Common Issues in Tax Application of Chinese Companies

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The State Taxation Administration (STA) is responsible for formulating and implementing the taxation system in the People's Republic of China. However, the handling and collecting of taxes are carried out locally by regional tax bureaus.

Taxes vary in certain locations and apply to specific industries, such as Free Trade Zones (FTZs). For example, the Shanghai FTZ focuses on international trade and finance with a 9% and 15% tax rate. The Tianjin FTZ focuses on research and development, design and aviation logistics. This area also has a rate between 9% and 15%.

If you run a wholly foreign-owned enterprise (WFOE), which means you're running a business in the country without a local partner, here are the taxes that would apply:

1. Taxes related to income and profit:

● The CIT - the tax on your business' income.

● Withholding Tax - taxes that apply to the profits of foreign-owned businesses operating in China.

2. Taxes related to sales and turnover:

● Value-added tax - A consumption-based tax.

● Consumption tax - Tax that applies to your purchases.

● Stamp tax - A tax on certifying legal documents.

● Real estate tax - A tax that applies on the property your business owns - also known as the property tax.

The Chinese tax system provides advantages for foreign businesses, including deductions for expenses like R&D, training, and donations, tax incentives like reduced rates and exemptions, extensive double taxation avoidance agreements with over 100 countries, and a transparent tax structure. These benefits can bolster cost savings and foreign enterprises' competitiveness in the Chinese market.

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The corporate income tax rate in China is 25%. For different companies, there are different exemptions. Please feel free to contact us for more information.

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Yes. The corporate tax rate applied to all companies set up in mainland China.

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All enterprises, including any organizations earning income in China, are liable for this tax. The CIT Law classifies enterprises into resident and non-resident enterprises, each with specific tax obligations.

Resident enterprise 

A resident enterprise refers to a Chinese or foreign company that is legally incorporated in China with business operations administered from the country. This includes wholly foreign-owned enterprises (WFOE), joint ventures (JVs), or foreign-invested commercial enterprises (FICE).

In this case, the businesses need to pay the corporate tax on the worldwide income earned, whether it comes from within or outside China.

Non-resident enterprise 

Your business is considered a non-resident enterprise if it is set up based on foreign regulations and isn't managed from within China. This implies that your business is established and operated primarily outside China. In this case, you'll only need to pay tax for the income you earned in China.

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The tax rate for companies in China is 25%.

This rate applies to resident and non-resident companies operating income-generating establishments in China.

However, as an SME, you may benefit from lower rates based on factors such as your entity type, size, sector, or location.

For China-sourced income unrelated to your establishments in the country, or if you are a non-resident company without establishments there, a temporary reduction to 20% is applied.

Small and low-profit enterprises qualify for a reduced CIT rate of 20%, while high-tech enterprises or those established in special zones like encouraged industries in Hainan can enjoy a reduced rate of 15%.
Also, if you're a qualified enterprise in key industries within FTZ areas, such as the Lingang New Area of the Shanghai Pilot FTZ, you can benefit from a reduced rate of 15% for five years from your business establishment date. Here are the list of key industries and FTZ:

Key industries: 

● Integrated circuits

● Artificial intelligence

● Biomedicine

● New energy

● New materials

● High-end equipment manufacturing

● Clean energy

● Advanced manufacturing

● Financial solutions

● Tourism

● Logistics

● Modern agriculture

FTZ Zone:

● Shanghai Free Trade Zone

● Guangdong Free Trade Zone

● Tianjin Free Trade Zone

● Fujian Free Trade Zone

● Chongqing Special Economic Zone

● Sichuan Free Trade Zone

● Shaanxi Special Economic Zone

● Henan Free Trade Zone

● Zhejiang Free Trade Zone

● Hubei Free Trade Zone

● Liaoning Special Economic Zone

● Hainan Free Trade Port

● Jiangsu Free Trade Zone

● Shandong Free Trade Zone

● Hebei Free Trade Zone

● Heilongjiang Free Trade Zone

● Guangxi Free Trade Zone

● Yunnan Free Trade Zone

● Beijing Free Trade Zone

● Anhui Free Trade Zone

● Hunan Free Trade Zone

These favourable rates can help lessen your tax burden and enhance financial flexibility.

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Taxable income is determined using an accrual basis, where earnings are gained, and costs are logged when accrued. There are two ways of calculating taxable income: direct and indirect.  

Direct method 

The direct method is the most common. The formula is as follows:  

Taxable income = Gross income – Non-taxable income – Tax-exempt income – Deductions – Taxes that can be brought forward from the prior tax year.

Let's take some time to go through each of these in detail.

Gross income

● Gross income refers to the income received in currency and non-currency, such as:

● Income from selling goods and/or services provided

● Income from property transfers

● Profits from equity investments like dividends and bonuses

● Rental income

● Income from interest and royalties

● Gift and donations

Non-taxable income and tax exemptions

Non-taxable income and exemptions are revenue items that are exempted from tax, including:

● Financial allocations

● Administrative costs

● Government funds such as subsidies

● Other income not taxed, as determined by the government

Meanwhile, tax-exempt income includes items such as:

● Income from interest on government bonds

● Profits from dividends

● Other gains in shared investments among eligible local companies or by foreign companies in China

● Income of non-profit groups

Deductibles

The tax law allows deductions from your taxable income based on your business expenses on the following.  

● Charitable donations

● Reasonable spending connected to business earnings

● Reasonable depreciation of tangible assets

● Gradual reduction in intangible assets

● Gradual prepaid expense reduction

● Inventory costs

● Transfer asset's net value

● Extra deductions as per the tax law

Caps are in place for specific deductible expenses, including:

● Employee welfare – up to 14% of the total employee salaries and wages.

● Labour union funds – up to 2% of the total employee salaries and wages.

● Employee education – up to 8% of the total employee salaries and wages. Excess expenses in this category can be brought forward to future tax filings. Also, if you're in the software and integrated circuit industries, a 100% deduction applies.

● Advertising and publicity – up to 15% of the sales revenue of the current year. Until 31 December 2025, enterprises producing or selling cosmetics, pharmaceuticals and producing non-alcoholic beverages will have a boosted deductible rate of 30%. Any excess amount can also be carried forward to future tax filings.

● Business entertainment costs related to production or business operations – up to 60% of the actual expenses you incurred, up to 0.5% of your total sales revenue for the current year, whichever is lower.

Indirect method 

The indirect method is less commonly used, but it can be applied when your business lacks a clear record of its income and expenses. The formula is as follows:

Taxable income = Gross profit as shown in the accounting book ±  Adjustments for tax purpose ± Income/profits to make up for the loss incurred in the previous year.

Please feel free to contact us for tailored solution.

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The process of funding a China company is a unique, and there are only three legal ways to get cash into a Chinese company. Legal filings and regulatory approvals must be obtained in the process. These three legal methods are:

1. Established Capital

2. Allowable Debt

3. Funds Internally Generated from Business Operations

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The capital is defined and capped in business license filings. It is legally required by the Chinese governmental authorities for filing a new company. Capital should be paid in within 5 years after the company is founded according to the latest Company Law.

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Cash and valuable and transferable non-cash investments such as hard assets, technologies, equipments.

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Yes. However, no matter to increase or to reduce the capital, certain approvals should be obtained from the Chinese authorities, and it might cost a few weeks or a few month to finish all the governmental proceedings.

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The allowable debt is determined and capped by the Chinese investment regulations based on the scale of the company, regardless of business type or location and would apply to all forms of loans, including intercompany loans, bank loans, subordinated debt, preferred (non-convertible) stock, etc.

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Because the local debt forms a natural balance sheet hedge against the FOREX (foreign exchange market) -driven revaluations that can impact consolidated earnings radically. If you balance your loans versus equity to the maximum degree possible, you minimize the FOREX revaluation effect on your earnings.

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There are three general sources of loans: domestic China banks, foreign banks licensed to issue commercial loans in China and official intercompany loans which would be a loan from the parent company.

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Local qualified collateral can include buildings, equipment, accounts receivable and inventory to various percentage qualifications. The most common path to satisfying the qualified collateral hurdle is through a parent guarantee of some form acceptable to the lender. Examples of parent guarantees include, but are not limited to:

1. Letters of Credit from the foreign parent company to back a direct loan by a Chinese bank.

2. Deposit in a Hong Kong bank branch of a foreign bank licensed to issue commercial loans in China.

3. Parent guarantee letter to a foreign bank licensed to issue commercial loans in China. This is possible but not common and is generally limited to the case where the foreign commercial bank had a longstanding relationship with the foreign parent company.