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International Tax Newsletter - Summer 2011 - China: Corporate Income Taxes (CIT) Treatment On Asset Transfer Income Derived By Enterprises

According to State Administration of Taxation (SAT) Announcement [2010] No. 19, when an enterprise has income from transfer of property (including various types of assets, equities and debts, etc.), debt restructuring, donations and irrecoverable debts, regardless of whether they are monetary or non-monetary, such income should be treated as one-off income and calculated into the taxable income of the year when such income is recognized.

SAT clarifies various CIT issues on cross-border transactions SAT Announcement [2011] No.24 (Announcement 24) was issued to control treaty shopping and tax avoidance by non-resident companies. The following five clauses are covered in the Announcement 24: 

  • Income is recognized as taxable income on the seller side for a direct transfer of equity settled by installments when (1) share transfer agreement becomes effective and (2) share alteration registration is completed.
  • Public share exemption is defined as share transaction without pre-agreed transaction parties, volume and price.
  • The term "effective controlling party" refers to the party that transfers the PRC equity indirectly; "effective tax" refers to the effective tax on the specific transaction; and "exempt tax" refers to those cases where the transaction is not subject to the income tax.
  • When multiple offshore parties indirectly transfer their equities, one representative party can complete tax filing on behalf of all parties.
  • For a deal involving multiple PRC target companies, the seller can select one representative tax authority among PRC target companies for combined filing. The selected tax authority will coordinate among other authorities in determining whether it is a tax case. If the transaction is deemed to be taxable, filing will be needed separately at the different locations of the PRC target companies. 

Announcement 24 also confirms the CIT treatments for certain PRC-sourced income derived by non-residents: 

  • Timing to withhold tax on passive income including interest, rents, royalties, etc.
  • PRC-sourced guarantee income treated as interest and subject to the CIT.
  • Tax on transfer of land-use right to be withheld.
  • Rental income of immovable properties and other assets.
  • Withholding deadline for equity investment income.

EXPANDING THE SCOPE OF COMPANIES WHICH CAN ADOPT THE "VAT EXEMPT, OFFSET AND REFUND" METHOD

SAT Announcement [2011] No. 18 clarifies that the "VAT exempt, offset and refund" method can be adopted by a company engaged in the design of integrated circuits, software and animation or recognized as a non-small scale High and New Technology Enterprise for more than two years, under certain conditions specified in the Announcement.

VERIFICATION OF INCOME DERIVED FROM THE ALIENATION OF SHARES FOR INDIVIDUAL INCOME TAX (IIT) PURPOSES

SAT Announcement [2010] No. 27 clarifies the calculation of income derived from selling shares of non-listed companies for IIT purposes. This income should not only be calculated based on the contract price but should be based on fair market price for IIT purposes. When the reported transfer price is obviously lower than fair market price without justifiable reason, the tax authority may determine the deemed transaction price and tax on such price.

POTENTIAL IMPACT OF THE NEW PRC SOCIAL SECURITY LAW ON FOREIGN NATIONALS WORKING IN CHINA

The Standing Committee of the National People's Congress approved the People's Republic of China Social Security Law coming into effect on 1 July 2011. Foreigners working in China will be able to participate in the PRC social security system. However, it is uncertain whether foreign nationals must join the PRC social security system mandatorily.

Based on the current PRC CIT and IIT, statutory social security contributions made by the employer are deductible for CIT, while statutory social security contributions made by the employee are exempt from IIT. Therefore, in cases where foreign nationals make social security contributions, it is possible that the tax treatment should be the same.

International Tax Newsletter - Summer 2011

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