Paying the Government without Taxing Your Patience
In dealing with China, you have to deal with both corporate and individual taxes. As we discuss in the upcoming sections, individual taxes for foreigners and Chinese nationals vary.
Corporate taxes
In March 2007, the government enacted a new corporate income tax (CIT) law, which takes effect January 1, 2008. Unfortunately, because the implementing regulations haven’t yet come out, the new tax regime isn’t entirely clear.
Here are some of the changes:
| ✓ | The main thrust of the new law is equalizing income tax treatment of Chinese companies and FIEs at a national tax rate of 25 percent (the current framework often favors FIEs over Chinese companies). Some companies may qualify for lower rates of 20 percent (for certain small companies) or 15 percent (for certain technology companies). |
| ✓ | The law also alters the tax-incentive structure. Most likely, incentives will be more narrowly tailored to encourage investment in certain industries, such as environmental protection, production safety, and clean energy. |
| ✓ | The new law provides for more stringent enforcement of the CIT, particularly focusing on transfer pricing — the prices for various goods and services that affiliated companies pay one another. (For info on representative office taxation, see Chapter 7.) |
The rest of this section explains China’s currently effective (as of writing) business tax framework, which the new CIT tax law alters. Despite the changes, reading this section is still useful because it can give you the lay of the tax land — particularly in regard to non-income related taxes. Also, portions of the current tax regime will remain in effect.
Speak with a tax professionals as soon as possible if you’re seriously considering starting a business (or opening a representative office) in the People’s Republic of China.
FIE income taxes and incentives
The biggest corporate tax in China is the income tax. All companies legally established in China are subject to a base income tax rate of 33 percent of pretax income (30 percent to the central government and 3 percent to the local government). FIE income tax must be paid within 15 days after the end of each calendar quarter based on estimated annual taxes, and FIEs must finally settle their taxes for a given year within five months of the end of the calendar year. We discuss representative office taxation in Chapter 7.
Even if you don’t set up an FIE in China, your company may still be subject to China tax if you’re doing business there. Depending on the type of business you’re doing, your China-based customers may be required to withhold your taxes for you.
Under the current framework, FIEs are able to take advantage of a number of tax preferences that greatly reduce these rates. As a result, the average FIE actually pays taxes of only around 10 percent! Income tax incentives are usually available to an FIE based on several factors, including the following:
| ✓ | How large the investment in the FIE is |
| ✓ | How much the FIE will export |
| ✓ | How advanced the FIE’s technology is |
| ✓ | How closely the FIE’s business matches China’s economic goals |
Take a look at the most common legally authorized tax subsidies:
| ✓ | Manufacturing FIEs that the Ministry of Commerce (MOFCOM) or the Commission of Foreign Trade and Economic Cooperation (COFTEC) certify as “technologically advanced” can have their 50 percent rate reduction extended another three years, provided that their tax rate is at least 10 percent during this period. |
| ✓ | FIEs located in the Special Economic Zones (SEZs) — Shenzhen, Xiamen, Zhuhai, Hainan, and Shantou — pay maximum income tax of only 15 percent (after expiration of any tax holidays or reductions). |
| ✓ | Qualifying service FIEs in SEZs may have a tax holiday during their first profitable year and pay only 50 percent of the tax rate (in other words, 7.5 percent) the following two years. |
| ✓ | Qualifying manufacturing and high technology FIEs in various economic development zones may have reduced income tax rates of 15 percent or 24 percent, and they may be eligible for full tax holidays of one to two years and 50 percent holidays for additional two- to three-year periods. |
| ✓ | Local governments can approve complete exemptions from local taxes for encouraged foreign investments (see Chapter 7 for info on encouraged status). |
| ✓ | A foreign investor in an FIE who directly reinvests his or her share of the FIE’s profit in that or another FIE with a term of at least five years can get a refund of 40 percent of the taxes paid on the amount reinvested. If the reinvestment goes into starting or expanding an “export-oriented” or “technologically advanced” company, the tax refund is 100 percent. |
Note: It’s technically illegal for local governments to offer tax subsidies beyond those specifically authorized by law. However, local governments receive a substantial portion of the central government’s 30 percent tax on corporate income. They also receive a lot of money from the other corporate taxes. Therefore, the local government may have the means to offer your company large financial incentives (although as we mention in Chapter 7, stay away from land subsidies!).
The following incentives are currently common, but they’ll be narrowed or will disappear under the implementing regulations of the new law:
| ✓ | Manufacturing FIEs with terms of at least 10 years have a complete tax holiday for their profitable year and a 50 percent rate reduction for the next three years. This incentive is the minimum incentive available to manufacturing FIEs. Manufacturing FIEs can still qualify for other applicable incentives. |
| ✓ | FIEs that export at least 70 percent of their output in any year can have a 50 percent reduction in their tax rate for that year, provided that their tax rate is at least 10 percent. |
Value-added tax for manufacturers
Manufacturing companies pay a value-added tax (VAT) on items they use as inputs for their production (that is, raw materials or parts). The VAT on most items is 17 percent. However, companies that export their production receive refunds of most or all VAT paid on the exported products.
Small businesses (defined as having sales of less than 1.0 million RMB or 1.8 million RMB, depending on the type of business) pay a VAT of 4 percent. These small businesses are not eligible for VAT refunds on exports, though.
Encouraged FIEs (FIEs that invest in sectors in which the government offers incentives for foreign investment — see Chapter 7) can import machinery and equipment free of VAT and customs duties, provided that they don’t sell these items for at least five years.
Business tax on services
Service businesses pay business tax on their sales related to most services. The business tax varies between 3 and 20 percent of sales, but most services are taxed at 5 percent.
Individual taxes
China’s individual income tax (IIT) system is progressive (see Table 10-1 for IIT rates). IIT must be paid each month. Employers located in China are responsible for withholding IIT payments from employees’ salaries. As a foreigner, how much (if any) of your income is subject to China tax depends on whether it’s China source income (see the upcoming section called “China source income for foreigners). As a foreigner, you’re entitled to deduct a decent amount of your income for various living expenses. Your Chinese employees’ income earned in China is all taxed at the standard rates, subject to only some small deductions.
| Monthly Taxable Income (RMB) | Tier Tax Rate | Cumulative Tax Owed |
|---|---|---|
| 0 to 500 | 5 percent | 0 |
| 500 to 2,000 | 10 percent | 25 |
| 2,000 to 5,000 | 15 percent | 175 |
| 5,000 to 20,000 | 20 percent | 625 |
| 20,000 to 40,000 | 25 percent | 3,625 |
| 40,000 to 60,000 | 30 percent | 8,625 |
| 60,000 to 80,000 | 35 percent | 14,625 |
| 80,000 to 100,000 | 40 percent | 21,625 |
| 100,000+ | 45 percent | 29,625 |
Here’s how to use Table 10-1 to calculate the amount of tax owed each month:
1. | Calculate your China-source monthly gross income (see the following section for details). |
2. | Subtract all allowable deductions (which we discuss later in “Allowable deductions for foreigners”) from monthly gross income to get the monthly taxable income. |
3. | Find the row that applies to the monthly income and subtract the lower end of the income range from the monthly income. For example, for a monthly taxable income of 30,000 (RMB), you go to the 20,000-to-40,000 row and subtract 20,000 from 30,000, which gives you 10,000 RMB. |
4. | Multiply the number you just got by the tier tax rate. Multiply 10,000 RMB by 25 percent (the tax rate for that row), which equals 2,500 RMB. |
5. | Add that number to the cumulative tax owed amount in your row. Add 2,500 RMB to 3,625 (the cumulative tax owed for that row), which gives you a total of 6,125 RMB. The monthly tax payment is 6,125 RMB. |
China source income for foreigners
In some cases, which income is China source income is clear. If you’re being paid a salary by a company established in China, it’s almost always China source income. However, if you’re being paid by a foreign company (such as the parent), your income may not be entirely (if at all) considered China source:
| ✓ | For people in most countries, if you’re in China less than 183 days in a year while being paid by a foreign company, then none of your income is China source. If China doesn’t have a tax treaty with your country, the cutoff is 90 days. |
| ✓ | If you’re in China more than 183 (or 90) days, your income may not be entirely China source if your job involves non-China duties (such as Director of Asia). In this case, you need to determine what portion of your income is from your duties in China. However, the entire amount of salaries paid to senior managers in China (that is, China CEOs, CFOs, and so on) is usually considered to be China source. |
As a related matter, China launched a compulsory individual tax filing system in January 2007. Under it, taxpayers must report their income with the local tax authorities if they meet one of the following criteria:
| ✓ | Their annual income exceeds 120,000 RMB. |
| ✓ | They receive income from more than two sources located in China. |
| ✓ | They receive income from abroad. |
After you figure out how much your China source income is, you can take your allowable deductions and then apply Table 10-1 to figure out about how much you owe in taxes.
If you live in China for five consecutive years without having been absent from China for an extended period in any one calendar year, then your global income will be subject to China tax. That means all your income from anywhere in the world will be taxed in China. If you’re in China for the long haul, you may want to plan on taking a long holiday outside of the country sometime before you begin your sixth year in China. You need to leave for at least 30 consecutive days or a total of 90 days in any calendar year.
Allowable deductions for foreigners
Foreigners are entitled to a standard deduction of 4,000 RMB per month. Foreigners are also allowed to deduct “reasonable amounts” of the following expenses from income:
| ✓ | Housing |
| ✓ | Laundry expenses |
| ✓ | Unprepared food and restaurant meals |
| ✓ | Transportation |
| ✓ | Two trips home per year with family members |
| ✓ | Language training and education for all accompanying family members |
The key, of course, is how much is reasonable. It depends on the city and even on the district within a city. Your company’s tax accounting firm should know what the local tax authorities’ policy is. The tricky part is that at the beginning of the year, you have to estimate how much your deductions will be for the entire year. You then divide those deductions by the number of months you’ll be paying taxes (12 for a full year, obviously) and subtract the monthly average deduction from your monthly gross China source income. Then you have your monthly taxable income.
You need to show official invoices called fa piao (fa pee-ow) for all expenses incurred in China. For expenses incurred outside of China, you need the receipts. If you don’t have enough receipts and fa piao at the end of the year, you have to pay extra tax.
Always ask for fa piao! Many businesses, especially grocery stores and restaurants, don’t give you fa piao unless you specifically ask for it.
Chinese employees’ IIT
Chinese employees’ IIT basically works the same way as foreigners’. The only real difference is that Chinese taxpayers aren’t entitled to the deductions that foreigners are. Chinese employees are usually entitled to deduct only 1,600 RMB each month from their gross incomes. This is a standard deduction, so they don’t need to show fa piao.