China extends withholding tax benefits for more foreign investment sectors
China has extended the withholding tax deferral benefits for profits reinvestment in more foreign investment sectors in China.
The new policy, which is set out in Caishui  102 (Circular 102), issued by several government agencies on September 29, 2018, states that the withholding tax deferral benefits have been extended from encouraged foreign investment projects to cover all foreign investment sectors that are not prohibited from investment.
Eligible foreign investors are limited to nonresident enterprises that do not have an establishment (permanent establishment) or place of business in China, or that have an establishment or place of business in China but whose income is not effectively connected with that establishment or place of business in China under article 3, paragraph 3, of the Enterprise Income Tax (EIT) Law.
Withholding tax deferral
According to article 1 of Circular 102, profits derived by a foreign investor from resident companies in China will be entitled to a tax deferral incentive and temporally will not trigger withholding tax if the investor reinvests the profits directly in any Chinese projects and fields that are not prohibited from investment.
Article 6 of Circular 102 defers the withholding tax until the foreign investor disposes of the direct investment by any means. Once the tax deferral expires, the foreign investor must pay the tax to the Chinese tax authorities within seven days after having received the investment proceeds.
Conditions for withholding tax deferral
Article 2 of Circular 102 states that to qualify for the tax deferral concession, a foreign investor must use the profits from resident companies located in China:
- to increase the paid-in capital or capital reserves of resident enterprises in China;
- to invest in newly incorporated resident enterprises in China;
- to acquire from unrelated parties the shares of resident enterprises in China; or
- in any other way designated by the MOF and SAT.
In addition, the foreign investor must meet all the following conditions to receive the tax deferral concession under article 2 of Circular 102:
- the profits distributed to the foreign investor must be dividend income arising from the distribution of realized retained earnings by resident enterprises in China to investors; and
- if the foreign investor makes the direct investment in cash, the cash must be transferred directly from the account of the profit-distributing enterprise to the account of the invested enterprise or share transferor; if the foreign investor makes the direct investment in tangible property, securities, or any other noncash property, the ownership of the noncash property must be transferred directly from the profit-distributing enterprise to the invested enterprise or share transferor and may not be temporarily held by any other entity or individual before the direct investment is made.
However, the withholding tax deferral will not apply if the profits are used to increase paid-in capital or capital reserves of publicly traded companies or to acquire shares in publicly traded companies unless the investment constitutes a qualifying strategic investment.
Tax deferral procedures
A foreign investor that meets the tax deferral conditions set forth in article 2 of Circular 102 must file tax returns in accordance with tax collection and administration requirements and provide the profit-distributing enterprise with materials supporting its satisfaction of those conditions. If the profit-distributing entity, based on its proper review, believes that the foreign investor meets those conditions, the entity will be allowed not to withhold the tax under article 37 of the EIT Law and will make a tax filing with its competent tax authorities.
Tax authorities will reinforce the post-event administration in accordance with law. According to Circular 102, if the tax authorities, during the post-event administration, determine that a foreign investor fails to meet the conditions for the tax deferral benefits but has enjoyed those tax benefits, the foreign investor will be treated as having failed to file and pay EIT and will be subject to all consequences as a result of the delay in paying tax, unless that was caused by the profit-distributing enterprise. In that case, the foreign investor will be subject to late payment interest at 0.05 percent per day, running from the date on which the relevant profits were paid.
Special tax treatment
If after a foreign investor has enjoyed the tax deferral benefits, the invested enterprise carries out a tax-free reorganization and elects to apply the special tax (tax-free) treatment, the foreign investor can continue to enjoy the tax deferral policy, without being required to pay the tax as described in article 6 of Circular 102.
Under article 5 of Circular 102, if a foreign investor should have enjoyed the tax deferral benefits in accordance with Circular 102 but fails to do so, it can retroactively apply tax deferral benefits within three years of the payment date of the tax, thereby receiving a tax refund.
Circular 102 abolishes Caishui  88 (Circular 88) with retroactive effect from January 1, 2018. Foreign investors that paid EIT on dividends derived on or after that retroactive effective date can apply for a tax refund in accordance with article 5 of Circular 102.
In China, foreign investment sectors are classified into four categories: encouraged sectors, permissible sectors, restricted sectors, and prohibited sectors. Foreign investors are disallowed to invest in prohibited sectors.
As a result of the issuance of Circular 102, foreign investors now become entitled to withholding tax deferral benefits on reinvestments of Chinese profits in permissible and restricted sectors, whereas they disqualified under Circular 88.
Therefore, foreign investors who reinvested Chinese profits in permissible and restricted sectors on or after January 1, 2018, now can apply for a withholding tax refund.
For more information, contact:
Glen Wei, Xuechun Zhou or Stone Yang
CHUNG RUI CTAs Group Limited