China: Tax incentives for Beijing demonstration zone
China: Tax incentives for Beijing demonstration zone
Beijing’s Municipal Bureau of Finance on 1 February 2021 officially unveiled income tax incentives for corporate venture capital enterprises in Beijing’s Zhongguancun National Innovation Demonstration Zone.
There are two incentives that aim to promote the development of the venture capital sector and encourage long-term investment. Meanwhile, double taxation issues for individual investors will be alleviated, and institutional investors will also benefit from the new policies.
China’s State Council in August 2020 authorized pilot corporate income tax incentive schemes for corporate venture capital enterprises (CVCEs) in the demonstration zone. Subsequently, the Ministry of Finance, the State Taxation Administration, the National Development and Reform Commission, and the Securities Regulatory Commission jointly published Announcement No.63 (2020) setting out specific detail on the new incentives and applicable conditions.
Announcement No. 63 sets out "two conditions" and "two incentives"
Two conditions (both must be met):
- The resident CVCE is registered and established in the demonstration zone and is subject to taxation based on audited financial statements.
- The CVCE must comply with the interim measures for the administration of venture capital enterprises (Decree No. 39) or the interim measures for the supervision and administration of private investment funds (Decree No. 105 ) and must meet the filing and operational requirements of the regulations.
Two incentives (corporate income tax of 50% or 100% exempt):
- For a given tax year, if the gains on the transfer of equity that has been held for not less than three years, exceeds 50% of the total gains on the transfer of equity that year, then the corporate income tax exemption is determined by the following formula:
Corporate income tax exemption = [Shareholding ratio of individual shareholders at year-end] x [corporate income tax liability for the year] ÷ 2
(i.e., 50% exemption for corporate income tax)
- For a given tax year, if the gains on the transfer of equity that has been held for not less than five years, exceed 50% of the total gains on the transfer of equity that year, then the corporate income tax exemption is determined by the following formula:
Corporate income tax exemption = [Shareholding ratio of individual shareholders at year-end] x [corporate income tax liability for year]
(i.e., 100% exemption for corporate income tax)
The shareholding ratio for the CVCE operates as follows—if individual investors hold 40% of the CVCE, and institutional investors hold 60%, the shareholding ratio in the formula above will be 40%.
Tax benefit arising from “passing-through” rule in Announcement No. 63
At corporate venture capital level:
- Dividends from invested enterprises are not covered by the Announcement No. 63 incentive. However, under the existing policies, dividends received from shares of non-listed companies, or from listed stocks held for not less than 12 consecutive months, are tax-exempt at fund level.
- For the gains from the transfer of equity of the invested enterprises, if the above two conditions are met, then the 50% or 100% corporate income tax exemption applies.
At investor (shareholder) level:
- Individual shareholder: Dividends obtained from the fund are subject to the 20% individual income tax. The double tax issue for individual investors is alleviated to some extent with the implementation of the incentives at fund level, compared with the 40% comprehensive tax burden without the corporate income tax incentives (i.e., 25% rate of corporate income tax on the CVCE’s disposal gains and 20% rate of individual income tax on the after-tax gains distributed to the shareholders). Note that the incentives are designed to reduce tax burden at corporate level rather than at individual level. In a situation when the 100% corporate income tax exemption is applied, there will still be 20% tax imposed on individual investors. The tax rate is the same as when an individual investor makes an investment via a partnership VC. Moreover, to qualify for 100% corporate income tax exemption, investors must all be individuals but not (professional) institutional investors. This is not a common situation in the VC fund industry. Correspondingly, if the shareholding ratio of individual investors is relatively low, the tax benefit passed through to individual investors will be greatly diluted.
- Corporate shareholder: Dividends obtained from the fund are exempt from corporate income tax. If the corporate income tax burden decreases at fund level (due to the presence of some individual investors at fund level), the distributable profit of the fund will increase correspondingly, and institutional investors will benefit as a result.
In combination with Announcement No. 63 and the existing tax policies, VC enterprises may consider the following:
- Prior to Announcement No. 63, there are regulations that encourage the development of VC enterprises—for instance, Caishui  No. 55 and Caishui  No. 8. From tax perspective, a corporate VC vehicle is different from a partnership VC vehicle in terms of tax determination, tax collection methods, and the conditions to enjoy tax incentives. As such, VC enterprises need to consider a comprehensive plan based on business operations for determination of the optimal legal form to be adopted.
- Announcement No. 63 is seen as being straightforward, and to some extent, this is expected to reduce the possibility of disputes and the difficulty in determining incentive applicability. However, several matters still need attention in the course of implementation. For example, how does one calculate the holding period for disposed of shares (i.e., has the three-year threshold been met?) what if there are separate investments in the same enterprise at discrete times? Will it be considered as intentional tax avoidance if the enterprise increases the shareholding ratio of individual shareholders at year-end? How to respond if individual shareholders demand to exclusively claim the tax incentives? In short, China's tax system for funds is still under development—thus, prudent investors will follow closely the latest polices and best practices for the industry in order to enjoy tax incentives in compliance with the regulations.
For more information, contact a KPMG tax professional:
David Ling | +1 609 874 4381 | email@example.com
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