According to Circular 88, which has become effective starting from January 1st 2017, a withholding tax (WHT) deferral policy is applicable to foreign investors whom would directly re-invest their attributable profits from their Foreign Invested Enterprise (FIE) in China back into “Encourage Projects” within China.
To further expand the scope of encouraged projects for foreign investments and re-investment projects which are eligible for the withholding tax deferral policy, the State Council announced Circular 102 on 27 September 2018. Following this announcement, the withholding tax deferral policy has also become applicable to projects which are not under the category of prohibited foreign investments (Negative List).
The new policy is aimed at attracting and retaining of foreign capital in and to China.
What is Withholding Tax?
Withholding tax is an enterprise income tax levied on non-resident enterprises in China that generate China-sourced income. There are several categories of China-sourced income, such as:
- Dividend income derived from equity investments (e.g. FIEs).
- Royalty income (e.g. licensing a trademark).
- Interest income derived from the provision of funds.
- Other income that may be deemed taxable by the Tax bureau.
Withholding tax is withheld by the entity in China that acts as the withholding agent.
The standard withholding tax rate on dividends, royalties and interest payable is 10%. This may be reduced according to the provisions of double taxation agreements between China and other countries. The Corporate Income Tax (CIT) withholding rate on other services consists of the CIT rate of 25% times the deemed profit rate. The deemed profit rate ranges from 15%-50% and will be determined by the local tax authority. In our experience, it is common for the tax bureau to accept a 40% deemed profit rate, resulting in a withholding tax rate of 10% (40% * 25 = 10%).
Requirements for Withholding Tax Deferral
After the release of Circular 102, the applicable scope of the withholding tax deferral policy has been expanded. Currently foreign investors who invest attributable profits from a Chinese tax resident enterprise into Non-Prohibited Projects are applicable for withholding tax deferral. This means that if dividends are used to re-invest back into China, either a 0% or 5% preferential tax rate is applicable.
A foreign investor is eligible for withholding tax deferral, if they meet all the following requirements:
- The direct re-investment must be made on Non-Prohibited Projects for which the re-invested enterprise carries out business activities during the foreign investor’s investment period.
- Covered by China’s Negative List.
- The qualified direct re-investment refers to equity investment conducted by foreign investors using the profits distributed by a Chinese resident enterprise. This includes the following methods.
- Capital increase in an existing Chinese tax resident enterprise.
- Capital contribution to a new Chinese tax resident enterprise.
- Acquisition of shares from a non-related party’s enterprise.
- The dividends used for re-investment shall be generated from the realized retained earnings.
- The profits used by foreign investors for direct re-investment must be paid or transferred directly from the distributing company to the investee company (or equity transferors) and cannot be transferred to any other foreign or domestic enterprises or individuals before direct re-investment.
Procedure for Withholding Tax Deferral
The Chinese enterprise that distributes the dividends should perform record filing procedures with the relevant in-charge tax authority for the purposes of deferring the withholding tax. This should be done after the Chinese enterprise affirms that the foreign investor is eligible to receive the WHT deferral treatment by submitting the relevant documents.
A foreign investor that has enjoyed the withholding tax deferral treatment will be subject to follow-up administration. If the foreign investor is found failing to meet the specified conditions from the tax authorities, they must make delayed tax payment according to the existing regulations.
Tax Refund and Repayment
Eligible foreign investors can also apply for the treatment retrospectively within three years from the date the tax payment was made and claim a refund of the tax paid.
However, if a foreign investor that availed withholding tax deferral treatment recoups their direct re-investments (through equity transfer, equity buyback, liquidation, or any other mean) they should report and settle the tax deferral payments with the in-charge tax authorities within seven days from the receipt of the relevant payment. Only if the invested enterprise restructures, and this restructuring meets all the conditions for ‘special restructuring’ and has met the requirements for tax treatment based on special restructuring, may the foreign investor continue to enjoy the preferential withholding tax deferral treatment.
Conclusion
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