The following matters are covered in this issue:
- Tax deduction for charitable donations (Cai Shui  No. 15)
- China to further liberalize rules for foreign-invested banks (CBRC  Order No. 3)
- Guidance on dividend reinvestment tax incentive
- MOF and SAT’s notice on recognition of non-profit organizations qualifying for tax exemption (Cai Shui  No. 13)
- SAT’s announcement on ‘one-visit’ list of tax matters (SAT Announcement  No. 12)
- SAT’s guidance on launching a campaign to facilitate taxpayers in 2018 (Shui Zong Fa  No. 19)
- SAT’s notice on implementation rules for verifying VAT filing returns (Shui Zong Han  No. 94
Tax deduction for charitable donations
In February 2017, China revised its Corporate Income Tax (CIT) Law (Article 9) dealing with tax deductions for charitable donations. This states that charitable donations made by an enterprise are deductible up to 12% of the enterprise’s gross annual profit. However, where donations exceed 12% of the profit in a year then the tax deductions for the excess are lost. As a development on this, under the revised CIT law, charitable donations exceeding 12% of gross annual profit are allowed to be carried forward and be deducted from the taxable income of an enterprise over the following 3 years (see KPMG China Tax Weekly Update (Issue 8, March 2017) for details).
Further to this, on 11 February 2018, the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) jointly issued Cai Shui  No.15 (“Circular 15”), setting out the detailed implementation rules, which apply retroactively from 1 January 2017:
- Charitable donations refer to donations made by an enterprise to qualified organizations and government institutions (county level and above). The donations must be used for charitable and public interest purposes.
- Charitable donations are deductible up to 12% of an enterprise’s annual gross profits in a tax year. These include donations made in that year and any unused donations carried forward from prior years.
- Any unused charitable donations (i.,e., donations exceeding 12% of the annual gross profit) are permitted to be carried forward for 3 years.
- In calculating the deduction for charitable donations, the deduction must first take into account the amount carried forward from the previous year and followed by donations made in the current year.
- Circular 15 may be applied provided that the charitable donations were made during the period of 1 September 2016 to 31 December 2016 and have yet to be deducted for CIT purposes for 2016 tax year.
China to further liberalize rules for foreign-invested banks
At the 10 November 2017 China-US economic cooperation meeting, Mr. Zhu Guangyao, deputy minster of finance, indicated that China will significantly lower the entry threshold for foreign investments in the financial sector (such as investments made in securities, fund management, futures and insurance companies).
Subsequently, the China Banking Regulatory Commission (CBRC) reaffirmed the said relaxation and also indicated that China will remove the foreign equity ownership holding requirement for Chinese-funded banks and financial asset management companies. At present there is a 20% limit for a single foreign investor and a 25% limit for foreign investors collectively.
Following the planned changes, both foreign investors and domestic private investors making investments in banks (which are generally state owned enterprises) will be subject to the same equity limit rules (see KPMG China Tax Weekly Update (Issue 45, November 2017) and (Issue 49, December 2017) for details).
On 24 February 2018, CBRC issued the revised Implementation Rules for Administrative Licensing for Foreign-invested Banks (CBRC Order  No. 3, “Order 3”). Order 3 supersedes the 2014-issued rules (CBRC Order  No. 6) and came into effect from its date of issuance (i.e., 24 February 2018).
Compared to the 2014-issued rules, Order 3 makes the following notable changes:
- Opening up the banking sector: According to Circular Yin Jian Ban Fa  No. 12, foreign-invested banks in China (excluding Chinese branches of foreign banks) may invest in domestic financial institutions (subject to satisfaction of risk management control standards). This include either setting up domestic banks or acquiring an equity interest in existing domestic banks. That is, a foreign bank may invest in domestic banking financial institutions, either through its offshore parent bank or its corporate bank incorporated in China, provided such investment is compliant with existing PRC laws and regulations.
In this regard, Order 3 also sets out licensing requirements, approval procedures and documentation requirements. To qualify for making the investment, Order 3 clarifies that foreign-invested banks must meet certain requirements, in particular, including:
- Have good corporate governance;
- Have a sound system of risk management and internal control; and
- Equity investments must not exceed 50% of net assets.
- Cancel or simplify administrative licensing requirements: Foreign-invested banks may carry out the following business activities without obtaining a specific license from the CBRC (only a regular reporting to CBRC is required):
- Overseas wealth management business on behalf of clients;
- Overseas wealth management custody business on behalf of clients;
- Securities investment fund custodian business;
- Cases where liquidated foreign-invested bank branches withdraw their interest-bearing assets from China. Under the existing rules, interest-bearing assets of foreign bank branches should be retained in China in the form of fixed deposits.
- Align market access criteria for foreign-invested banks with those for Chinese-funded banks. Make both foreign-invested banks and Chinese-funded banks, to the extent possible, subject to the same licensing requirements and approval procedures. These include:
- Cancel the pre-approval, currently required, for preparation work relating to the sett up of bank sub-branches throughout China. However, the final launch of the sub-branches still requires pre-approval.
- Simplify the qualification requirements which currently apply to foreign-invested banks issuing debt and augmenting capital (e.g. through share issuance).
- Simplify the review procedures for qualifying senior executives. Going forward, where a senior executive, working at a foreign-invested bank, is transferred to another bank, with their titles remain unchanged (or lowered), a recordal filing suffices. Previously, it would be subject to a pre-approval.
Guidance on dividend reinvestment tax incentive
On 28 December 2017, the MOF, SAT, National Development and Reform Commission (NDRC), and Ministry of Commerce (MOFCOM)) jointly issued Cai Shui  No. 88 (“Circular 88”). This established a withholding tax (WHT) deferral incentive for profit reinvestment in China. Subsequently, on 2 January 2018, SAT issued SAT Announcement  No. 3 (“Announcement 3”), setting out implementation rules for the WHT deferral incentive (see KPMG China Tax Weekly Update (Issue 1, January 2018) and (Issue 3, January 2018) for details).
Further to this, on 27 February 2018, the SAT held a webcast and further clarified implementation issues, using a range of practical examples.
- Circular 88 provided that, the WHT deferral treatment is available for direct equity investments in Chinese enterprises. In particular, qualifying equity investments include:
- Increases in paid-in capital or capital reserves of China resident enterprises;
- Set up of newly incorporated China resident enterprises;
- Acquisition of equity in Chinese resident enterprises from unrelated parties.
WHT deferral does not apply to the following:
- Increases to paid-in capital or capital reserves of publicly listed companies or acquisition of shares in publicly listed companies. This limitation does not, however, apply if the investment qualifies as a ‘strategic investment’ as defined in MOFCOM Decree  No. 28; or
- Acquisition of shares from related parties.
The SAT tax official giving the webcast also clarified that where a distributed profit payment is used for multiple purposes, clear delineation needs to be made. For example, take the case of a foreign investor which receives a RMB300 million dividend from a Chinese resident enterprise and uses RMB200 million for increasing the paid-in capital of another China resident enterprise. The remaining RMB100 million, remitted out of China, was not used for investment purposes. Under this scenario, RMB200 million would be eligible for WHT deferral treatment while the RMB100 million would be subject to dividend WHT (usually 10% before treaty relief).
- Per Circular 88, the profit distributions eligible for WHT deferral treatment include dividends, profit distributions and other returns on equity investment, where distributed out of realized retained earnings of China resident enterprise. It is clarified that:
- Dividends and profit distributions from liquidation proceeds may be eligible for the WHT deferral treatment.
- Retained earnings of Chinese resident enterprises include undistributed profits earned prior to the effective date of the relief (January 2017). However, this assumes that the profits have been recognized as an addition to the accounting reserves in the financial statements prepared after the year end of a particular financial/tax accounting year. If a distribution is made within a year, out of profits earned in that year (but not yet recognized by the financial statements as retained earnings) then the WHT deferral treatment will not be applicable to that payment.
- Where capital reserves (i.e. ‘non-distributable reserves’) are used to increase capital, dividend WHT would not be imposed. Consequently, the WHT deferral treatment would not apply.
- Where surplus reserves (i.e. ‘distributable reserves’) are used to increase capital, WHT deferral treatment would apply.
- Circular 88 stipulates that only ‘direct’ investments are within the scope of the relief. When distributed profits are reinvested in a Chinese enterprise, the relevant cash funds must be transferred directly to the account of invested enterprise or the equity transferor (rather than transferred via a third party (i.e., indirectly transferred)).
When the direct investment is made using non-cash payment such as tangible assets or securities, ownership of the assets must be transferred directly from the profit-distributing enterprise to the invested enterprise (or transferor, in the case of acquisition). Such assets should not be temporarily held by any other company or individual before the direct investment is made.
The tax official clarified that, to determine whether arrangements would qualify, the tax authorities will look at whether the ‘direct investment’ criteria are properly satisfied.
For example, a foreign investor acquires an equity interest in a Chinese resident enterprise from unrelated parties and the acquisition consideration is paid out of distributed profits received by the foreign investor from a separate Chinese subsidiary. The transaction is arranged as: (i) the profit-distributing enterprise remits profits to an account which was jointly set up in China by the equity transferor and the equity transferee; and (ii) upon completion of the relevant transfer formalities, the amount then will be transferred to the account of equity transferor. The case would be eligible for the WHT deferral treatment as long as the foreign investor did not previously indirectly control the Chinese enterprise, the equity of which is being transferred to him.
- Announcement 3 stipulated that the invested enterprises must carry on one or more of the following activities in connection with ‘encouraged’ projects:
- Producing products or providing services;
- Research and development (R&D) activities;
- Investing in construction projects or purchasing equipment; or
- Other business activities.
The tax official clarified that there are no requirements concerning the extent to which the encouraged activities contribute to the profits of the invested enterprise.
- Circular 88 stipulates that that the relief is applicable to profits distributed to foreign investors, on or after 1 January 2017. Any foreign investors who are entitled to the concession, but which have paid WHT previously, can retroactively apply for the benefit and claim tax refunds within 3 years of payment. An example is set out for illustrating how to determine the tax refund amount under two circumstances.
For example, on 1 August 2017, a Chinese resident enterprise (“China Co B”) distributed profits of RMB50 million to its overseas shareholder - foreign company A (“Foreign Co A”). RMB45 million (out of RMB50 million) was used by Foreign Co A to increase its paid-in capital in China Co B and the remaining RMB5 million was used to pay WHT (i.e. RMB50million*10%) on the profit distribution (withheld by China B Co). Assuming that the reinvestment meets the qualifying conditions set out in Circular 88, Foreign Co A may retroactively apply for the relief and the withheld tax will be refunded as follows:
- The full WHT (i.e. RMB5 million) is refunded to China Co B. When China Co B finally pays this RMB5 million refunded amount onwards to Foreign Co A, 10% dividend WHT, totaling RMB0.5 million, would be applied (i.e. RMB5million*10%).
- WHT is refunded to Foreign Co A. In this case, the nominal WHT refund amount (i.e. RMB5 million), arising from the initial China reinvestment, would be treated as an additional distribution to Foreign Co A, and RMB0.5 million (i.e. RMB5million*10%) would be withheld. In consequence, RMB4.5 million (i.e. RMB5million – RMB0.5 million) will be the amount actually refunded to Foreign Co A.
The tax official further clarified that the relief can also be retroactively applied, even if the WHT was paid before 1 January 2017.
- Per Circular 88 and Announcement 3, a foreign investor must provide information and supporting materials to profit-distributing enterprises (i.e., the WHT agent) to confirm that the foreign investor qualifies for WHT deferral. The profit-distributing enterprise must, on receipt of the information, confirm that the information received is complete. If the profit-distributing enterprise fails to properly review the information and distributes profits without appropriate application of WHT, there are potential penalties. In particular, the profit-distributing enterprise’s in-charge tax authority may pursue the profit-distributing enterprise for penalties.
A fine of 50% to 300% of the under-withheld tax may be imposed on the profit-distributing enterprise. However, the underpaid tax itself is to be recovered from the foreign investor and not from the WHT agent (it should be noted that this is a different approach to underpaid WHT recovery from that set out in SAT Announcement  No. 37, which provided that the tax authorities could either pursue the WHT agent or the foreign payee for underpaid WHT [see KPMG China Tax Weekly Update (Issue 42, November 2017) for details]. Despite the wording of Announcement 3, one cannot discount the possibility that local tax authorities might look to invoke Announcement 37 and recover the WHT from the WHT agent).
The tax official further clarified that, a profit-distributing enterprise’s responsibilities arising from application of the WHT deferral by its foreign investor would not be changed, even if the foreign investor transfers its equity interest in the profit-distributing enterprise to another party.
For a more detailed analysis and interpretation of Circular 88, you may read the following KPMG publication:
Other recent regulatory and tax circulars:
- MOF and SAT’s notice on recognition of non-profit organizations qualifying for tax exemption (Cai Shui  No. 13, issued on 7 February 2018)
- SAT’s announcement on ‘one-visit’ list of tax matters (SAT Announcement  No. 12, issued on 23 February 2018)
- SAT’s guidance on launching a campaign to facilitate taxpayers in 2018 (Shui Zong Fa  No. 19, issued on 22 February 2018)
- SAT’s notice on implementation rules for verifying VAT filing returns (Shui Zong Han  No. 94, issued on 27 February 2018)