from companies if the interest-bearing loans of the enterprise exceed a certain prescribed ratio. At the time of this publication, the prescribed ratio is still yet to be provided by the respective authority. For the purposes of this rule, debt includes only the interest bearing loans obtained directly or indirectly from related parties. Indirect loans include back-to-back arrangements, related party loan guarantees and those with joint and several repayment obligations as well as other loans provided by related parties. Cost sharing arrangements Article 41 of the CITL includes a provision codifying tax deductibility of cost sharing arrangements (CSA). In order to claim a tax deduction on the cost sharing payment, an enterprise will need to share the costs with its related parties or parties at arms length based on the principle of matching of costs and expected benefits. In addition, it will also need to file the relevant information with the tax authorities within the period as required by the tax authorities. Although the new provision provides for tax deductibility of CSA payments, it seems that the SAT will remain focused on CSAs relating to R&D for the time being. It is widely expected that the SAT will ensure that relevant
211
Transfer pricing
implementation rules will be in place in the near future. Overseas affiliates participating in the CSAs of R&D or shared services with Chinese companies should also be aware of withholding tax and business tax issues. Commercial substance needs Under Article 47 of the CITL, Chinese tax authorities can make adjustments where the taxpayer enters into an arrangement without reasonable commercial purpose but for the reduction, exemption or deferral of tax payments. In the past, China placed much emphasis on the form of activities. Now, substance needs to be equally considered by taxpayers for their commercial and intercompany arrangements. Secret comparables and public databases Article 20 of Guoshuifa [1998] No. 59 required the tax authorities to set up a transfer pricing database. The database contains relevant transfer pricing information, such as information reported in income tax returns, market prices of major commodities, trade and industrial profitability ratios, borrowing and lending interest rates, as well as structural and managerial information on MNCs. The Chinese tax authorities often take advantage of the tax return information filed by other companies in the industry to determine an appropriate benchmark for the target company. This database is shared within the tax administration system and is not available to the public. In addition, the tax authorities are encouraged to use the databases of the National Bureau of Statistics and Bureau van Dijk databases, as directed in Guoshuihan [2005] No. 239. The officials are also considering subscribing to other databases to improve their benchmarking capability.
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Chapter 21
Mergers and Acquisitions
Key messages Transfer of ownership may take the form of transferring shares or assets. Various taxes apply in cases of transferring of assets. Parties should be aware of the thin capitalisation rule when arranging financing. Interest deduction for financing seems unlikely. Additional attention required on post-deal issues. General comments on merger and acquisition taxation in the Peoples Republic of China This chapter details the main issues that are relevant to both purchasers and sellers on a transfer of ownership of an enterprise in the Peoples Republic of China (China). It is generally assumed that all sellers are China enterprises and that all purchases are made either by a foreign enterprise (FE) or through a FIE in China, unless otherwise indicated. A transfer of ownership of a Chinese enterprise may take the form of a disposal of shares or assets. The relevant taxes to be considered in the context of a merger and acquisition (M&A) transaction are detailed as follows: Corporate income tax (CIT): generally, Chinese enterprises are taxed on a stand-alone basis. Previously, the taxation of FIEs was governed by the Foreign Enterprise Income Tax Law (FEITL) as distinguished from domestic enterprises. However, FIEs are now covered by the new unified CITL. The profits earned by an enterprise are taxed at the CIT rate of 25%.
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An FE that has no permanent establishment or place of business in China, but derives profit, interest and other income from sources in China, is subject to withholding tax at the rate of 20% with the possibility of exemption or reduction. The withholding tax rate is reduced to 10% by the detailed implementation rules of the new CITL. Value added tax (VAT): a sales tax where up to 17% is added to the sales price charged for goods (except for certain categories of sales which are exempt from or outside the scope of VAT). Business tax (BT): generally, a BT of 5% is imposed on any transfer of immovable assets (e.g. land and real estate) and intangible assets (e.g. trademarks, patents and copyrights). In addition, an FE that derives interest income from China is also subject to BT at the rate of 5%. Consumption tax (CT): a CT is imposed on 14 categories of goods, including cigarettes, alcoholic beverages and certain luxury items. Stamp tax: a stamp tax is payable by both the purchaser and seller at rates ranging from 0.03% to 0.05% on the value of equity or assets transferred. Land appreciation tax (LAT): a LAT is imposed on the seller upon the transfer of land use rights and buildings and is assessed at progressive rates from 30% to 60% of the appreciated amount of the land use right and building. Deed tax: a deed tax is payable by a purchaser at rates ranging from 3% to 5% on the purchase price of land use rights or buildings.
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Acquisitions According to the Provisions on Acquisition of Domestic Enterprises by Foreign Investors (Order No. 10), which came into effect on 8 September 2006 and was issued by the Ministry of Commerce (MOC), the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), the State Administration of Taxation (SAT), the State Administration of Industry and Commerce (SAIC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE), foreign investors are now allowed to acquire Chinese enterprises in one of the following ways: An acquisition of the equity or share holdings of a non-FIE by a foreign investor. This acquisition, subsequently, converts the target entity into an FIE (hereinafter referred to as a stock deal). An acquisition of the assets of a non-FIE by an existing FIE or by a foreign investor through the formation of a new FIE (hereinafter referred to as an asset deal). In light of the above, special rules and regulations apply if foreign investors acquire stock in listed Chinese enterprises. The adoption of an asset deal or a stock deal for an acquisition in China largely depends on the regulatory situation, as well as the commercial and tax objectives of the investors. For example, in some cases an asset deal may be the only option for acquiring businesses from Chinese domestic enterprises. Order No. 10 is the first Chinese regulation legally endorsing and setting out the regulatory framework for cross-border share swap as a form of payment for foreign investors to acquire shares of domestic
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enterprises. Domestic enterprises must engage an M&A advisor to perform a due diligence review on the foreign investor. The M&A advisor, which should be a reputable agency registered in China, has to issue a report setting out its professional opinion on the financial status of the foreign investor. Stock deals According to Order No. 10, under a stock acquisition the target enterprise remains an ongoing concern subject to its originally approved operating period. The acquirer also inherits the business risk and hidden or contingent liabilities, if any, of the target enterprise. Accordingly, this risk should be addressed by performing due diligence on the target; through adjusting the purchase price; and/or obtaining a contractual warranty from the target enterprises prior shareholders, where commercially viable. Under a stock deal, there is no change in the legal existence or disruption to the attributes of the acquired Chinese enterprise. Thus, the target enterprise may not re-value its asset basis for Chinese tax purposes. The transfer of a stock interest in a Chinese entity is subject to stamp tax on the transfer price. Said stamp tax is payable by both the buyer and the seller. Any acquisition expense incurred by the buyer may not be allocated to the target enterprise and, therefore, such expenses generally incurred by the offshore buyer may not be claimed as a tax deduction in China. Generally, tax losses of the target enterprise arising prior to the acquisition may continue to be carried forward after the stock acquisition for any period remaining within the five-year limit.
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Asset deal In general, an asset acquisition involves the formation of a new enterprise for the purpose of acquiring the assets, liabilities and business of a target enterprise. However, it should be noted that the formation of a new enterprise requires certain approval. An asset deal is typically used in order to leave behind some of the inherent risks associated with the target enterprise. An asset acquisition helps to restrict the risks to the specific assets, liabilities and businesses being acquired. Thus, the acquirer generally does not assume any contingent or hidden liabilities of the target enterprise. However, in certain specific situations, an asset deal is not immune from the inherent risks related to the assets acquired. For example, if there is any default on the target enterprises payment of import duty and VAT on the assets acquired, Chinas customs may pursue the assets, notwithstanding that they have been sold. The seller is required to pay Chinese taxes in respect of the transfer of the following assets: Nature of assets acquired Land and building Intangibles Inventory Inventory Category of goods subject to CT Used equipment sold above original cost Relevant tax LAT at various rates and business tax of 5% Business tax of 5% VAT of 17% CT at various rates VAT of 2%
Motor vehicles sold higher VAT of 2% than the original cost
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Generally, the seller and buyer may only retain and carry forward their respective tax losses and may not transfer the tax losses to the other party through the transfer of their assets and business operations to the other party. Financing of acquisitions Thin capitalisation According to the prevailing Chinese FIE laws and regulations, an FIE should comply with the prescribed debt-to-equity ratio (i.e. the difference between the total investment and registered capital may be financed by debt). Moreover, the new CITL contains a specific thin capitalisation rule disallowing interest deductions on borrowing from related enterprises if the interest bearing loans of the enterprise exceed certain prescribed debtequity ratios, which will be addressed by future circulars. Deductibility of interest Under the new CITL, interest expenses incurred in respect of loans used to acquire an investment or stock shall be capitalised and are not deductible from taxable income. An asset deal generally involves the formation of a new enterprise to acquire the relevant assets. In respect of a new enterprise, interest incurred to acquire the relevant assets shall be capitalised and depreciated over the useful life of the assets for CIT purposes. Merger In China, a merger refers to the combination of two or more enterprises into one enterprise. Such a combination may take the form of an absorption merger or a new enterprise merger.
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An absorption merger is a merger where one party continues to exist while other parties to the merger are dissolved. A new enterprise merger is a merger where all the parties to the merger are dissolved, and a new enterprise is established to take over the merged business. Other structuring and post-deal issues Apart from the issues covered above, the following issues are other statutory and post-deal issues that need to be considered: Repatriation of profits Under the CITL, any after-tax profit remitted by an FIE to its foreign investors is subject to Chinese withholding tax at 20% but with a possibility of exemption or reduction. The detailed implementation rules confirm that the withholding tax rate is reduced to 10%. Meanwhile, by virtue of a grandfathering treatment, dividend paid out of the cumulative retained earnings as of 31 December 2007 shall be exempt from Chinese withholding income tax. However, before an FIE may distribute dividends to its foreign investor, the FIE must meet the following conditions: The registered capital has been duly paid in accordance with the provisions of its articles of association. The company has begun to make a profit (i.e. show profits after covering the accumulated tax losses from prior years, if any). CIT has been paid by the FIE or the company is in a tax exemption period. The statutory after-tax reserve funds (see below) have been provided for.
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According to Chinas Equity Joint Venture Law, a foreign equity joint venture company is required to contribute its after-tax profit to a statutory reserve fund before any after-tax profit may be distributed to its shareholders as dividends. Components of the statutory reserve fund include the general reserve fund (GRF), staff benefit and welfare fund (SBWF) and enterprise development fund (EDF). The contribution rate to the SBWF and EDF is at the discretion of the FIE. However, the company must contribute at least 10% of its after-tax profits to the GRF until the cumulative amount represents 50% of the registered capital. A WFOE is only required to provide GRF and SBWF, and not EDF. In addition, an FIE is allowed to repatriate its after-tax profits as dividend payments in foreign currency upon the presentation of the following documents/certificates: The board of directors resolution on distribution of profits. An audit report issued by a Chinese CPA certifying the amount of distributable profits. The relevant tax payment certificates. Generally, profit remittances as dividend payments do not need the approval of the SAFE but may be made by the remitters through their basic foreign exchange accounts at a bank. Losses carried forward and applicable tax rate Under the old FEIT regime, tax losses arising in premerger periods could continue to be carried forward by the surviving entity for not more than five years.
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The FEIT rates applicable to different operations of the surviving entity are determined according to the locality and industrial nature of the actual business activities of the operation. Where different tax holiday treatments or tax rates are applicable to different operations of the surviving entity, an apportionment of taxable income is required for FEIT purposes. Losses carried forward from operations entitled to different tax treatments, for example, tax holiday concessionary rates (hereinafter referred to as tax operations), may be offset only against the corresponding apportioned taxable income of the surviving entity. Where different tax rates apply, the taxable income of the surviving entity is apportioned based on the rules below: Actual basis Where different tax operations are maintained by the surviving entity and separate accounting books are kept to record the activities of each tax operation, taxable income may be apportioned on an actual basis (i.e. based on each operations own accounting records). The resulting apportionment should still be accurate and reasonable. Deemed ratio Where the surviving entity does not maintain different tax operations or where the surviving entity maintains different tax operations but is unable to compute the respective taxable income on an accurate and reasonable basis, the surviving entity should apportion its total taxable income among the tax operations based on certain financial ratios (e.g. annual turnover, cost, expense, assets, number of employees, wages and salaries). The taxpayer may use one or a weighted average of all such ratios subject to the tax authoritys agreement. Where the relevant ratios for the year of merger are difficult to determine, the records for the last complete tax year before the merger may be used.
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When the surviving entity has a net profit or loss, income tax should be levied at the rates applicable to the profit making operations. For those operations which have been sustaining losses but which have turned profitable in a later year, special rules apply in determining the tax rate. It is not specified whether the above treatments will remain intact in the new CITL. It is anticipated that further regulations regarding CIT treatments of mergers and acquisitions will be issued by the Chinese tax authorities. Continuation of tax incentives Unless otherwise stipulated, when the ratio of foreign investment in an FIE falls below 25% of the total registered capital after an acquisition, merger or demerger, Chinas FEIT laws and regulations applicable to FIEs no longer apply to that reorganised entity. Instead, the reorganised entity is treated as a domestic enterprise (as opposed to an FIE) for tax purposes. As a result, any FEIT exemption or reduction already enjoyed by the original FIE during its FEIT holidays should be treated as follows: If all of the foreign investment in the FIE remains in the reorganised entity, no clawback of the exempted or reduced FEIT will be required regardless of the actual operating term of the reorganised entity. If all or some of the foreign investment in the FIE has been withdrawn or transferred to domestic investors during the reorganisation, and the operating term of the reorganised entity does not meet the FEIT holiday requirement (normally 10 years), a clawback is required for the previously exempted or reduced FEIT amounts.
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The new CITL has not specified whether the above treatments will remain intact. It is anticipated that further regulations regarding CIT treatments of mergers and acquisitions will be issued by the Chinese tax authorities. Group relief Taxation for FIEs in China is on an entity basis. Group relief is not generally applicable to FIEs in China. Disposals The adoption of an asset deal or a stock deal for an acquisition in China largely depends on the regulatory situation, as well as the commercial and tax objectives of the investors. In some cases, an asset deal may be the only option for selling the business by the seller (especially for state-owned enterprises) due to regulatory restrictions. De-mergers In China, a de-merger refers to the split of one entity into two (or more) entities (referred to as the surviving entities) according to the relevant Chinese laws and regulations. De-mergers can be categorised as split-off de-mergers and spin-off mergers. Listing/Initial Public Offer (IPO) The tax status of an enterprise being listed and its subsidiaries is generally unaffected by a listing/IPO.
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Appendix I
Corporate income tax rates
Income tax rates applicable to tax resident enterprises Effective from 1 January 2008 Tax Non-tax resident resident enterprises enterprises % All taxable income Taxable income attributable to an establishment or place in China Passive income (Withholding tax on profits, interest, rentals, royalties, and other income)
* 10% concessionary rate is available under the detailed implementation rules of the new corporate income tax law and further reduced rates may also be available under double tax treaties. Notes: 1. Certain exemptions from and reductions in income tax are available for tax resident enterprises engaged in some encouraged industries. 2. A foreign enterprise which is a non-tax resident enterprise in China is subject to a standard income tax rate of 25% on income derived from its place(s) of business or its establishment(s) in China. 3. Withholding tax is levied on non-tax resident foreign enterprises with no establishment or place of business in China and on income not effectively connected with an establishment or place of business. In certain circumstances concessionary reductions are available under certain tax treaties and in respect of royalties received for the provision of technical know-how.
Nature of income
% 25
25
20*
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Appendix II
Tax depreciation rates
Under Chinas tax laws, depreciation of fixed assets should be computed according to the straight-line method. Under certain circumstances, accelerated depreciation is allowed. In computing depreciation on fixed assets, the residual value is to be assessed and deducted from the original value. The residual value should be determined at the beginning based on the nature of the fixed asset concerned and the usage pattern. Once the residual value is fixed, no change can be made. The tax authorities have set minimum depreciation periods for certain assets, as follows: Minimum number of years Premises, buildings and structures Aircrafts, trains, ships, machinery, and other production equipment Appliances, tools and furniture relating to production and business operations Means of transportation other than aircrafts, trains and ships Electronic equipment 20 10 5 4 3
For enterprises engaged in petroleum exploitation, different depreciation methods are required for fixed assets. In addition, biological assets are required to accrue depreciation based on straight-line method. Similarly, in computing depreciation on biological assets, the residual value is to be assessed and deducted from the original value. The residual value should be determined at the beginning based on the nature of the fixed asset concerned and the utilisation pattern. Once the residual value is fixed, no change can be made.
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Tax depreciation rates
The tax authorities have set minimum depreciation periods for certain biological assets, as follows: Minimum number of years Forestry related Animal related 10 3
For representative offices, fixed assets should be written off during the year of purchase. If the cost of fixed assets (e.g. buildings, automobiles, computers, decoration expenditure resulted from removal) is material and the representative office can provide complete books and records to the tax authorities for examination, depreciation of fixed assets may be allowed. In computing depreciation of fixed assets, the straight-line method, without retaining the residual value, and the minimum depreciation periods set out above, must be used.
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Appendix III
Corporate tax calculations
Sample tax calculations for resident enterprises are as follows: Equity joint venture Year 200X Party A (Chinese): 60% Party B (Foreign): 40% Gross revenue LessExpenses Taxable profit Income tax (at 25%) After-tax profit LessFund distributions: Reserve fund Enterprise expansion fund Staff bonus and welfare fund Distributable profit (after tax ) Profit distribution to Party A: Profit distributed to Party A (6,750,000 x 60%) Income tax on Party A --- Nil Profit distribution to Party B: Profit distributed to Party B (6,750,000 x 40%) Dividend withholding tax (at 10%**) on Party B (2,700,000 x 10%) Profit remittable abroad to Party B RMB 2,430,000 270,000 RMB 2,700,000 0 RMB 4,050,000 RMB 750,000 6,750,000 RMB 100,000,000 90,000,000 10,000,000 2,500,000 7,500,000
** Assuming the withholding income tax rate for dividend under the tax treaty between China and the country of Party B is not lower than 10%.
Appendix IV
Tax treaty summary
Summary of Withholding Taxes for Corporations Resident in Treaty Countries/Region

(Mainland China has signed 90 tax treaties with 90 countries and two arrangements with two special administrative regions as at 31 December 2007)*
No. 1 2 3 4
Countries (in English) Albania Algeria Armenia Australia
Countries (in Chinese)
Dividends % 10 10,5 (3a) 10,5 (3a) 15
Interest (1) % 10 7 10 10
Royalties (2) % 10 10 10 10
Date of Signature 13 Sep. 2004 6 Nov. 2006 5 May. 1996 17 Nov. 1988
Place of Signature Beijing Beijing Beijing Canberra
Effective Date 28 Jul. 2005 27 Jul. 2007 28 Nov. 1996 28 Dec. 1990
Enforcement Date 1 Jan. 2006 1 Jan. 2008 1 Jan. 1997 1 Jan. 1991 (Mainland China) / 1 Jul. 1991 (Australia) 1 Jan. 1993 1 Jan. 2006 1 Jan. 2003 1 Jan. 1998 (Mainland China) / 1 Jul. 1998 (Bangladesh) 1 Jan. 2001 1 Jan. 1997 1 Jan. 1988 1 Jan. 1994 1 Jan. 1991 / 1 Jan. 2003 (revised version)
5 6 7 8
Austria Azerbaijan Bahrain Bangladesh
10,7 (3b) 10 5 10
10,7 (4a) 10 10 10
10,6 10 10 10
10 Apr. 1991 17 Mar. 2005 16 May. 2002 12 Sep. 1996
Beijing Beijing Beijing Beijing
1 Nov. 1992 17 Aug. 2005 8 Aug. 2002 10 Apr. 1997
9 10 11 12 13
Barbados Belarus Belgium Brazil Bulgaria
5 10 10 15 10
10 10 10 15 10
10 10 10,6 25,15 (5) 10,7
15 May. 2000 17 Jan. 1995 18 Apr. 1985 5 Aug. 1991 6 Nov. 1989 / 15 Jul. 2002 (revised version) 21 Sep. 2004
Beijing Beijing Beijing Beijing Beijing
27 Oct. 2000 3 Oct. 1996 11 Sep. 1987 6 Jan. 1993 25 May 1990 / 2 Jan. 2003 (revised version) 29 Dec. 2006
14
Brunei
10
10
Beijing
1 Jan. 2007
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Tax treaty summary
No. 15 16 17 18 19 20 21 22 23 24 25 26
Countries (in English) Canada Croatia Cuba Cyprus Czech Republic Denmark Egypt Estonia Finland France Georgia Germany
Dividends % 15,10 (8b) 5 10,5 (3a) 10 10 10 8 10,5 (3a) 10 10 10,5,0 (3e) 10
Interest (1) % 10 10 7.5 10 10 10 10 10 10 10 10 10
Royalties (2) % 10 10 5 10 10 10,7 8 10 10,7 10,6 5 10,7
Date of Signature 12 May. 1986 9 Jan. 1995 13 Apr. 2001 25 Oct. 1990 11 Jun. 1987 26 Mar. 1986 13 Aug. 1997 12 May. 1998 12 May. 1986 30 May. 1984 22 Jun. 2005 10 Jun. 1985
Place of Signature Beijing Beijing Havana Beijing Prague Beijing Cairo Beijing Helsinki Pairs Beijing Bonn
Effective Date 29 Dec. 1986 18 May. 2001 17 Oct. 2003 5 Oct. 1991 23 Dec. 1987 10 Nov. 1986 24 Mar. 1999 8 Jan. 1999 18 Dec. 1987 20 Feb. 1985 10 Nov. 2005 14 May. 1986
Enforcement Date 1 Jan. 1987 1 Jan. 2001 1 Jan. 2004 1 Jan. 1992 1 Jan. 1988 1 Jan. 1987 1 Jan. 2000 1 Jan. 2000 1 Jan. 1988 1 Jan. 1986 1 Jan. 2006 1 Jan. 1985 / 1 Jul. 1985 (royalties and interest only)
27
Greece
10, 5 (3a)
10
10
3 Jun. 2002
Beijing
11 Nov. 2005 1 Jan. 2006 8 Dec. 2006 1 Jan. 2007 (Mainland China) / 1 Apr. 2007 (Hong Kong) 1 Jan. 1995 1 Jan. 1998 1 Jan. 1995 1 Jan. 2004 1 Jan. 2004
28
Hong Kong Special Administrative Region Hungary Iceland India Indonesia Iran
10,5 (3f)
7, 0 (4b)
21 Aug. 2006 (new version) 17 Jun. 1992 3 Jun. 1996 18 Jul. 1994 7 Nov. 2001 20 Apr. 2002
Hong Kong
29 30 31 32 33
10 10,5 (3a) 10 10 10
10 10 10 10 10
10 10,7 10 10 10
Beijing Beijing New Delhi Jakarta Teheran
31 Dec. 1994 5 Feb. 1997 19 Nov. 1994 25 Aug. 2003 14 Aug. 2003
229
Tax treaty summary
No. 34
Countries (in English) Ireland
Dividends % 10,5 (3b)
Interest (1) % 10
Royalties (2) % 10,6
Date of Signature 19 Apr. 2000
Place of Signature Dublin
Effective Date 29 Dec. 2000
Enforcement Date 1 Jan. 2001 (Mainland China)/ 1 Jan 2001 (corporate tax in Ireland); 6 Apr. 2001 (income and capital gains taxes in Ireland) 1 Jan. 1996 1 Jan. 1990 1 Jan. 1998 1 Jan. 1985 1 Jan. 2004 1 Jan. 1995 1 Jan. 1989 1 Jan. 2004 1 Jan. 2000
35 36 37 38 39 40 41 42 43
Israel Italy Jamaica Japan Kazakstan Korea, Rep. Of Kuwait Kyrgizastan Laos
10 10 5 10 10 10,5 (3a) 5 10 5
10,7 (4a) 10 7.5 10 10 10 5 10 5 (in Laos) 10 (in Mainland China) 10 10 10 10 , 7 (4a)
10,7 10,7 10 10 10 10 10 10 5 (in Laos) 10 (in Mainland China) 10 10 10,6 10
8 Apr. 1995 31 Oct. 1986 3 Jun. 1996 6 Sep. 1983 12 Sep. 2001 28 Mar. 1994 25 Dec. 1989 24 Jun. 2002 25 Jan. 1999
Beijing Beijing Beijing Beijing Beijing Kuwait Beijing Beijing
22 Dec. 1995 14 Nov. 1989 15 Mar. 1997 26 Jun. 1984 27 Jul. 2003 27 Sep. 1994 20 Jul.1990 29 Mar. 2003 22 Jun. 1999
44 45 46 47
Latvia Lithuania Luxembourg Macao Special Administrative Region Macedonia Malaysia Malta
10,5 (3a) 10,5 (3a) 10,5 (3a) 10
7 Jun. 1996 3 Jun. 1996 12 Mar. 1994 17 Dec. 2003
Riga Vilnius Beijing Macao
27 Jan. 1997 18 Oct. 1996 28 Jul.1995 30 Dec. 2003
1 Jan. 1998 1 Jan. 1997 1 Jan. 1996 1 Jan. 2004
48 49 50
5 10 10
10 10 10
10 15 (7),10 10
9 Jun. 1997 23 Nov. 1985 2 Feb. 1993
Beijing Beijing Beijing
29 Nov. 1997 14 Sep. 1986 30 Mar. 1994
1 Jan. 1998 1 Jan. 1987 1 Jan. 1995
230
Tax treaty summary
No. 51 52 53 54 55 56 57 58 59 60 61 62
Countries (in English) Mauritius Mexico Moldova Mongolia Morocco Nepal Netherlands New Zealand Nigeria Norway Oman Pakistan
Dividends % 5 5 10,5 (3a) 5 10 10 10 15 7.5 15 5 10
Interest (1) % 10 10 10 10 10 10 10 10 7.5 10 10 10
Royalties (2) % 10 10 10 10 10 15 (6) 10,6 10 7.5 10 10 12.5
Date of Signature 1 Aug. 1994 12 Sep.2005 7 Jun. 2000 26 Aug. 1991 27 Aug. 2002 14 May. 2001 13 May. 1987 16 Sep. 1986 15 Apr. 2002 25 Feb. 1986 25 Mar. 2002 15 Nov. 1989
Place of Signature Beijing Mexico City Beijing Ulaan Baator Katmandu Netherlands Wellington Beijing Islamabad
Effective Date 4 May. 1995 1 Mar. 2006 26 May. 2001 23 Jun. 1992 16 Aug. 2006 Not yet in force 5 Mar. 1988 17 Dec. 1986 Not yet in force 21 Dec. 1986 20 Jul. 2002 27 Dec. 1989
Enforcement Date 1 Jan. 1996 1 Jan. 2007 1 Jan. 2002 1 Jan. 1993 1 Jan. 2007
1 Jan. 1989 1 Jan. 1987
1 Jan. 1987 1 Jan. 2003 1 Jan. 1990 (Mainland China) / 1 Jul. 1990 (withholding tax in Mainland China only) / 1 Jul. 1990 (Pakistan) 1 Jan. 1996 1 Jan. 2002 1 Jan. 1990 1 Jan. 2001
63 64 65 66 67 68 69
Papua New Guinea Philippines Poland Portugal Qatar Romania Russia
15 15,10 (8c) 10 10 10 10 10
10 10 10 10 10 10 10
10 15 (7),10 10,7 10 10 7 10
14 Jul. 1994 18 Nov. 1999 7 Jun. 1988 21 Apr. 1998 2 Apr. 2001 16 Jan. 1991 27 May. 1994
Beijing Beijing Beijing Beijing Beijing Beijing Beijing
16 Aug. 1995 23 Mar. 2001 7 Jan. 1989 7 Jun. 2000 Not yet in force 5 Mar. 1992 10 Apr. 1997
1 Jan. 1993 1 Jan. 1998
231
Tax treaty summary
No. 70
Countries (in English) Saudi Arabia
Dividends % 5
Interest (1) % 10
Royalties (2) % 10
Date of Signature 23 Jan 2006
Place of Signature Beijing
Effective Date 1 Sep. 2006 1 Jan. 2007 17 Dec. 1999 18 Sep. 2007
Enforcement Date
71 72
Seychelles Singapore
5 10,5 (3a)
10 10,7 (4a)
10 10,6
26 Aug. 1999 11 Jul. 2007
Beijing Singapore
1 Jan. 2000 1 Jan. 2008 (Mainland China) / 1 Jan. 2009 (Singapore) 1 Jan. 1988 1 Jan. 1996 1 Jan. 2002 1 Jan. 1993 1 Jan. 2006 1 Jan. 2000 1 Jan. 1987 1 Jan. 1990 1 Jan. 1987 1 Jun. 2005 / 1 Jan. 2006 (depending on the type of taxes) 1 Jan. 2004 1 Jan. 1998 1 Jan. 1997 (Mainland China) / 1 Jan. 1997 (Ukraine) / 17 Dec. 1996 (dividends, interest and royalties in the Ukraine only)
73 74 75 76 77 78 79 80 81 82
Slovak Republic Slovenia South Africa Spain Sri Lanka Sudan Sweden Switzerland Thailand Trinidad and Tobago, Rep. Of
10 5 5 10 10 5 10,5 (3a) 10 20,15 (3c)
10 10 10 10 10 10 10 10 10 10
10 10 10,7 10,6 10 10 10,7 10,6 15 10
11 Jun. 1987 13 Feb. 1995 25 Apr. 2000 22 Nov. 1990 11 Aug. 2003 30 May. 1997 16 May. 1986 6 Jul. 1990 27 Oct. 1986 18 Sep. 2003
Prague Beijing Pretoria Beijing Beijing Beijing Stockholm Beijing Bangkok Spain Port
23 Dec. 1987 27 Dec. 1995 7 Jan. 2001 20 May. 1992 22 May. 2005 9 Feb. 1999 3 Jan. 1987 27 Sep. 1991 29 Dec. 1986 22 May 2005
10,5 (3a)
83 84 85
Tunisia Turkey Ukraine
8 10 10,5 (3a)
10 10 10
10,5 (9) 10 10
16 Apr. 2002 23 May. 1995 4 Dec. 1995
Tunisia Beijing Beijing
23 Sep. 2003 20 Jan. 1997 18 Oct. 1996
232
Tax treaty summary
No. 86 87
Countries (in English) United Arab Emirates United Kingdom
Dividends % 7 10
Interest (1) % 7 10
Royalties (2) % 10 10,7
Date of Signature 1 Jul. 1993 26 Jul. 1984
Place of Signature Abu Dhabi Beijing
Effective Date 14 Jul. 1994 23 Dec. 1984
Enforcement Date 1 Jan. 1995 1 Jan. 1985 (Mainland China) / 1 Apr. 1985 (corporate tax in the UK) / 6 Apr. 1985 (income and capital gains taxes in the UK) 1 Jan. 1987 1 Jan. 1997 1 Jan. 2005 1 Jan. 1997 1 Jan. 1998
88 89 90 91 92
United States Uzbekistan Venezuela Vietnam Yugoslavia
10 10 10,5 (8d) 10 5
10 10 10,5 (4a) 10 10
10,7 10 10 10 10
30 Apr. 1984 3 Jul. 1996 17 Apr. 2001 17 May. 1995 21 Mar. 1997
Beijing Tashkent Beijing Belgrade
21 Nov. 1986 3 Jul. 1996 23 Dec. 2004 18 Oct. 1996 1 Jan. 1998
The numbers in parentheses above refer to the notes below. 1 Nil on interest paid to government bodies. Reference should be made to the individual tax treaties. 2 The lower rate on royalties applies for the use of or right to use any industrial, commercial or scientific equipment. Reference should be made to the individual tax treaties. 3a The lower rate applies to dividends paid by a company (not a partnership) and received by a company owning at least 25% of the capital of the paying company. 3b The lower rate applies to dividends paid by a company and received by a company owning at least 25% of the voting power of the paying company. 3c The lower rate applies to dividends paid by a company (not a partnership) and received by a company owning at least 25% of the shareholding of the paying company. 3d The lower rate applies to dividends paid by a company or a partnership and received by a company owning at least 25% of the shareholding of the paying company. 3e The lowest rate (i.e. 0%) applies to dividends paid by a company (not a partnership) and received by a company owning at least 50% of the shareholding of the paying company or investment amounting to Euro2 million. The lower rate (i.e. 5%) applies to dividends paid by a company (not a partnership) and received by a company owning at least 10% of the shareholding of the paying company or investment amounting to Euro100 thousand. 3f The lower rate applies to dividends paid by a company and received by a company owning at least 25% of the capital of the paying company.
233
Tax treaty summary
4a The lower rate applies to interest payable to banks or financial institutions. 4b The lower rate applies to interest payable to organisations nominated by ones government or tax authorities of both sides. 5 The higher rate applies to trademarks. 6 The tax rate may be reduced to a lower rate if Nepal agrees a lower tax rate with any other countries. 7 The higher rate applies to artistic royalties/cinematographic films and tapes for television or broadcasting. 8a The lower rate applies where the beneficial owner of the dividend is a company (not a partnership) that owns at least 10% of the shareholding of the paying company. 8b The lower rate applies where the beneficial owner of the dividend is a company that owns at least 10% of the voting stock of the paying company. 8c The lower rate applies where the beneficial owner of the dividend is a company that owns at least 10% of the shareholding of the paying company. 8d The lower rate applies where the beneficial owner is a company (other than a partnership) which holds directly at least 10% of the capital of the company paying the dividends. 9 The lower rate applies to technology or economic research or technology subsidies. General attention points : This table is a summary only and does not reproduce all the provisions relevant in determining the application of withholding taxes in each tax treaty/arrangement. The former Czechoslovak Socialist Republic is divided into the Czech Republic and the Slovak Republic. The former Yugoslavia is divided into Bosnia, Croatia, Macedonia, Serbia, Slovenia and Yugoslavia There is no tax treaty signed between China and Bosnia and Serbia.
234
Appendix V
Tax rates Foreign nationals working in China
Individual income tax rates Monthly taxable income Over (Column 1) 0 RMB 500 2,000 5,000 20,000 40,000 60,000 80,000 100,000 RMB 500 2,000 5,000 20,000 40,000 60,000 80,000 100,000 RMB 25 175 625 3,625 8,625 14,625 21,625 29,625 5 10 15 20 25 30 35 40 45 Not over Tax on Column 1 Percentage on excess
The following table shows the comparison in the tax rates after the individuals liability has been calculated on the gross up basis and the non-gross up basis. Individual income tax ratesComparison (US$1 = RMB8*) Effective tax rate Taxable income** US$ 20,000 40,000 60,000 80,000 100,000 150,000 200,000 300,000 Without With gross up effect gross up effect (Employee pays tax) (Employer pays tax) % 10 15 19 21 23 28 32 36 % 12 20 26 31 36 50 58 66
*Approximately. **Annual salary.

Appendix VI
Personal allowances Foreign nationals working in China
The Individual Income Tax Law of the PRC allows deductions from certain categories of income in computing the individual income tax of foreign individual taxpayers, as follows. Taxable income Income from wages and salaries Additional monthly deduction on wages and salaries for foreign individuals Income from compensation for personal services, remuneration from manuscripts, royalties or the leased properties: If the receipt is less than RMB4,000 If the receipt is in the amount of RMB4,000 or more
Notes: 1. For income from compensation for personal services, remuneration from manuscripts, royalties or the leased properties, the economic substance of a transaction will determine whether income received in several installments of not more than RMB4,000 each (and thus eligible for multiple RMB800 standard deductions) will be treated as a lump sum. If the installment payments are the result of a single economic transaction, they will be treated as a lump sum. Actual expenses are not deductible against compensation for personal services, remuneration from manuscripts, and royalties. A limited deduction is available for expenses incurred in connection with the leased properties. 2. Interest, dividends, bonuses on investments, contingent income, and other kinds of income are taxed on the gross amounts received, without deductions.
Deduction RMB2,000 per month RMB2,800 per month
RMB800 20%
236
Appendix VII Individual tax calculation Foreign nationals working in China
The following example illustrates the calculation of the gross up method. Assumptions 1. The individual is a foreign expatriate for income tax purposes. Therefore, a monthly personal allowance of RMB4,800 is available. 2. The monthly compensation is as follows: Gross up method RMB Gross monthly salary Hypo tax deduction, say Monthly income 30,000 (4,500) 25,500 Non-gross up method RMB 30,000 N/A 30,000
Computation of individual income tax Gross up Non-gross up calculation calculation RMB Monthly income Less: Personal allowance Monthly taxable income Gross up income* Tax at applicable rate of 25% Less: Quick deduction Monthly tax payable 25,500 4,800 20,700 25,767 6,442 (1,375) 5,067 RMB 30,000 4,800 25,200 N/A 6,300 (1,375) 4,925
*Gross up calculation: (20,700 -1,375) (1 25%) = 25,767
237
Individual tax calculation Foreign nationals working in China
Formulas and quick deduction table Gross up taxable income = (Monthly taxable income applicable quick deduction) (1 applicable tax rate) Tax payable = (Gross up taxable income applicable tax rate) applicable quick deduction.
238
Appendix VIII Selected indirect taxes
Value-added tax Goods subject to 13% tax rate Food grains, edible vegetable oils Tap water, heating, air-conditioning, hot water, coal gas, liquefied petroleum gas, natural gas, methane gas, coal and charcoal products for household use Books, newspapers, magazines Feeds, certain chemical fertilizers, certain agricultural chemicals, agricultural machinery, plastic covering film for farming Other goods as stipulated by the State Council Goods exempt from VAT Self-produced agricultural products sold by agricultural producers. Contraceptive medicines and devices. Antique books. Imported instruments and equipment used directly in scientific research, experiment and education. Materials and equipment imported free of charge from foreign governments and international organizations. Equipment and machinery required to be imported under contract processing, contract assembly and compensation trade. Articles imported directly by organizations for the disabled for special use by the disabled. Certain secondhand goods.
239
Selected indirect taxes
Business tax Taxable items and tax rates Taxable items Communications and transportation Scope of charge Transportation by land, water, air, Pipeline; loading, unloading and delivery Construction, installation, repair, decoration, other engineering work Tax rate % 3
Construction
Finance and insurance Postal services and telecommunications Culture and sports Entertainment Night clubs, karaoke lounges, singing and dancing bars and lounges, music halls, snooker and billiards parlors, golf, bowling, other amusement facilities Services Agencies, hotels, catering, tourism, warehousing, leasing, advertising, other services Transfer of Land-use rights, intangible assets patents, nonpatented technology, trademark rights, copyrights, goodwill Sale of immovable Buildings, other fixtures properties attached to land
5 3 3 520
240
Consumption tax Taxable Item

I. Tobacco 1. Cigarettes Basic charge Additional charge 2. Cigars 3. Cut tobacco II. Alcoholic drinks and alcohol 1. White spirits made from cereal or potatoes Basic charge Additional charge 2. Yellow spirits 3. Beer 4. Other alcoholic drinks 5. Alcohol III. Cosmetics (including cosmetic sets and luxurious skin-care products) Precious jewellery, precious jade and stones (including all kinds of gold, silver, jewellery, and pre-ciousstone ornaments ) and jewellery made with gold, silver and gold and silver mixed with alloys Firecrackers and firework Motor vehicle tyre (Note 1) Motorcycle Cylinder capacity of 250 ml or below Cylinder capacity of more than 250 ml 3% 10% Ton Ton Catty (500g) RMB0.5 20% RMB240 RMB220-250 10% 5% 30% 50,000 pieces RMB150 30%/45% 25% 30%
Taxable Unit
Tax Rate / Amount
IV.
5%/10%
V. VI. VII.
15% 3%
241
Taxable Item VIII. Motor car 1. Private car Cylinder capacity of 1.5 li-tres and below Cylinder capacity of 1.5 2 litres (including 2 litres) Cylinder capacity of 2 2.5 litres (including 2.5 li-tres) Cylinder capacity of 2.5 3 litres (including 3 litres) Cylinder capacity of 3 - 4 litres (including 4 litres) Cylinder capacity of more than 4 litres 2. Medium/Light vehicle for busi-ness use IX. X. XI. XII. XIII. XIV. Golf ball and equipment Luxury watch Yacht Disposable wooden chopsticks Wooden floorboard Product oil 1. Gasoline Unlead Lead (contain lead of over 0.013g/litre) 2. Diesel 3. Naphtha (Note 2) 4. Solvent oil (Note 2)
Taxable Unit
Tax Rate / Amount
3% 5% 9%
12% 15% 20% 5% 10% 20% 10% 5% 5%
Litre Litre Litre Litre (1 Ton =1,385 Litres) Litre (1 Ton =1,282 Litres)
RMB0.2 RMB0.28 RMB0.1 RMB0.2 RMB0.2
242
Taxable Item 5. Lubricating oil (Note 2) 6. Fuel oil (Note 2) 7. Aviation kerosene (Note 3)
Taxable Unit Litre (1 Ton =1,126 Litres) Litre (1 Ton =1,015 Litres) Litre (1 Ton =1,246 Litres)
Tax Rate / Amount RMB0.2 RMB0.1 RMB0.1
Note : 1. Radial-ply tyres are temporarily exempted from CT. 2. 70% consumption tax naphtha, solvent oil, lubricating oil and fuel oil is temporarily exempted. 3. Consumption tax on aviation kerosene is temporarily exempted.
243
Appendix IX
Illustrative financial statements
XYZ Limited Company Balance sheet As of 31 December 20X9 (In thousands of renminbi) 20X9 Assets Current assets: Cash at bank and in hand Financial assets held for trading Notes receivable Account receivables Prepayments Interest receivable Dividends receivable Other receivables Inventories Current portion of non-current assets Total current assets Non-current assets: Available-for-sale financial assets Held-to-maturity investments Long-term receivables Long-term equity investments Investment properties Fixed assets Construction in progress 10,015 7,800 2,322 13,373 3,000 149,895 2,100 22,228 14,839 9,449 3,672 2,123 331 423 3,456 24,700 311 81,532 20X8
244
(In thousands of renminbi) 20X9 Construction materials Intangible assets Development expenditures Goodwill Long-term prepaid expenses Deferred tax assets Total non-current assets Total assets 346 20,631 2,233 2,100 458 3,319 217,592 299,124 (In thousands of renminbi) 20X9 Liabilities and Owners equity Current liabilities: Short-term borrowings Financial liabilities held for trading Notes payable Account payables Advance from customers Employee benefits payable Taxes payable Interest payable Dividends payable Other payables Current portion of non-current liabilities Total current liabilities 9,524 595 5,200 12,470 316 2,788 2,942 678 758 1,230 992 37,493 20X8 20X8
245
(In thousands of renminbi) 20X9 Non-current liabilities: Long-term borrowings Long-term payables Provisions Deferred tax liabilities Other non-current liabilities Total non-current liabilities Total liabilities Owners equity: Paid-in capital Capital reserves Surplus reserves Undistributed profits Total owners equity Total liabilities and owners equity 25,300 16,092 14,699 84,535 140,626 299,124 158,498 100,825 3,259 4,231 12,370 320 121,005 20X8
246
XYZ Limited Company Income Statement For the year ended 31 December 20X9 (In thousands of renminbi) 20X9 Revenue Less: Operating costs Taxes and levies on operations Selling and distribution expenses Administrative expenses Financial expenses net Impairment of assets Add: Gains/(losses) from changes in fair values Investment income/(losses) Operating profit Add: Non-operating income Less: Non-operating expenses Total profit Less: Income tax expenses Net profit (550) (174) 40,708 1,963 (90) 42,581 (10,005) 32,576 (76,737) (5,416) (46,940) (28,786) (7,073) (4,650) 211,034 20X8
247
XYZ Limited Company Cash Flow Statement For the year ended 31 December 20X9 (In thousands of renminbi) 20X9 1. Cash flows from operating activities Cash received from sales of goods and rendering of services Receipts of tax refunds Cash received relating to operating activities Subtotal of cash inflows Cash payments for goods purchased and services received Cash payments to and on behalf of employees Payments of taxes and levies Other cash payments relating to operating activities Subtotal of cash outflows Net cash flows from operating activities 212,373 20X8
2,210 1,420 216,003 (69,203)
(4,509) (10,317) (101,706)
(185,735) 30,268
248
(In thousands of renminbi) 20X9 2. Cash flows from investing activities Proceeds from disposal of investments Cash received from returns on investments Net cash received from disposal of fixed assets, intangible assets and other long-term assets Subtotal of cash inflows Cash payments to acquire fixed assets, intangible assets and other long-term assets Cash payments to acquire investments Subtotal of cash outflows Net cash flows from investing activities 880 448 474 20X8
1,802 (12,205)
(1,331) (13,536) (11,734)
249
(In thousands of renminbi) 20X9 3. Cash flows from financing activities Cash received from capital contributions Cash received from borrowings Subtotal of cash inflows Repayments of amounts borrowed Payments for interest expenses and distribution of dividends or profits Subtotal of cash outflows Net cash flows from financing activities 4. Effect of foreign exchange rate changes on cash and cash equivalents 5. Net increase in cash and cash equivalents Add: Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period 950 58,500 20X8
59,450 (71,000) (21,503)
(92,503) (33,053) 535
(13,984) 36,212
22,228
250
XYZ Limited Company Statement of Changes in Owners Equity For the year ended 31 December 20X9
(In thousands of renminbi) 20X9 Paid in Capital Balance at the beginning of the year Profit for the year Fair value gains on available for sale financial assets Capital contributed by the owners Profit distribution 1. Appropriation to surplus reserve 2. Dividend distribution to owners Balance at the end of the year Capital Surplus Undistributed Reserves Reserves Profit Total
24,350
15,742
11,441
69,189 32,576
120,722 32,576
350
350
950
950
3,258
(3,258)
(13,972)
(13,972)
25,300
16,092
14,699
84,535
140,626
(Note: comparative figures are not presented in these illustrative financial statements)
251
Appendix X
Comparison between China Accounting Standards and IFRS
Comparison of Index of CAS 2006 and IFRS Type R CAS Basic standard Type IFRS Framework for the Preparation and Presentation of Financial Statements G G IAS 2 Inventories IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 31 Interests in Joint Ventures N R 3. Investment Property 4. Fixed Assets G G IAS 40 Investment Property IAS 16 Property, Plant and Equipment IFRS 5 Non-current Assets Held for Sale and Discontinued Operations N R R 5. Biological Assets 6. Intangible Assets 7. Exchange of Nonmonetary Assets I G G IAS 41 Agriculture IAS 38 Intangible Assets IAS 16 Property, Plant and Equipment IAS 38 Intangible Assets IAS 40 Investment Property N N N 8. Impairment of Assets 9. Employee Benefits 10. Enterprise Pension Funds 11. Share-based Payment 12. Debt Restructurings G G I IAS 36 Impairment of Assets IAS 19 Employee Benefits IAS 26 Accounting and Reporting by Retirement Benefit Plans IFRS 2 Share-based Payment IAS 39 Financial Instruments: Recognition and Measurement IAS 37 Provisions, Contingent Liabilities and Contingent Assets
R R
1. Inventories 2. Long-term Equity Investments
N R
G G
13. Contingencies
252
Comparison of Index of CAS 2006 and IFRS Type R R N CAS 14. Revenue 15. Construction Contracts 16. Government Grants Type G G G IFRS IAS 18 Revenue IAS 11 Construction Contracts IAS 20 Accounting for Government Grants and Disclosure of Government Assistance IAS 23 Borrowing Costs IAS 12 Income Taxes IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 29 Financial Reporting in Hyperinflationary Economies N R N 20. Business Combinations 21. Leases 22. Recognition and Measurement of Financial Instruments 23. Transfer of Financial Assets 24. Hedging G G G IFRS 3 Business Combinations IAS 17 Leases IAS 39 Financial Instruments: Recognition and Measurement IAS 39 Financial Instruments: Recognition and Measurement IAS 39 Financial Instruments: Recognition and Measurement IFRS 4 Insurance Contracts IFRS 4 Insurance Contracts IFRS 6 Exploration for and Evaluation of Mineral Resources IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
R N N
17. Borrowing Costs 18. Income Taxes 19. Foreign Currency Translation
G G G
N N N
25. Direct Insurance Contracts 26. Reinsurance Contracts 27. Extraction of Oil and Natural Gas 28. Changes in Accounting Policies, Estimates and Corrections of Errors
I I I
253
Comparison of Index of CAS 2006 and IFRS Type R N CAS 29. Events After the Balance Sheet Date 30. Presentation of Financial Statements Type G RD IFRS IAS 10 Events after the Balance Sheet Date IAS 1 Presentation of Financial Statements IFRS 5 Non-current Assets Held for Sale and Discontinued Operations R R N 31. Cash Flow Statements 32. Interim Financial Reporting RD RD IAS 7 Cash Flow Statements IAS 34 Interim Financial Reporting IAS 27 Consolidated and Separate Financial Statements IAS 33 Earnings per Share IAS 14 Segment Reporting IFRS 8 Operating Segments (will replace IAS 14 effective from 1 January 2009) R N 36. Related Party Disclosures 37. Presentation and Disclosures of Financial Instruments RD RD IAS 24 Related Party Disclosures IFRS 7 Financial Instruments: Disclosures IAS 32 Financial Instruments: Disclosure and Presentation G IFRS 1 First-time Adoption of International Financial Reporting Standards
33. Consolidated Financial RD Statements 34. Earnings per Share 35. Segment Reporting RD RD
N N
38. First-time Adoption of Accounting Standards for Business Enterprises
Note: G General Standards I Specific Industry Standards RD Reporting and Disclosure Standards N New Standards R Revised Standards
254
Appendix XI
Government of the Peoples Republic of China
State Council
Ministry of National Defense Ministry of Education Ministry of Transport
Ministry of Foreign Affairs
Ministry of National Development and Reform Commission
Ministry of Science and Technology
State Ethnic Affairs Commission
Ministry of Public Security
Ministry of State Security
Ministry of Supervision
Ministry of Civil Affairs
Ministry of Justice
Ministry of Finance
Ministry of Human Resources and Social Security
Ministry of Land and Resources
Ministry of Housing and Urban-Rural Construction
Ministry of Railways
National Audit Office
Ministry of Industry and Information
Ministry of Water Resources
Ministry of Agriculture
Ministry of Commerce
Ministry of Culture
Ministry of Health
National Population and Family Planning Commission
The Peoples Bank of China
Ministry of Environmental Protection
255
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Doing Business and Investing in China

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Silas Yang () Executive Chairman & Senior Partner

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Corporate income tax rates Tax depreciation rates

Appendix XI Government of the Peoples Republic of China

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PricewaterhouseCoopers China Offices

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Peoples Republic of China A Profile

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Doing Business and Investing in China

Peoples Republic of China A Profile

Doing Business and Investing in China

Peoples Republic of China A Profile

Doing Business and Investing in China

Peoples Republic of China A Profile

Doing Business and Investing in China

Peoples Republic of China A Profile

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Peoples Republic of China A Profile

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Peoples Republic of China A Profile

using values from 3 April 2008. Source http://www.x-rates.com

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Doing Business and Investing in China

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Doing Business and Investing in China

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Doing Business and Investing in China

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