State Administration of Taxation of the PRC ("SAT") promulgated the Administrative Rules on Income Tax for Policy-based Relocation of Enterprises on August 10, 2012 ("Rule 40") which is set to become effective on October 1, 2012. Policy based relocation refers to relocations at the request of the authority rather than voluntary relocations by enterprises (see below for more details).
Rule 40 aims at establishing more specific and systematic rules in terms of preferential tax treatments which apply to policy-based relocations. This new rule will replace the Circular on Relevant Issues concerning Enterprise Income Tax on Incomes from Policy-based Relocation or Disposal of Assets promulgated by State Administration of Taxation on March 12, 2009 ("Circular 118").
Basically, Rule 40 takes the principles on income tax deferral provided in Circular 118, while at the same time specifying relocation income and relocation expenses to be compensated as well as setting a framework for the application procedures. One important change is that the cost and expenses for purchasing assets during the relocation can no longer be deducted from the relocation income. Set out below are highlights of Rule 40:
Preferential Tax Treatment for Policy-based Relocation - According to Rule 40 and its official interpretation, the preferential tax treatment which will be applied to a qualified policy-based relocation will mainly be limited to 1) deferral of tax imposed on relocation income after deduction of relocation cost; 2) deferral period based on relocation period which allows for a maximum period of five years; and 3) in case of any remaining losses not yet made up before the relocation, then relocation period can be subtracted from the mandatory loss carry-forward period.
Scope of Policy-based Relocation - Rule 40 simplifies the definition of the policy-based relocation to be a relocation or partial relocation initiated by the government for the purpose of the public interest. According to the rule, a relocation may falls within the scope of a policy-based relocation if it is conducted for the purpose of national defense, diplomacy, government-organized infrastructure, residential construction for social welfare or renovation of historic rural buildings.
Independent accounting requirement – As a condition to enjoy the preferential income tax treatments, Rule 40 requires separate accounting for items relating to the relocation, covering the relocation income, relocation expense and relevant tax. Failure to observe this requirement may be deemed as a waiver of the preferential treatment provided for under Rule 40.
Relocation Income – Under Rule 40, the relocation income basically is composed of two major parts, i.e. relocation compensation and income arising from asset disposal. The relocation compensation refers to the monetary and non-monetary income, which is obtained as compensation for requisition of assets, relocation of assets and employees, losses for shutdown of business during the relocation, insurance to cover the damages occurred in the relocation process, etc.. The income arising from asset disposal refers to the income obtained for disposal of assets in the process of relocation.
Rule 40 specifically excludes revenue for disposal of inventory from relocation income.
Relocation expense – Relocation expenses under Rule 40 is composed of relocation fee and relocation expenses for asset disposal which including expenses occurred for employee settlement and relocation, salary and pensions paid to employees during the shutdown, expense for temporarily warehousing the inventory, fees and relevant tax for disposal the assets, etc.
One major change incorporated in Rule 40 is that expenses for the purchase of assets during the relocation will no longer regarded as a relocation expense which can be deducted from the relocation gain before taxation. In addition, the expenses for technical updates or renovation, which was allowed to be deducted from the relocation income under Circular 118, are not specifically provided for in Rule 40. Therefore there is some uncertainty in this regard.
Tax Treatment – Similar as Circular 118, Rule 40 provides that tax imposed on relocation gain and expense can be deferred to the year when the relocation has been completed. The new rule allows a maximum five years for the relocation. The relocation will be deemed to be completed if 1) the relocation planning has been basically completed; and 2) operational revenue accounts for more than 50% of the annual revenue before the relocation.
Application Procedures – Rule 40 clarifies the procedures as to how to apply for the preferential treatment. Failure to follow the requirements may result in failing to be qualified as a policy-based relocation.
- Application period. The application shall be submitted during the period from relocation commencement date to 31 May of the next year.
- Tax authorities in charge. The application shall be submitted to tax authorities in the places where is enterprise is currently located and will be relocated. The new rule also specifies that the tax authority in the jurisdiction to which an enterprise will be relocated, will be in charge for the final tax clearance of the relocation. This indicates the tax authority in the relocated place will play a more important role in the relocation cases than previously.
Application materials. The application materials include government issued relocation publication, relocation planning document, compensation agreement, asset disposal plan and other relevant documentation.