I. withholding tax of unpaid payable payment incomes
When PRC enterprise pays income such as interest, rent or royalties to a non-resident enterprise under a relevant contract or agreement, if the PRC enterprise does not actually make such payments in accordance with the contract or agreement, or may delay payment due to changes or amendments made to the contract or agreement, however, if the PRC enterprise were to book that expense in its accounts and claim a deduction for the expense in its EIT return filed for that tax year, it would have to withhold tax on the related income (payable to non-resident enterprise) when filing its EIT return for that tax year.
The PRC enterprise may also capitalize the interest, rent or royalties in the cost of an asset or pre-operating expense and only claim deductions for the depreciation or amortization expenses in future periods after the asset has been put to use or business operations commence. In such cases, the PRC enterprise should withhold tax on the income when filing its EIT return for the tax year when the income (payable to non-resident enterprise) is capitalized.
Lastly, in the event the actual payment is made by the PRC resident enterprise to the non-resident enterprise before the contractual payment date, tax should be withheld in accordance with the EIT Law as at actual payment date.
II. Guarantee fees
Guarantee fees received by a non-resident enterprise that are sourced from China would be subject to EIT at the rate applicable to interest income. Such guarantee fees are defined in Article 2 of the Bulletin as guarantee fees or fees of similar nature paid by a PRC enterprise, establishment or individual for the guarantee provided by the non-resident enterprise in relation to lending, trading, freight of goods, subcontract processing, renting, the undertaking of a contracted project, etc.
III. Transfer of land use rights
Gains recognized from the transfer of land use rights by a non-resident enterprise without an establishment in China, or one with an establishment but where the gains cannot be attributable to the establishment in substance, would be subject to EIT on a withholding basis. Such gains should be calculated with reference to the consideration received for the land use rights, less the tax base of the rights. The EIT payable on the gains should be withheld by the relevant withholding agent. While the Bulletin does not provide a definition of “tax base”, reference may be made to Article 66(1) of the Implementation Rules to the EIT Law, which defines the tax base of purchased intangible asset as the purchase price, relevant taxes and expenses paid, and other expenditures directly attributable to putting an asset into condition for its intended use.
IV. Finance leases and rental income from immovable property
1) Where a non-resident enterprise without an establishment in China extends a finance lease of equipment or other items for use by a PRC enterprise, where the ownership of the equipment or items would be transferred to the PRC enterprise by the end of the lease (including transfers undertaken at a certain price). The net lease income received by the non-resident enterprise within the lease term should be calculated using the finance lease income (including any transfer price payable at the end of the lease under the finance lease agreement) less the price of the equipment or item. The net lease income would be treated as interest and subject to EIT and it should be withheld by the PRC enterprise.
2) Non-resident enterprises that lease houses, buildings or other immovable property in China, but do not have establishments in China through which to provide daily management of such immovable property, would be subject to EIT on the gross rental income derived. The PRC EIT payable should be withheld by the PRC tenant when the rent is paid to the non-resident enterprise, or when the rent falls due.
However, if the non-resident enterprise were to send personnel to China, or engage other enterprises or individuals in China to provide daily management of the immovable property, it should be regarded as having an establishment in China, and the non-resident enterprise should undertake the reporting and payment of the PRC EIT payable within the deadlines stipulated in the EIT Law.
VI. To fully implement Notice of the State Administration of Taxation on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises’ Equity Transfer Income (Circular 698)
1) If a non-resident enterprise transfers a PRC resident enterprise directly, and the relevant sales and purchase contract or agreement stipulates that the consideration of the sale is to be paid by installments, the recognition of income from the sale should take place on the date on which the related sales and purchase contract or agreement takes effect and upon the completion of procedures in respect of the share transfer.
2) Listed shares in Chinese resident enterprises bought and sold over a public securities market” as referred to in Article 1 of Circular 698 are defined as those whereby the party from whom the shares are purchased, the party to whom the shares are sold, quantity of the shares and price of the shares are not determined upfront between the buyer and seller, but are determined based on the normal trading principles of a public securities market.
3) “foreign investor (party with effective control)” stipulated in Article 5, Article 6 and Article 8 of Circular 698 means ALL foreign investors who have indirectly transferred a Chinese resident enterprise; the “effective tax burden” stipulated in Article 5 of Circular 698 refers to the effective tax imposed on the gains on the share transfer transaction per se, and “does not tax foreign-sourced income” means that Enterprise Income Tax will not b levied on the share transfer transaction incomes.
4) If two or more non-resident enterprises were to undertake an indirect transfer of the equity in a PRC resident enterprise, one of the non-resident enterprises could, in accordance with Article 5 of Circular 698, report the indirect transfer to the local PRC tax bureau where the PRC resident enterprise is located.
5) If a non-resident enterprise were to undertake an indirect transfer of two or more PRC resident enterprises located in different provinces (cities), the non-resident transferor could choose to report the indirect transfer to any one of the local PRC tax bureaus in those provinces (cities). The chosen PRC tax bureau would liaise with the other relevant PRC tax bureaus to assess whether the non-resident enterprise should be subject to EIT on the transaction and report to the SAT. If the non-resident enterprise were assessed to EIT, it will have to pay the tax due to all the relevant PRC tax bureaus.
VII. The Notice takes effect from 1 April 2011 and also applies to transactions that have occurred prior to its issuance for which the relevant PRC tax matters have not been dealt with.
The new Rules for the Tax Administrative Review (Order of SAT  No. 21) (hereinafter the “New Rules”), issued by the State Administration of Taxation (“SAT”), have superseded the Interim Rules for the Tax Administrative Review (Order of SAT No. 8). One of the aims of the New Rules is, arguably, to increase protection of the legal rights of taxpayers and other interested parties. It is also evidence that one purpose is to ensure supervision of the tax authorities so that they lawfully exercise their authority. The New Rules introduce several major modifications to the tax administrative review system, such as the scope of administrative review, rules on admissible evidence and the method of hearings.
However, probably the most significant change is the introduction of a compromise and conciliation system in accordance with Articles 40 and 50 of the New Rules. Whilst negotiation with the tax authorities in China, both prior to commending litigation and during litigation, is already a common practice there were long standing concerns about the legality of such practices and whether agreements that had been reached were, in fact, enforceable. The New Rules seek to provide a stronger legal basis for such practices.
The New Rules outline the requirements for a binding compromise agreement. It is first noted that the content of a compromise agreement shall not damage the interests of the public and/or individuals. Once a compromise agreement has been approved by the relevant administrative review organ, an applicant is not permitted to apply for review on basis of the same fact and reason. However, apart from this, the New Rules do not specifically detail the legal effect of a compromise agreement. There are still concerns as to the extent to which a compromise agreement can be enforced. It is also not clear whether the applicants can revoke a compromise agreement and reapply for review should new evidence come to light. Finally, the New Rules do not outline that the action that can be taken when one party does not meet their obligations under the compromise agreement.
The new Rules represent a significant attempt by the SAT to bring legitimacy and transparency to the tax administrative review system in China. Whether they achieve such an aim is yet to be seen.
On 10th February 2010 the State Administration of Taxation (SAT) issued new Tax Administrative Review Rules (SAT Order  22) (the “Rules”) providing a comprehensive guideline for tax disputes in China. There are 105 articles in the Rules, which is 53 more articles than was contained in the original. A fundamental component of the new Rules is the introduction of a reconciliation and compromise system. The Rules are operable from 1 April 2010.
Reconciliation and compromise
As introduced by the stakeholder, the added reconciliation and compromise system stipulates the applicable scope and fundamental principle of the reconciliation and compromise. It also designs details of procedures and requirements . The new rules allow the applicant and the respondent to reach a settlement agreement voluntarily and the administrative review shall terminate after permitted by institution of administrative review, however , the applicant shall not apply the administrative review again for the same fact and reason .The institution of administrative review shall conduct the conciliation in accordance with the principle of voluntary.
Some of the other more important changes in the Rules include guidance on the admissibility of evidence, a shift from documentary hearings to full public oral hearings, stipulations on which level of local taxation bureaus have jurisdiction for administrative review and a direction that tax authorities of all levels must provide guidance and supervision in respect of tax administrative review.
A translation of the new Rules will be posted on the Hwuason website within the next 7 days.
In mid-February the SAT issued Administrative Measures Concerning the Administrative Norms of Drafting Taxation Documents (SAT Order  No. 20) (the “Measures”). The Measures aim to establish a standardized method for the drafting of official documents by tax authorities at or above the county level. Different from other inner management documents and its predecessor, the new measures not only imposes restrictions on authorities and procedures in respect of drafting of documents but also pays more attention to the protection of taxpayers. This continues the general trend in China to increase taxpayers’ rights. Some of the changes in the Measures are as follows:
- Article 2 of the Measure replaces the term “person subject to taxation administration” to the “taxation administrative counterpart”. The reasoning behind this change is to indicate that the relationship between the tax authorities and taxpayers is not “to manage or to be managed” but is of relative equality.
- The Measures aim to solve conflict in current practices for the drafting of taxation documents. In China, tax authorities at different levels unveil hundreds of fresh policies and documents every year and these official documents are often in conflict. This Measures’ require that revoked documents be specified and for the SAT to clean up all the taxation documents every two years. The SAT is required to release a directory of those documents that have been withdrawn or annulled.
- Article 6 of the Measures clarifies that the taxation bureaus at the county level shall formulate the authority files only whereas the taxation bureaus at the provincial level or above shall give explicit authorization for them. This article will limit the role that taxation bureaus at the county level have in relation to the formulation of official documents.
- Article 14 outlines the rules for the implementation new regulations. The original Administrative Measures specified that as a general rule new regulations shall take effect from the date of issue. The new Measures provide that regulations shall be in effect from 30 days after the date of issue.
Here at Hwuason we have seen a general trend over the past 12 months indicating that the SAT intends to provide greater rights and certainty for tax payers. This is one of the latest signs of this trend.
Many readers may have come across the many different types of tax regulations and policies in China – such as Caishui, Guoshuifa, Guoshuian etc. This can all be quite confusing at times so we thought that we would attempt to clarify how the laws, regulations etc interact. We will use the Enterprise Income Tax system as an example.
The taxation of enterprises is governed principally by the Enterprise Income Tax Law which was promulgated by the National People’s Congress (China’s governing parliament). The EITL is what is referred to as a Basic Law. This is the fundamental law underpinning a certain legal area (in this case the income taxation of enterprises). The NPC only meets once a year so Basic Laws can be very difficult to change. It can take up to ten years from an initial draft stage to the promulgation stage. Also, as with any political system, the more decision makes involved in a process the more highly politicised an issue will be. As such, Basic Laws are usually very … basic. They tend to be quite short and vaguely drafted in order to accomodate change at the level of regulations and to obtain a broad consensus.
The next document in respect of enterprise income taxation is the Implementing Regulations of Enterprise Income Tax Law which is issued by the State Council. Now we start to get a bit more substantive. The State Council meets on a regular basis and is a relatively small group (in contrast to the NPC). The Implementing Regulations puts the meat on the bone of the EITL. However, once again the Implementing Regulations are not overly detailed and leave a lot to the imagination (or the tax authorities). Implementing Regulations are basically drafted by the SAT and signed off by the State Council.
Circulars and Measures
There are a number of different circulars and measures that are issued at different levels of the tax administration including the following:
- Guofa - these are circulars issued by the State Council. These are usually very short and confined to a single issue or topic area;
- Caishui – these are notices jointly issued by the SAT and the Ministry of Commerce;
- Guoshuifa (or Measures) – these are issued by the State Administration of Taxation and can be quite detailed. In 2009 the SAT issued Guoshuifa (No 2) a very detailed range of measures on anti-avoidance practices.
- Guoshuihan – these are internal circulars issued by the SAT to the various provincial and local level SATs and local taxation bureaus outlining policy practice in respect of a certain area. In early December 2009 the SAT issued Guoshuihan  2009 which outlined a new practice in respect of the taxation of off-shore equity transactions.
From a theoretical legal perpsective, the regulations higher up the end of the chain will have more force. For example, if a Guoshuihan circular contradicts a Caishui circular, the latter will prevail. However, in practice they are all fairly equal in terms of the need to be obeyed. Whilst Guoshuihan circulars are only internal policies, they effectively reflect the terms of the superior Laws and Regulations themselves, or at least the SAT’s interpretation of those Laws and Regulations.
To make things more confusing, these are just the regulations issued at a national level. Each provincial level SAT and, in fact, each provincial taxation bureau have their own set of regulations and policies.