On 21 December 2017, the Ministry of Finance (MOF), State Administration of Taxation (SAT), National Development and Reform Committee (NDRC) and Ministry of Commerce (MOFCOM) jointly issued a new circular – Circular 88 – which sets out formal guidance on the withholding tax deferral incentive for foreign investors. This will apply to qualified reinvestment made after 1 January 2017.
Before 2008, foreign investors were generally exempt from withholding tax (WHT) on dividend income derived from their investment in China under the prior PRC Enterprise Income Tax Law for Foreign Invested Enterprises and Foreign Enterprises.
This preferential treatment was abolished by the new PRC Enterprise Income Tax Law, which generally subjects foreign investors to 10% WHT on their dividend income, unless a more favourable rate can be accessed through a relevant tax treaty. However last year, China’s premier Li Keqiang announced to the State Council’s executive meeting that China would be rolling out a series of new policies and incentives to further boost foreign investments.
Under Circular 88, if foreign investors directly reinvest their profits distributed by China resident enterprises to some ‘Encouraged Industries’ and meet certain prescribed conditions, then the 10% WHT on the distributed profits may be deferred until the foreign investors’ disposal of such reinvestment in China.
A reinvestment can be effected through the following types of equity investment:
- Increase in capital or capital surplus in an existing Chinese subsidiary;
- Formation of a new Chinese subsidiary;
- Acquisition of equity interests in a Chinese company from a third party;
- Other forms of investment activities permitted by the MOF and/or SAT.
Investments in listed companies are generally excluded, unless they satisfy the strategic investment conditions of the Administrative Measures for Strategic Investment by Foreign Investors in Listed Companies.
Where cash dividends are directly reinvested by foreign investors, they should be directly transferred from the account of the distributing Chinese enterprise to the account of the investee Chinese enterprise or to the account of the equity transferor. They may not be routed through any other bank accounts before the intended direct reinvestment.
Where they are in-kind contributions, such as tangible assets and securities, the ownership should be directly transferred from the distributing Chinese enterprise to the investee Chinese enterprise or the equity transferor. They not be held on behalf by or temporarily passed on to another enterprise or individual before the intended direct reinvestment.
‘Encouraged Industries’ are those listed as encouraged for foreign investment under either the Catalogue for the Guidance of Foreign Investment Industries or the Catalogue of Priority Industries for Foreign Investment in the Central-Western Region. These were both updated in 2017.
If the foreign investor qualifies for the WHT deferral treatment, the Chinese subsidiary should submit the required documents to its tax authorities on behalf of its foreign investor. Upon completion of the filing, the Chinese subsidiary suspends withholding or payment of the corresponding WHT.
Circular 88 is retroactively effective as of 1 January 2017. A foreign investor may apply for a tax refund within three years of the WHT payment, if it is eligible for the WHT deferral treatment but has not received the benefit.
If you are interested in increasing your understanding of the China market and the potential opportunities for your brand, online or offline, please contact Mark Ray at Sovereign’s Shanghai office.