As of the end of 2024, China elevated 14 out of 18 tax categories from administrative regulations to formal laws, marking a milestone in aligning domestic practices with international standards. Central to this transformation is the Value-Added Tax (VAT) Law, which represents China’s largest tax category and reflects years of legislative refinement to meet evolving economic, cultural and technological needs.

The new VAT Law, effective from 1 January 2026, consolidates decades of VAT practice into a streamlined framework of 38 articles in six chapters, covering critical areas such as tax rates, taxable amounts, collection methods and preferential policies.

This article analyses the main updates to the China VAT Law and their effects on foreign invested enterprises (FIEs), assisting senior executives, accounting and tax professionals in examining their businesses’ internal processes and adapting tax planning, daily workflows, and operational risk management.

Certainty in VAT rates: stability amid transition

The new VAT Law retains the three-tier tax rates, i.e. 13%, 9%, and 6%, while simplifying collection methods for specific sectors. Notably, transactions previously taxed at 5%, such as labour dispatch services, HR outsourcing, real estate sales, property leasing, and land-use rights transfers, may now fall under a unified 3% simplified rate, a key change in the updated VAT framework.

This adjustment reduces tax burdens for taxpayers in particular industries. Foreign businesses in real estate, logistics, or outsourcing are suggested to prioritise rate reclassification assessments to optimise cash flow and mitigate risks of commercial disputes. For example, companies should review contracts with stakeholders to reallocate potential tax savings, update billing systems to align with revised rate classifications, and monitor transitional guidelines for specific sectors.

Redefined VAT treatment rules: providing clarity for cross-sector transactions

The new VAT law clarifies definitions of “mixed sales” and “sideline business” to reduce ambiguity for cross-sector transactions. The updated framework shifts focus to the primary business activity driving the transaction to determine the applicable VAT rate.

Under the new China VAT Law:

• Mixed Sales is defined as a single taxable transaction with two or more tax rates. Transactions with multiple tax rates are taxed according to the primary business activity’s applicable rate – a departure from the previous requirement that such sales must combine goods and services within the same transaction.
• Sideline Business is defined as two or more taxable transactions with different tax rates. Entities must still separately account for sales at different rates. Non-compliance triggers the highest rate.

This streamlined approach reduces compliance complexity by aligning taxation with the economic substance of the transaction, enabling businesses to classify their primary activities over rigid goods-versus-service distinctions. Foreign companies with diversified operations – such as retailers engaging in leasing – should strengthen internal accounting systems to ensure accurate activity classification and mitigate overpayment risks.

Enhanced flexibility for companies in waiving VAT preferential treatments


Historically, taxpayers are allowed to voluntarily forfeit preferential treatments (e.g. exemptions, reduced rates), but subject to a uniform 36-month lockout period regardless of taxpayer classification (general or small-scale). Article 27 of the new VAT Law retains the 36-month restriction but limits its scope to the specific preferential treatment waived, meaning forfeiting one benefit does not preclude eligibility for other incentives.

The explicit exclusion of small-scale taxpayers underscores the government’s commitment to sustaining support for micro and small enterprises (MSEs), reflecting a policy shift toward tailored, growth-oriented measures for this critical sector. This adjustment aligns with China’s broader objective of institutionalising MSE-friendly frameworks while maintaining fiscal discipline.

Narrowed scope of “deemed sales” in new VAT Law: Simplifying intra-entity transfers

The new VAT Law removes the prior classification of cross-regional goods transfers between branches or jurisdictions as deemed taxable transactions. Under the new framework, intra-company transfers – such as inventory movements between headquarters and branches – will no longer incur VAT.

This reform particularly benefits foreign enterprises in the trading and wholesale business sectors, which frequently redistribute goods across locations. Historically, many businesses deferred output VAT payments on unsold inventory, but the elimination of deemed sales now simplifies compliance by exempting such transfers.

For manufacturers, the change raises considerations around reconciling input VAT credits (claimed at production sites) with output VAT liabilities (accrued at sales branches). Companies must now reassess VAT carryover processes, transactional records, and alignment with accounting or income tax practices to avoid discrepancies.

Additionally, asset transfers tied to investments, profit distributions, or similar activities are explicitly excluded from deemed sales treatment, as these inherently fall under taxable transactions. However, further clarification around free-of-charge services is expected to be addressed in forthcoming implementing regulations.

Potential impact of input VAT deductibility on loans

Under current regulations, businesses are unable to deduct input VAT credits related to loan services. However, if upcoming implementing rules do not introduce further restrictions, VAT incurred on interest payments from loans or financing activities could become deductible, potentially reducing corporate borrowing cost. This shift would directly impact financial mechanisms, such as group cash pooling, margin trading, bill discounting, sale-leaseback financing, on-lending, and other “principal-guaranteed” financial instruments or asset management plans. While this policy adjustment may stimulate financial market engagement, details – including eligibility criteria and procedural requirements – await formal clarification from authorities.

Standardised input VAT credit refunds: Balancing efficiency and compliance

The China VAT Law explicitly grants taxpayers, including foreign enterprises, the right to choose between refunds or carry-forward of excess input VAT credits, aligning with international tax practices. While China has actively promoted input VAT refund policies over the past three years to ease pandemic-related cash flow pressures, implementation remains inconsistent. Tax authorities often impose multi-layered reviews on refund applications, demanding detailed justifications for input VAT sources, which leads to processing delays.

However, fraudulent practices – such as inflating input VAT credits, underreporting output VAT by concealing revenue, fabricating qualifications, and submitting false declarations – highlight the need for stricter oversight. Moving forward, implementing rules are expected to establish unified standards, streamlining procedures, improving compliance, and reducing the risk of abuse.

Conclusion

China’s new VAT Law strikes a balance between continuity and innovation, emphasising legal clarity, digital governance, and cross-border alignment. Foreign invested companies are recommended to update tax management systems to accommodate redefined categories, revisit contracts and pricing models to reflect rate changes, and engage advisors to navigate transitional uncertainties. By proactively adapting to these shifts, businesses can convert regulatory complexities into competitive strengths, ensuring resilience in China’s fast-evolving market landscape.

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Effective since 8 April 2025, China’s instant VAT refund initiative allows eligible international visitors to receive VAT refunds directly at the point of purchase, as opposed to claiming refunds upon departure.​

The policy, which was piloted in major tourist destinations like Beijing, Shanghai, and Shenzhen, has now been expanded across the country. Foreign tourists (non-resident status will be verified through passport and visa) can obtain immediate tax rebates by presenting their passports at designated tax-free retailers equipped with digital invoicing systems. The hope is that this streamlined process will not only enhance the shopping experience but also encourage tourists to spend more during their stay.​

Retailers participating in the programme are required to be registered under China’s Tax-Free Retail Programme and must operate digital invoicing systems integrated with the State Taxation Administration’s platforms. The policy stipulates a minimum eligible purchase amount of RMB 500 per shop, per day, with refunds applicable only to eligible goods and potentially subject to final customs checks.​

According to China Briefing, refunds will be based on standard formulas. For example, on a RMB 1,000 purchase with a 13% VAT and an 80% refund rate, a tourist would receive around RMB 92 back.

The implementation of this policy aligns with China’s broader economic strategy to boost spending in the local economy amid global trade tensions. By simplifying the tax refund process, like it has also done with its visa requirements, China hopes to attract more international tourists and enhance their spending within the country. In 2024, the country recorded 64.88 million border crossings by foreign nationals, marking an 82.9% increase year-on-year. The first quarter of 2025 saw 17.44 million crossings, up 33.4% compared to the same period in 2024.​

According to the China Daily, economists project that inbound consumption in China could generate between $1.7 trillion (£1.2 trillion) and $4.5 trillion (£3.3 trillion) over the next decade. The instant VAT refund policy is expected to play a significant role in achieving this target by making shopping in China more attractive to foreign visitors.​

However, the success of this policy hinges on widespread retailer participation and the robustness of digital infrastructure to handle real-time transactions. Experts suggest that ensuring that a broad range of shops and goods are integrated into the refund programme, along with leveraging technologies like artificial intelligence (AI) to boost the efficiency of processing, could further enhance the shopping experience for tourists.​

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In 2019, China introduced a significant change to its individual income tax (IIT) system by implementing the “six-year rule” for foreigners. This rule, which starts applying in 2024, determines how foreign residents are taxed on their overseas income.

What is the six-year rule?

According to the revised IIT system, foreigners who reside in China for 183 days or more each calendar year are considered tax residents. If a foreign individual remains a tax resident for more than six years, they become liable for tax on their global income, including income from foreign sources. This is known as the “six-year rule.”

China’s tax rates are relatively high for high-income earners — 35% for annual taxable income between RMB 660,000 (approximately £70,250) and RMB 960,000 (approximately £102,183), and 45% for income exceeding RMB 960,000. Due to these rates, foreigners often seek to avoid IIT on their overseas income.

The year 2024 is crucial as it is the first time the six-year rule will be enforced. Foreigners should carefully review their tax residency status and consider strategies to reset their six-year period.

How is the six-year rule period counted?

On 16 March 2019, China’s Ministry of Finance (MOF) and State Taxation Administration (STA) issued Announcement [2019] No. 34, which outlines the calculation of tax residency for foreigners.

The key points from the announcement are as follows:

• The six-year period calculation starts from 1 January 2019. Any residency prior to this date does not count.
• A year of residence is defined as staying in China for at least 183 days within a calendar year.
• Days spent in China for less than 24 hours in a single day are not counted.

Example:

Mr Chen, a Hong Kong resident working in Shenzhen, travels to China every Monday morning and returns every Friday evening. His stays are less than 24 hours on Mondays and Fridays, and he spends weekends in Hong Kong. Hence, for tax purposes, Mr Chen is considered to be in China for only three days per week. With 52 weeks in a year, his total stay amounts to 156 days, which is fewer than the 183 days required to be a tax resident. Consequently, Mr. Chen’s overseas income remains tax-exempt in China.

Resetting the six-year rule period

According to the MOF STA Announcement [2019] No. 34, if a foreigner has stayed in China for fewer than 183 days in any year within the previous six years, or if they leave China for more than 30 consecutive days, they can reset the six-year period.

Example:

Ms Patel moved to Shanghai on 1 January 2015 and has been living there since. However, since the counting of years started only from 1 January 2019, Ms Patel is not yet subject to global income tax in China. To avoid worldwide income tax starting in 2025, Ms Patel decided to spend January and February 2024 in Hong Kong. By leaving China for over 30 consecutive days, Ms Patel resets her six-year period.

Tax Implications After Six Years

From 2025 onwards, if a foreign individual has lived in China for 183 days or more in each year over the previous six years and has not left for more than 30 consecutive days in any year, they will be taxed on their global income.

Example:

Mr. Zhang moved to Beijing on 1 January 2019. Except for a two-month absence in 2025, he has lived in China for at least 183 days each year and never left for over 30 days. His tax obligations in China are as follows:

In this example, Mr Zhang’s two-month absence in 2025 triggers the six-year rule, making him liable for global income tax starting in 2025, though his absence allows him to reset his tax obligations in 2026.

The six-year rule affects various types of income, including wages, service remuneration, author’s fees, royalties, business income, interest, dividends, lease income, property transfer income, and contingent income. Foreigners should manage their residence days and departure times carefully to avoid unexpected tax liabilities.

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Against the backdrop of China’s New Company Law, which will come into effect on 1 July 2024 after a long revision process, companies, shareholders, and creditors will face new tax implications. Before transferring capital to a new company, deciding the contribution form, deciding to buy or sell the equity in a company, or planning to reduce capital for making up losses, companies and individual investors are advised to carefully consider the corresponding tax implications and adopt a cautious yet proactive approach for tax planning and financial strategy development.

Five-year subscribed capital payment term and relevant tax implications

Article 47 of the New Company Law stipulates that shareholders of a Limited Liability Company (LLC) must fully pay their subscribed capital within five years from the company’s establishment. This five-year contribution term applies not only to new companies but also to existing companies established before the New Company Law takes effect on July 1, 2024. For the latter, it is necessary to adjust their contribution term to align with the new five-year requirement during the transition period.

Pre-tax deduction of interest expense

According to Article 38 of the Implementation Regulations for the Corporate Income Tax Law (CIT Regulation), the following interest expenditure incurred by an enterprise in production and business activities shall be deductible:

• Interest expenditure for borrowings made by a non-financial enterprise from a financial enterprise;
• Interest expenditure for approved bonds issued by an enterprise; and
• Interest expenditure for borrowings made by a non-financial enterprise from a non-financial enterprise which does not exceed the amount computed according to the interest rate for the same type of loans of a financial enterprise during the same period.

By these provisions, the interest expenses related to a company’s external loans are eligible for pre-tax deduction. However, the Reply of the State Taxation Administration on Pre-tax Deduction of Interest Expenses Incurred on Unpaid Investments by Enterprise Investors (Guo Shui Han [2009] No. 312) imposes certain limitations on this tax treatment.

As per Guo Shui Han, if an investor fails to pay the payable capital amount within the specified period, the interest incurred from external borrowings – equivalent to the interest payable on the difference between the actual paid-up capital and the capital amount due within the stipulated period – shall not be considered a reasonable expenditure for the enterprise. Thus, this interest burden shall be borne by the investors and cannot be deducted when calculating the taxable income of the enterprise.

The term “specified period” generally refers to the capital contribution timeframe specified in the articles of association. Under the existing Company Law, there is no specific time limit for capital contributions, leading many enterprises to set lengthy contribution terms. In such cases, triggering the pre-tax deduction restriction on loan interest becomes less likely.

However, with the introduction of the 5-year contribution term requirement in the New Company Law, it has become easier to activate the loan interest deduction restrictions.

Therefore, we recommend that LLCs with a substantial amount of outstanding unpaid capital exercise vigilance when obtaining external loans. It is advisable to proactively engage with competent tax authorities to clarify the applicable tax treatment, accurately calculate the pre-tax deduction for interest expenses, and fulfil enterprise income tax obligations.

Additionally, Article 49 of the New Company Law states that shareholders who fail to pay their capital contribution in full in a timely manner must not only settle the full amount owed to the company, but also assume liability for any resulting losses incurred by the company. If the corresponding interest cannot be deducted before tax due to the shareholder’s unpaid contribution, the company is entitled to request the shareholder to bear this tax loss.

Potential tax on capital reduction

Under the context of the New Company Law, many companies may opt to reduce their registered capital to lower the required paid-in capital.

Reducing capital may trigger income tax liabilities. Taking the company shareholders as an example, according to the State Taxation Administration Announcement [2011] No. 34, the assets obtained by an investing enterprise through capital reduction can be divided into three categories:

• Investment cost recovery: This corresponds to the portion of assets acquired by the investing enterprise from the invested enterprise, equivalent to the initial capital
• Dividend income: Equivalent to the proportion of undistributed profits and accumulated surplus reserves of the invested enterprise, calculated based on the reduction in paid-in capital.
• Income from investment asset transfer

Among the three categories, only the portion related to income from investment asset transfer is subject to CIT payment.

Under the New Company Law, when companies decrease their registered capital to lower paid- in capital, shareholders may not receive income from investment asset transfers due to the capital reduction, thus avoiding CIT payment. However, if a company has significant net assets and retained earnings, shareholders reducing capital without receiving investment income may face scrutiny from the tax bureau.

Tax implication of non-monetary contributions

Article 48 of the New Company Law adds that a shareholder may make capital contributions in equity rights and creditor’s rights, in addition to the previous forms. Equity and debt investments both fall under the category of non-monetary contributions, which often involve complex tax implications.

Moreover, when transferring assets like equity and creditor’s rights, it may entail debt restructuring between enterprises, leading to complex tax treatment. Additionally, capital contribution in non-monetary assets may qualify for specific preferential tax treatment.

Given these, evaluating the tax burden associated with non-monetary contributions is complicated, with tax implications differing greatly depending on the nature of the non-monetary investment. Therefore, we highly recommend that both companies and individuals thoroughly assess potential tax burdens beforehand when making non-monetary asset contributions. Recognising these tax implications as crucial elements in investment costs is imperative.

Potential tax implications for equity transfer

Article 88 of the New Company Law adds that the transferor and transferee in equity transfer bear joint liability for the insufficient capital contribution unless the transferee is not aware and ought not to know that the transferor fails to make capital contribution as prescribed, or the non-monetary property used as capital contribution is defective.

In this context, the obligation of the transferee to assume the contributions for the transferor should be factored into the consideration for the equity transfer when calculating capital gains, and corresponding IIT or CIT should be paid consequently.

Profit distribution and relevant tax implications

Article 212 of the New Company Law addresses the statutory deadline for profit distribution. It mandates that company boards must distribute profits within six months from the date when shareholders’ meetings pass profit distribution resolutions. The amendment aims to reduce the time gap between resolution and actual profit distribution within companies.

However, does this acceleration imply a faster tax obligation for shareholders’ dividend income?

For resident enterprise shareholders, in many cases, the dividend income they receive from invested resident enterprises can enjoy CIT exemption. Even if dividend income is subject to CIT, Guo Shui Han [2010] No. 79 specifies that income from equity investments in the form of dividends or bonuses should be determined based on the date when the invested enterprise’s shareholders’ meeting makes profit distribution decisions. Therefore, the timing of tax obligations for resident enterprise shareholders regarding dividend income remains unaffected.

Nevertheless, for non-resident enterprise shareholders and individual shareholders, their dividend income tax is generally withheld at the source during payment. This means that the invested enterprise deducts and withholds taxes when distributing dividends. Consequently, early profit distribution may impact the tax-related arrangements for the invested enterprise. Companies with such shareholders should not only promptly carry out profit distribution within the statutory period but also prepare for relevant tax-related work to ensure timely and compliant tax withholding declarations.

Key takeaways

As the effective date of implementation of the New Company Law approaches, relevant entities must consider not only the various changes introduced by the new law but also the potential tax implications when undertaking actions, such as company establishment, capital contribution, equity transfer, profit distribution, and loss compensation. The recent revision of the Company Law encompasses all stages of a company’s life cycle, from registration to dissolution and liquidation.

The tax implications associated with these changes extend well beyond the scope of this article.

Dezan Shira recommend that relevant entities thoroughly study the New Company Law, stay informed about subsequent legal regulations, and assess the comprehensive impact of the new law on their investment and business planning.

When necessary, businesses can also maintain communication with legal and tax specialists to proactively address potential business and tax risks.

This article was originally published on Dezan Shira’s China Briefing with the title ‘Tax Implications for Businesses Under China’s New Company Law’

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One of the main questions foreign investors have when deciding to establish a new business in China is: can I repatriate my profits out of the country?

The answer is simply yes. Just as in any other country in the world, you will be able to transfer your funds out of China, either as a company or as an individual. The most important thing is to ensure that your business operates in a transparent and legal way, within the country’s rule of law, and complies with all its fiscal obligations.

Nevertheless, the Chinese government wants to attract and maintain capital in the country so that it can be reinvested and used to push economic growth. As a result, the application process to repatriate funds or cross-border payments entails tedious paperwork and explanations.

Over the past six years in particular, Chinese tax authorities have become better educated regarding tax-optimised structures and investigate any request to approve profit repatriation. This is important to know for both foreign companies established in China and those dealing with Chinese companies from abroad. Every cross-border contract is scrutinised by the authorities to ensure it is legitimate.

However, there are a few practical things you can do to facilitate the process. As long as you are organised and you have the correct documentation, it’s not as complex as it may seem.

A good place to start is to talk to your bank and tax officer to discuss the paperwork involved. You can try to negotiate the documentation and tax rates that would be applied. It is in your best interest to pick your battles wisely and decide what is worth fighting for and what is a lost cause.

If your company cannot provide the documentation required for the transfer of capital, you won’t be allowed to do it. If you cannot produce valid papers to verify and justify a transfer that is going abroad, then you should not be doing the transfer in the first place.

The ultimate target of any company established in China is to become profitable and be able to pay back investors or reinvest its funds. It is crucial to establish a profit repatriation strategy early on in order to create a tax-optimised structure that helps you develop authentic agreements and contracts from the get-go.

Nobody else but you – and your company – decides what to do with the money. As long as you abide by the procedures, your capital can be maintained to grow and expand your business in China, or if it’s needed elsewhere, it can be transferred out of the country. Many entities feel pressure to repatriate funds, but when they face a period of further expansion or investment into new product lines, they find themselves without the resources to do it.

Similarly, organising payment in cross-border transactions between foreign and Chinese companies can be intricate. It helps to learn how to communicate and be patient with your Chinese counterparts to avoid any tax violation.

It is not easy for your Chinese counterpart to get contracts approved. The process involves extensive negotiations with tax officers, which means that any cross-border transaction, whether it is dividend repatriation strategies or just general service transactions, must have a valid and authentic agreement in China.

The State Administration of Foreign Exchange (SAFE) is the government bureau tasked with controlling capital flows into and out of China. Flows are strictly controlled, and foreign invested enterprises (FIEs) should be careful to avoid raising any red flags with the authorities. Any of the following may hinder a company’s ability to remit their profits abroad:

• profits that are not in line with industry standards;
• dealings with companies in tax havens;
• failure to complete all required documentation.

Tax implications and tax planning are important considerations for determining an optimal profit repatriation strategy. Since 1 January 2019, the corporate income tax (CIT) rate has been a standard 25%. However, there are special benefits for small to medium-sized companies and start-ups in China.

If a company reaches a revenue level of less than RMB 1 million, the tax rate will be 5%. If it is between RMB 1 and 3 million, the tax rate jumps to 10%. Once an FIE is profitable and before it can distribute after-tax profits, it is required to make up any losses carried forward from previous years, up to five years.

In addition to making up any losses, in order for a company to distribute and repatriate profits back to its investors, it must complete an external annual audit conducted by an accounting firm, settle its income tax liabilities, and set aside a minimum 10% of after-tax profits in a reserve fund until the accumulated reserve fund reaches 50% of the registered capital, which ensures that a portion of the profits are re-invested into the company.

The remaining amount is distributable profits. The withholding tax will be deducted before the dividend can be remitted back to the investors.

The most common profit repatriation strategy in China is a dividend payment, which can be done only once a year. It is relatively easy to repatriate profit by way of dividends, but the tax burden could be high from the China side (corporate income tax and withholding tax).

A number of documents will be required for this process (and these may vary depending on the bank and tax officer), but the most common to be presented are

• A resolution from the board of directors on the distribution of profits
• The latest audit report on the paid-in capital
• A certificate of filing at the tax bureau in case the amount is above $50,000
• A tax-payable receipt
• The business license.

China applies a 5-10% tax on dividends sent overseas, although the existence of double taxation agreements (DTAs) with some countries (including the UK) can reduce this by half.

Another strategy is the repatriation of service fees. The first thing is to have a valid and true business reason for implementing the service fee, which must be of economic substance.

For example, a company has a marketing service agreement with a Chinese entity and money is owed to cover travel costs of team members travelling regularly to China. The tax bureau could ask for proof of these marketing services, such as projects and advertisements, as well as to see the passport copies of all people who have travelled to China to render the services charged.

Foreign investors can provide services and thus get paid under service agreements with their FIEs in China. The service will be subject to China VAT if either the service provider or recipient is located in the country or the services are rendered in China.

For onshore services, whereby the servicing period is long enough (generally more than six months in any 12-month period) to constitute a permanent establishment (“PE”) in China, 25% corporate income tax (CIT) will be charged on the profits, which varies from 15% to 50% of the income arising from onshore service provision.

If a PE could not be established, CIT is theoretically not applicable. However, if certain conditions are met, e.g. the services are related to licenses, royalties, and know-how, tax authorities would treat the fees as royalties and levy a withholding tax. Service fees at ‘arm’s length’ are normally deductible for a FIE’s CIT purposes.

Royalties are fees paid in relation to the use of intellectual property, such as trademarks, patents, copyrights, and proprietary technology. Royalties are deductible for CIT purposes provided they are directly related to the FIE’s business operations and charged at normal market rates. Royalty remittances are subject to a 5-10% withholding CIT and 6% VAT.

The statutory CIT withholding tax rate of 10% can be reduced to a lower tax rate if a tax treaty is applicable. In order to receive a reduced withholding tax rate under a DTA, it is necessary to submit an application to the tax authority, which includes a Statement of Beneficial Owner.

There are many other ways of repatriating funds from China, such as reduction of registered capital, which is an exceedingly difficult process, and the company should have been extremely profitable. Other approaches include acquiring assets overseas, offering loans to overseas shareholders or sister companies, and offshore investments.

This article was originally published by Woodburn Global with the title ‘Developing profit repatriation strategies for your China business’

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The extension of the individual income tax (IIT) preferential policies means that non-China domiciled tax residents (i.e., people who do not have a domicile in China but live for 183 days or more in China in a given tax year) can continue to enjoy tax exemptions on eight categories:

• Housing rental
• Expenses for children’s education
• Language training expenses
• Meal fees
• Laundry fees
• Relocation expenses
• Business travel expenses
• Home leave expenses (i.e., travel to home country)

These benefits are usually not included in the salary and wages but are paid on a reimbursement and non-cash basis. They can be exempted from IIT provided that the expenses are reasonable in amount and there are corresponding supporting documents, such as invoices (fapiao), for each expense. In addition, there are some specific requirements for each category. For example, for home leave expenses, only two trips per year for the expat from China to their or their spouse’s home country can be exempt from IIT.

Many analysts were confident that the policy would be extended beyond the previous deadline of 31 December 2023, especially since the economy is showing signs of a slowdown and the government is attempting to reduce the tax burden on the middle classes to encourage consumer spending. Nevertheless, the extension has come as a relief for foreign workers, who would have seen their personal tax burden increase significantly, especially in terms of the cost of educating their children (tuition fees at international schools in first-tier cities can be up to £38,000 per year). It will also benefit companies trying to increase their hiring of foreign talent now that China’s borders are fully open post-Covid.

What does this mean for companies operating in China?

Overall, these policy extensions are likely to benefit companies in China, as it may help them to attract and retain new talent. It will also been seen as a positive move by the international education sector, as it means that foreign professionals in China will likely continue sending their children to pricey international schools.

Nevertheless, companies that made preparations for the original tax income policy change, such as amending labour contracts, restructuring salary packages, and reshuffling staff allocations, may need to roll back the decisions for the time being and save their plans for possible future needs.

Portions of this article first appeared in Dezan Shira & Associate’s China Briefing

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The VAT incentives are meant to help vulnerable businesses overcome the difficulties of the Covid-19 pandemic and represent an extension of previous policies. A wide range of tax incentives and cuts have been put in place in China in the past few years to encourage and support economic growth.

In 2022, the country implemented record-high value-added tax credit refunds, which totalled about 2.4 trillion yuan. The new VAT exemption and reduction policies will be valid from 1 January 2023 to 31 December 2023.

If a small business has monthly sales under RMB 100,000 (approx. $14,740), or if the quarterly sales are under RMB 300,000 (approx. $44,220) for taxpayers who choose one quarter as a tax payment period, the taxpayer will not be subject to VAT.

This represents a lower threshold than in 2021 and 2022. During the period from 1 April 2021 to 31 December 2022, the VAT limit for small-scale taxpayers was RMB 150,000 (approx. $22,110) per month (or RMB 450,000 per quarter, approx. $66,300).

The VAT administration notice clarifies that small-scale taxpayers with total monthly sales of over RMB 100,000 – but whose sales when excluding real estate sales occurring in the current period is less than RMB 100,000 – will be exempt from paying VAT on the sale of goods, labour services and intangible assets.

Small businesses can choose to waive the VAT exemption incentive and instead issue special VAT invoices for a specific sale.

Between 1 January 2023 and 31 December 2023, small-scale taxpayers that are subject to a VAT levy rate of 3% can enjoy a reduced levy rate of 1%. The VAT items subject to a 3% VAT prepayment rate will enjoy a reduced prepayment rate of 1%.

An additional VAT deduction policy has also been issued for lifestyle and production-oriented services in 2023. Taxpayers in these sectors can enjoy 5% additional VAT deductions based on the deductible input VAT in the current period. Taxpayers in the lifestyle services sector can enjoy 10% additional VAT deductions based on the deductible input VAT in the current period. Production-oriented services include ‘postal services’, ‘telecommunication services’, ‘modern services’ and ‘lifestyle services’. Taxpayers in these sectors must have sales from ‘lifestyle services’ that represent more than 50% of their total sales.

Previously, taxpayers in the postal, telecommunications, modern services and lifestyle services industries were granted a 10% additional VAT deduction based on the deductible input VAT between 1 April 2019 and 31 December 2021, and taxpayers in lifestyle services enjoyed a 15% additional VAT deduction from 1 October 2019 to 31 December 2021. Tax authorities in China extended this additional VAT deduction policy to 31 December 2022.

In recent years, a key aspect of China’s new tax rules and policy directions has been tax incentives and cuts to boost the economy and encourage investment and research and development activities. At the same time, China is also making efforts to improve its tax administration environment, in particular the administration of transfer pricing issues relating to multinational enterprises.

The strict Covid-19 prevention measures imposed under China’s zero-covid policy significantly affected businesses and the economy in general. However, since the government decided to lift restrictions and quarantines, experts have raised their forecasts for China’s real GDP growth to 5.2% in 2023 (from 4.7%).

Adapting to a new reality and possible repeated surges of covid cases will be challenging for China. The government will have to consider creative ways to get the country’s economy back on track and rebuild businesses and investors’ confidence.

According to analysts, China may decide to extend most of the tax incentives that it has offered in the past, at least until the end of 2023. With respect to tax audits, there has also been a comparatively calmer tax audit environment in the past three years. However, China will continue to focus on improving its tax enforcement.

Tax authorities may become more aggressive in their enforcement activities in the future in order to plug the gap in tax revenue collection created by a slower economy and to make up for the reduction in tax revenue arising from various tax cut measures.

Call +44 (0)20 7802 2000 or email enquiries@cbbc.org now to connect with CBBC staff who can advise on company chops and other Chinese legal requirements.

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One of the most visible expressions of China’s new ‘Common Prosperity’ policy has been the stricter enforcement of individual income tax violations. In December 2021, Chinese tax authorities fined live-streamer Huang Wei – also known as Viya – the record sum of RMB 1.34 billion (around £186 million) for non-payment of individual income tax (IIT). This is the largest fine since Fang Bingbing, a movie star, was ordered to pay around £100 million for the same offence in 2018. 

At a meeting earlier this month, Wang Jun, the head of the Chinese state tax administration (SAT) vowed to “punish severely all kinds of tax evasion and show no forgiveness.” Somewhat contradictorily, Chinese authorities also said in December that they would show leniency to live streamers who settled their outstanding tax payments voluntarily before the end of 2021. Wang even announced that SAT would implement a policy to exempt first-time offences. At the central government level, the message about IIT is equally equivocal. 

At the Central Economic Work Conference in December, Chinese leaders repeated their promises to further reduce taxes and other fees. In total, the financial burden on businesses will be reduced by RMB 1.1 trillion (£139 billion) in 2022, following a similar reduction the previous year. The government also announced that it would maintain tax benefits for ‘talents’ and highly educated employees. Beijing even extended – at the last minute – a tax exemption on fringe benefits for expats. 

While China’s stoic adherence to supply-side policies might be good news for companies and foreign employees, the tightening control and increasing use of big data by Chinese tax authorities also requires a far more circumspect approach to Chinese operations.

Background 

China’s tax system for individual incomes has undergone several important reforms over the last couple of years. Most of the changes have been aimed at improving tax compliance and the SAT’s own efficiency. China’s fapiao reform in 2017 – following the introduction of a nationwide VAT a year earlier – targeted widespread tax fraud which relied on false invoices (called fapiao) to skirt IIT obligations. 

Tax authorities also expanded their online tax platform – the ‘Golden Tax System’. Initially designed to process VAT invoices, the system has expanded over the last couple of years, including ever more data. Importantly, it has also served as a tool to integrate tax files from different tax offices. Previously, each tax bureau had its own independent reporting system, requiring companies to de- and re-register their tax records if they wanted to move offices from one district to another. The latest expansion – called ‘Golden Tax IV’ – which will go online this year, not only increases tax sharing capabilities between local and state levels, but also monitors non-tax contributions, such as social insurance fees. 

The new system thus incorporates the 2018 reform which expanded the SAT’s remit to include not only taxes but social insurance fee collection as well. Previously, these fees – including healthcare, pension, unemployment, sick pay, and maternity pay, plus a contribution to the local housing fund – were overseen by a separate social insurance administration. Unsurprisingly, the lack of data exchange between tax and social insurance authorities made it easy for employers to game the system by underreporting income, thus dodging both contributions and taxes. 

It is against the background of these reforms that the recent crackdown on film and online celebrities is taking place. Better access to tax and social insurance data has allowed Chinese tax authorities to collect revenues more efficiently. 

The new online system also allows tax officers to absorb more information. In the case of live streamers, this has had a significant impact. As Caixin, the Chinese business weekly, pointed out, many artists and social media influences (Key Opinion Leaders or KOLs) have set up sole proprietorship enterprises or partnership enterprises.

Unlike larger companies or wholly foreign-owned enterprises (WFOEs), they do not pay corporate income tax (CIT), but only individual income tax plus social insurance fees. But because of the lack of proper accounting, tax authorities often charged taxes based on estimates rather than bank statements, receipts or transaction records. This appears to have made it possible for live streamers to hide a considerable chunk of their income and lower their effective tax rate from a maximum rate of 45% to often less than 10%, according to Caixin. 

That approach changed this year, with tax bureaus now demanding the same financial documentation as from other companies. Additionally, greater access to data also allows authorities to compare transactions across the entire sector and thus get a better idea of the actual amount of money paid to live streamers and other celebrities.

Tax income distribution in 2020

China’s lopsided income tax distribution 

The improved tax compliance of high-net-worth individuals is certainly a positive development. But whether it is enough to help cash-strapped provinces and local authorities to improve social services remains to be seen, not least because individual income tax is only of minor importance for the Chinese government’s budget. In 2020, IIT accounted for only 7.5% of the government’s tax revenue, compared to 24.2% in the UK and 23.5% among OECD countries. The majority comes from the VAT and corporate income tax (CIT), which together accounted for 60.4% last year. 

Nonetheless, Chinese official statistics suggest that the individual tax burden has increased over the last ten years, especially for high-income earners. Tax income from IIT increased by 169% between 2010 and 2020, compared to a total growth of 111% for all government revenue. More importantly, disposable income derived from wages and salaries only grew 145% in the same period. If we further consider the monthly tax-allowance of RMB 5,000 (60,000 RMB/year), and that only a fifth of Chinese households recorded an annual income above that threshold, then it becomes clear that a tiny fraction of China’s working-age population has carried the brunt of the government’s growing IIT revenue. 

This lopsided tax burden explains the government’s conflicting messaging on tax cuts and stricter enforcement. It also points at one of the core challenges for Xi Jinping’s new ‘Common Prosperity’ policy: how to convince China’s growing middle class to spend and invest more while also increasing government revenue to meet the growing demand for better education and social services.

Increase in tax income between 2010 and 2020

Integration instead of increases 

One place to look for a possible solution to this problem is Zhejiang province, which also serves as a ‘Common Prosperity’ pilot zone. Coincidentally, it was a Zhejiang court, which ordered Huang Wei, the live-streamer, to pay the record fine for tax evasion. Nevertheless, tax policies – especially for small businesses in the province’s hugely important export sector – remain favourable. A press release from October 2021 noted that tax cuts in the province had surpassed RMB 200 billion (around £28 billion) in the first three quarters of the year. 

To provide better funding for poorer areas despite tax cuts, Zhejiang wants to create a transfer mechanism that would funnel money from its affluent capital Hangzhou and export hubs like Ningbo and Yiwu, to less well-endowed parts of the province. What’s more, a plan for ‘Fiscal Promotion of Common Prosperity’ published in December 2021 also proposes a system that would direct more central government support to cities which absorb large numbers of labour migrants – a group which, so far, is not covered by local government services. In short, the plan aims to create a province-wide budget process that can allocate money across administrative boundaries. 

What Zhejiang’s approach suggests is that integration and optimisation – and not an increase – of both tax collection and expenditure remain the principal tools for China’s fiscal policy in the age of ‘Common Prosperity’. 

The CBBC view 

China’s fiscal carrot-and-stick approach carries some significant risks for businesses. On the one hand, additional tax benefits and exemptions seem to be good news, and the breaking down of administrative tax barriers benefits companies, too, as this makes it easier for companies to relocate within China. 

On the other hand, the tax authorities’ ever-improving ‘panopticon’ requires a more comprehensive accounting approach to operations, especially if a company is active in multiple locations across China. An office-by-office approach and localised accounting might have to give way to a nationwide management strategy. Businesses should also be careful when registering companies in low-tax jurisdictions such as Wuxi, Dongyang, or Songjiang district in Shanghai. As the cases against live streamers have demonstrated, income improperly recorded in these tax districts might be perceived as tax evasion by other Chinese jurisdictions. 

Finally, Beijing’s penchant for seeking out high-profile targets to act as an example to others – an approach best described by the Chinese proverb ‘kill the chicken to scare the monkey’ – is probably the largest source of uncertainty. For example, marketing strategies relying on KOLs will require more due diligence to make sure that campaigns do not collapse midway through because of a sudden tax investigation. Creative industries, too, will have to pay greater attention to the contractual arrangements of actors, artists and freelancers. 

Overall then, it seems tax inspection rather than tax rises will be the main concern for businesses in the new age of ‘Common Prosperity’.

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The extension of the individual income tax (IIT) preferential policies means that non-China domiciled tax residents (i.e., people who do not have a domicile in China but live for 183 days or more in China in a given tax year) can continue to enjoy tax exemptions on eight categories:

• Housing rental
• Expenses for children’s education
• Language training expenses
• Meal fees
• Laundry fees
• Relocation expenses
• Business travel expenses
• Home leave expenses

The policy extension has brought immediate relief for some foreign workers, who would have seen a significant increase in their personal tax liability, especially in terms of the cost of educating their children. Companies trying to hire and retain foreign talent will also benefit from this policy.

This extension of IIT benefits for foreign professionals followed another announcement on 29 December 2021 in which China extended preferential treatment for annual one-time bonuses until the end of 2023. Under this scheme, IIT on annual one-time bonuses is calculated separately, rather than being combined and taxed together with overall income.

The extension of this policy is aimed to reduce the tax burden of middle-income groups at a time when the Chinese economy has been showing signs of a slowdown. For example, the following groups are expected to benefit the most from separate IIT on bonuses: (1) employees with an annual one-time bonus no less than RMB36,000; (2) employees with an annual income (annual bonus + annual salary – social security payments and various deductible expenses) no less than RMB 96,000; and (3) employees with an annual salary higher than their annual one-time bonus

What does this mean for companies operating in China?

Overall, these policy extensions are likely to be of benefit for companies in China, as it may help them to attract new talent. It is also a positive outcome for the international education sector, as it means that foreign professionals in China may no longer need to reconsider sending their children to pricey international schools.

Nevertheless, companies that made preparations for the original tax income policy change, such as amending labour contracts, restructuring salary packages, and reshuffling staff allocations, may need to roll back the decisions for the time being and save their plans for possible future needs.

Portions of this article first appeared in Dezan Shira & Associate’s China Briefing

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As China endeavours to shift from a low-end mass manufacturer to a high-end producer, the government has doubled down on encouraging targeted investments in R&D and technological innovation. The ongoing technology confrontation with the US is another factor at play, impacting a wide range of segments from access to chips and other key input technologies and products. This has resulted in increased government support for the technology sector as a strategic one and for which government support has increased.

This article summarises the major tax incentives to encourage technology innovation currently available in China and how they can help UK businesses.

High and new technology enterprises (HNTEs)

HNTE treatment, which reduces a qualified taxpayer’s applicable corporate income tax (CIT) rate from the standard 25% to 15%, is one of the core tax incentives encouraging innovation in China.

In addition to the lower CIT rate, starting from 1 January 2018 for qualified HTNEs, losses that occur five years prior to the year in which they become qualified and have not been made up can be carried forward to subsequent years to be made up. The maximum carry-forward period has also been increased to 10 years (usually only five years).

To qualify for HNTE status, a company must meet a range of criteria, including owning the intellectual property rights for the core technology of its main product or service, and having more than 10% of its total staff engaging in R&D.

Starting in 2021, certain companies in Beijing can qualify for HTNE status with lower qualifications or via simplified procedures. To be eligible, a company must be a production and research enterprise engaging in integrated circuits, artificial intelligence, biopharmaceuticals, or key materials, with a reported annual revenue of over RMB 20 million; be registered in Beijing and be in operation for over a year; and spend at least 50% of total R&D expenses within China.

Qualified companies are required to provide far fewer materials than usual to apply for HNTE status, which can be submitted online. The National HNTE Leading Team Office will approve the application soon after the it has undergone expert assessment and review by the HNTE accreditation authority. The public comment procedure is also exempted, meaning overall turnaround time is much shorter.

Technology-based small and medium-sized enterprises (TSMEs)

TSMEs fall under the scope of SMEs that conduct technology-based activities and have scientific and technological personnel who are involved in R&D activities and obtain IP for creating high-tech products or services.

Unlike HNTEs, TSME status has special requirements on an enterprise’s number of total employees (no more than 500), annual sales revenue, and total assets (no more than RMB 200 million). On the other hand, while becoming an HNTE requires that the core technology of a company’s key products or services is specially encouraged by the state and the ratio of income from high-tech related operations against total income is not lower than 60% in the current period, TSMEs have no such requirements. In general, it is easier to apply for TSME status for smaller businesses.

Advanced technology service enterprises (ATSEs)

ATSE status is another core innovation tax policy to encourage the provision of information technology outsourcing (ITO), business process outsourcing (BPO), or knowledge process outsourcing (KPO) services to overseas entities. To be qualified as an ATSE, an enterprise must fulfil a range of requirements, including more than 50% of its staff holding a college degree or above.

Originally launched in the Suzhou Industrial Park in 2016, the ATSE incentive was rolled out nationwide in 2017, reducing the corporate income tax rate for a qualified ATSE from the standard 25% to 15%, similar to HNTEs.

In addition, ATSEs are subject to zero VAT for the provision of certain offshore services, which means they can be exempted where a simple tax computation method is applicable, or they can use the tax exemption, credit, and refund method where a VAT general tax computation method is applicable.

Summary

Beyond the major innovation tax policies introduced above, there are other preferential policies designed to encourage the development of the tech sector, such as the tax incentives for the integrated circuit and software sector and faster refund of VAT incremental credit balance for advanced manufacturing taxpayers.

Businesses in China may find documentation requirements and application procedures tough going if they are not familiar with the established tax system and eligibility criteria for accessing supportive measures. It is recommended that potentially qualified enterprises carefully study the application requirements for each incentive and choose one or more best suited to their own situation. For example, ATSE status is more suitable for an enterprise that doesn’t own the local IP rights of the key technologies of its core products or services, since HNTE status has local IP requirements.

A version of this article was first published by China Briefing, which is produced by Dezan Shira & Associates. The firm assists foreign investors throughout Asia from offices across the world. Readers may write to info@dezshira.com for more support.

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