In April 2009, China’s Ministry of Finance (MOF) and State Administration of Taxation (SAT) issued a series of circulars to further clarify the preferential enterprise income tax (EIT) treatments available under the Enterprise Income Tax Law of the PRC (New EIT Law). These circulars include:
- SAT’s Circular on Relevant Issues Regarding the Implementation of Preferential EIT Treatments for High-Tech Enterprises, (Circular 203);
- SAT’s Circular on Relevant Issues Regarding the Implementation of Preferential EIT Treatments for Public Infrastructure Projects Eligible for Key Support from the State, (Circular 80);
- SAT’s Circular on Relevant Issues Regarding Accelerated Depreciation of Fixed Assets for EIT Purposes, (Circular 81);
- SAT’s Circular on Several Issues Regarding the Implementation of EIT Policies, (Circular 202);
- SAT’s Circular on Relevant Issues Regarding EIT Reduction and Exemption for Income from Technology Transfers, (Circular 212);
- MOF and SAT’s Circular on Several Issues Regarding the Implementation of Preferential EIT Policies (Circular 69); and
- SAT’s Circular on the Implementation of Preferential EIT Treatments for Venture Capital Enterprises (Circular 87).
All of these circulars retroactively apply to January 1 2008, the date on which the New EIT Law and the Implementation Rules for the New EIT Law (the Implementation Rules) took effect.
Circular 203 addresses the preferential EIT treatments granted to high-tech enterprises under the old EIT regime in light of the New EIT Law. If a company was certified as a high-tech enterprise and enjoyed preferential EIT treatments under the old EIT regime, and is also certified as a high-tech enterprise under the New EIT Law, it may, from January 1, 2008, continue enjoying the former preferential EIT treatments until they expire. If a high-tech enterprise was incorporated between January 1, 2006 and March 16, 2007 and suffered cumulative losses through the end of 2007, the enterprise will, starting from January 1, 2008, be entitled to the preferential EIT treatments granted by the old EIT regime if it is certified as a high-tech enterprise under the New EIT Law. Circular 203 also allows a high-tech enterprise to apply for and enjoy preferential EIT treatments starting from the year the company is certified as a high-tech enterprise under the New EIT Law.
Circular 80 clarifies that only resident enterprises may enjoy preferential EIT treatments for qualified public infrastructure projects. It reiterates that the income earned by a resident enterprise from investment in a public infrastructure project that falls within the Catalogue for Public Infrastructure Projects Eligible for Preferential EIT Treatments (Catalogue) will be eligible for a 100 percent EIT exemption for the first three years and a 50 percent EIT exemption for the next three years, starting from the year the project starts generating operating income.
The Implementation Rules, however, provide that an enterprise that engages in
- the contractual operation or construction of a public infrastructure project as a contractor under a contract, or
- the self-construction and self-use of a public infrastructure project, may not enjoy such preferential EIT treatments for the income earned by the enterprise from the project even if the project falls within the scope of the Catalogue.
Circular 80 further defines the point at which a project “starts generating operating income” as the time when the project generates main business income for the first time since the project’s completion and begins to operate (including a test run). In addition, Circular 80 defines the terms “contractual operation, ” “contractual construction,” and “the self-construction and selfuse of a public infrastructure project.” It also lists the parameters that an enterprise should use to calculate the reasonable expenses to be apportioned to the public infrastructure project when the enterprise derives income from other business as well. These parameters include the investment amount, sales revenue, assets, staff salaries and wages, and the like.
Circular 80 also requires that an enterprise file certain prescribed documents with the competent tax authority within 15 days after the project starts generating operating income. When a change in the enterprise’s business or an adjustment of the Catalogue results in the enterprise’s non-eligibility for the preferential EIT treatments granted by Circular 80, the enterprise should submit a report to the competent tax authority within 15 days after the change occurs and will no longer enjoy the preferential EIT treatments.
Circular 81 clarifies certain issues involved in the accelerated depreciation of fixed assets for EIT purposes. According to Circular 81, if an enterprise acquires a fixed asset and has never used the same or a similar fixed asset before, but has sufficient evidence to prove that the expected life span of the fixed asset will be shorter than the minimum depreciable period required by the Implementation Rules, the enterprise may apply the shortened depreciable period or accelerated depreciation method to this asset.
However, if the enterprise replaces an old fixed asset with a new fixed asset (with the same or similar function) before the minimum depreciable period of the old asset expires, the enterprise may apply the shortened depreciable period or accelerated depreciation method to the new asset based on the actual usage period of the old asset. Circular 81 sets forth rules on how the shortened depreciable period should be applied in cases involving new and used fixed assets, respectively. Circular 81 also specifies how to apply the two types of accelerated depreciation methods.
Circular 202 addresses the following EIT issues:
- How to determine the sales revenue base in order to calculate the maximum deduction for entertainment, advertising and promotional expenses;
- How to handle any remaining reserves set aside by an EIT taxpayer prior to January 1, 2008;
- The deduction of special donations for EIT purposes; and
- The deduction of staff education expenses incurred by software manufacturing enterprises. According to the Implementation Rules, deductible entertainment expenses may not exceed 0.5 percent of sales revenue, and the total deductible advertising and promotional expenses may not exceed 15 percent of sales revenue.
Under Circular 202, donations made by an EIT taxpayer for special purposes such as the Wenchuan earthquake, Beijing Olympic Games or Shanghai Exposition will be fully deductible for EIT purposes. Other donations, however, will be subject to the deduction ceiling set forth in the New EIT Law and its Implementation Rules.
According to Circular 202, in order to enjoy the full deduction of staff training expenses, a software manufacturing enterprise should carefully differentiate its staff training expenses from staff education expenses. Otherwise, all staff education expenses, including staff training expenses, will be subject to the deduction ceiling (i.e. 2.5 percent of total salaries and wages) set forth in the Implementation Rules. When a software manufacturing enterprise is able to accurately identify staff training expenses, only the difference between the staff education expenses and staff training expenses will be subject to the deduction ceiling.
Circular 212 deals with preferential EIT treatments for technology transfers. Under the Circular 212, technology transfers eligible for preferential EIT treatments must meet all of the following conditions:
- The transferor must be a resident enterprise under the New EIT Law;
- Technology transfer must fall within the scope specified by MOF and SAT;
- A domestic technology transfer must be certified by the science and technology authority at or above the provincial level;
- An outbound technology transfer must be certified by the commerce authority at or above the provincial level; and
- Other conditions required by the State Council’s tax authority.
Circular 212 also provides a formula for calculating the taxable income from a technology transfer, which equals the revenue from the technology transfer minus the sum of the costs for the technology transfer and relevant taxes and fees. According to Circular 212, the revenue from the technology transfer may not include:
- Revenue from the sale of equipment, instruments, parts, raw materials or other nontechnology revenue; or
- Revenue from consulting services, technology services or technology training that is not indispensable for the technology transfer.
Circular 212 further requires that a transferor account for income from a technology transfer separately from other income as a prerequisite for enjoying the preferential EIT treatments granted to qualified technology transferors. In addition, Circular 212 provides that a technology transferor should, after a tax year has ended and before it files its EIT tax return, submit to the competent tax authority certain documents relating to the preferential EIT treatments available for income from technology transfers.
Circular 69 touches on a number of issues involving preferential EIT treatments. For example, if an enterprise is entitled to transitional preferential EIT treatments under the Circular on the Implementation of Policies on Transitional Preferential EIT Treatments (Circular 39) or preferential EIT treatments related to the development of western China, Circular 69 provides that it may use the applicable preferential EIT rate as the base to calculate the half EIT exemption that it enjoys during half exemption tax holidays, while any other enterprise must use 25 percent as the base to calculate the half EIT exemption it enjoys, if such enterprise is entitled to half exemption tax holidays.
According to Circular 69, an enterprise may not enjoy both (1) the transitional EIT treatments granted by the old EIT regime and (2) the EIT tax holidays and lower tax rate granted by the New EIT Law and its Implementation Rules. An enterprise may, however, enjoy different preferential EIT treatments granted by the New EIT Law and its Implementation Rules if it meets the specific conditions set forth therein. In addition, Circular 69 provides that if a merger, spin-off or reorganization occurs to an enterprise that enjoys the transitional preferential EIT treatments, the Circular on Several Issues Regarding EIT Issues Relevant to Enterprises’ Business Reorganization (Circular 59) will govern.
Circular 69 clarifies that the distribution of dividends and other equity investment returns between resident enterprises based on accumulative undistributed profits formed before 2008 will be exempt from EIT. However, if the dividends and other equity investment returns received by a resident enterprise are generated from publicly issued and traded shares that it has held for less than 12 months, it will not be entitled to EIT exemption for such dividends and returns.
Circular 69 also refers to Circular 39. If a branch office established by an enterprise prior to March 16, 2007 has enjoyed preferential EIT treatments under the old EIT regime and meets the conditions for transitional preferential EIT treatments set forth in Circular 39, Circular 69 affirms that the branch office may enjoy these transitional preferential EIT treatments.
With respect to preferential treatments available for an EIT taxpayer’s purchase of certain equipment, Circular 69 provides that these preferential treatments (which may include a tax credit equal to 10 percent of the investment in the equipment) will also apply to a lessee in a financial lease if the lessee obtains ownership of the equipment at the end of the lease term (otherwise, the lessee must refund the tax credit). Applicable equipment includes equipment to be used for purposes of environmental protection, power and water conservation or safe manufacturing.
As for preferential EIT treatments available for a venture capital enterprises, Circular 69 states that the duration of a venture capital enterprise’s investment in an unlisted small or medium high-tech enterprise prior to January 1, 2008 will be considered in the calculation of the twoyear duration threshold. In addition, a small or medium high-tech enterprise that was certified as a high-tech enterprise prior to the end of 2007 will not have to be re-certified until valid period of its high-tech enterprise certification expires. Circular 69 further defines key terms such as “international financial organization,” “preferential loans,” and “newly-established software manufacturing enterprise.”
Circular 87 further clarifies preferential EIT treatments granted by the New EIT Law and its Implementation Rules to venture capital enterprises. According to Circular 87, a venture capital enterprise must be an enterprise or economic organization incorporated in the PRC in accordance with the Provisional Measures for the Administration of Venture Capital Enterprises and the Regulations on the Administration of Foreign Invested Venture Capital Enterprises, for the special purpose of engaging in venture capital investment activities. The New EIT Law allows a qualified venture capital enterprise to offset a certain percentage of its investment against its taxable income for EIT purposes, and the Implementation Rules further set this percentage at 70 percent (provided that the venture capital enterprise has invested for more than two years in the equity of a small or medium high-tech enterprise that has not been listed on a stock exchange). Circular 87 sets forth certain conditions that a venture capital enterprise must meet in order to enjoy the preferential EIT treatments, including that its business scope be consistent with the Measures and it has been registered with the industry and commerce authority as a “venture capital limited liability company,” “venture capital joint stock company,” or another type of professional legal person venture capital enterprise. Furthermore, in addition to having passed the high-tech enterprise certification procedure according to the relevant administrative measures, the small or medium high-tech enterprise that the venture capital enterprise has invested in must have a staff of not more than 500, annual sales revenue of not more than RMB200 million, and total assets of not more than RMB200 million.
Under Circular 87, if a small or medium enterprise is certified as a high-tech enterprise after receiving the venture capital investment, the investment duration of the venture capital enterprise will be calculated from the year of certification. If, at any point during the investment duration, the small or medium enterprise no longer meets the standards for a small or medium enterprise due to the venture capital it has received but still meets the standards for a high-tech enterprise, the venture capital enterprise will still be entitled to preferential EIT treatments.
The above seven circulars aim to provide clear guidance for EIT taxpayers and tax authorities with regard to the implementation of the New EIT Law and its Implementation Rules. EIT taxpayers should evaluate the implications of these circulars on their EIT burdens as soon as possible.