Deferred Tax for Reinvested Profits
According to China's Company Income Tax Law, non-resident investors receiving dividends from their Chinese subsidiary shall be subject to a withholding tax, which is generally equal to 10%, unless a reduced rate from a tax treaty applies.
In December 2017, the China State Administration of Taxation (SAT), jointly with the Ministry of Finance (MOF), the National Development and Reform Commission (NDRC), and the Ministry of Commerce (MOC), issued the Circular on “Policy Issues concerning Temporarily Not Levying the Withholding Tax on Distributed Profits Used by Overseas Investors for Direct Investment” (Caishui [2017] No. 88, “Circular 88”), to implement several decisions made by the State Council to boost foreign investments. Circular 88 introduced a tax deferral policy for profits obtained by foreign investors, which are directly reinvested in another encouraged project.
In September 2018, the SAT issued the Circular on “Expanding the Application Scope of Withholding Deferral Treatment on direct reinvestments made by foreign investors” (Caishui [2018] No. 102, “Circular 102”), extending the scope of the preferential treatment introduced by Circular 88.
Under the preferential treatment, foreign investors who obtain distributable profits from a Chinese resident subsidiary can enjoy a deferral of the withholding tax which would otherwise be imposed on the distribution, provided certain conditions are met and upon filing procedure.
To benefit from the preferential treatment, the following conditions shall be satisfied:
1.Direct investment: the non-resident investor shall use the distributable profit for another direct investment in China, which includes:
Injection in capital or reserve of a Chinese resident enterprise;
Establishment of a new Chinese resident enterprise;
Acquisition of the equity of a Chinese resident enterprise from unrelated parties; and
Other forms of investments specified by MOF and SAT.
A direct investment does not include:
Injection in capital or reserve of publicly listed companies (unless the investment is considered as a strategic investment according to MOC Order [2005] no. 28;
Acquisition of equity shares of publicly listed companies (unless the investment is considered as a strategic investment according to MOC Order [2005] no. 28; and
Acquisition of the equity of a Chinese resident enterprise from related parties.
2.Qualified distributable profit: it refers to dividends and profit on an equity investment from the distribution of realized retained earnings by the Chinese resident enterprise, including undistributed profits in prior years.
3.Profit must be directly transferred to the investee enterprise: if the investment is in cash, it must be remitted directly to the bank accounts of the investee; if the investment is in kind, it must be transferred directly to the investee.
4.Investment in not prohibited projects: According to Caishui 88, the investee enterprise/s shall be engaged in encouraged projects under the “Industry Catalogue Guide for Foreign Investment” or under the “Preferential Industry Catalogue for Foreign Investment in Central and Western Regions”. This requirement has been abolished by Caishui 102, which extended the preferential tax policy to all foreign investments that are not prohibited for foreign investments.
The preferential treatment can be applied for qualified dividends received from January 1, 2017 and is subject to filing from the distributing enterprise with the relevant PRC tax authorities.