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Breakthrough for Trading Companies operating in FTZ's
The Administration of Industry and Commerce recently issued a circular
providing foreign investment enterprises ("FIE") more flexibility
in setting up branches outside free trade zones ("FTZ").
Previously FIE's already registered in FTZ's were not allowed to
establish branches or representative offices outside the FTZ. Trading
companies previously were restricted to acting simply as invoicing
agents or pass-through entities. The business scope of such representative
offices is restricted to conducting business liaison activities
for its head office. Furthermore, the new rules state that the representative
offices located outside the FTZ cannot enjoy the tax incentives
available to its head office within the FTZ. The FTZ FIE can now
branch out to other locations in China to conduct liaison activities.
A tax planning opportunity also exists for those foreign investors
that have representative offices and FTZ companies. By converting
the foreign representative office to an office of the FTZ company,
investors can save the tax that are currently imposed on the foreign
representative offices.
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Clarification of Tax Issues for Foreign-Invested Real Estate Developers
The State Administration of Taxation (SAT) has issued a circular
to clarify certain income tax issues for foreign-invested real estate
developers ("Developers").
Previously, developers had to pay income tax based on the estimated
profit and then settle the final tax liability when the final piece
of property is transferred to the purchaser (especially important
with large-scale appartment buildings), and the sale is recognized.
Under the new Circular, developers are required to continue to
pay the income tax on the estimated profit on a quarterly basis,
but the final settlement will be made when the relevant government
authority issues the Property Project Qualification Certificate,
or when the right of use of the property is transferred, or when
the title of the property is transferred (whichever is earlier).
In effect, the final tax settlement will be accelerated.
The Circular also provides rules for recognizing revenue under
different modes of sale, e.g. lump-sum payment, pre-payment, payment
by installments or property swap or through mortgage loans, etc.,
and stresses the matching principle between revenue and cost. This
principle should also apply when the property is allocated among
shareholders as return of investment. The developer is required
to aggregate all the expenses and costs of the invested project
and then allocate them among shareholders based on the shareholders
agreement. Shareholders shall settle their own tax accordingly upon
sale of real estate.
Expenses for auxiliary projects, incurred after sale of properties
such as road-building and tree-planting, may be accrued based on
a pre-determined percentage subject to the approval by the tax authority.
Also, developers are required to combine rental income and other
operating income together to provide a total income amount. Depreciation
of the underlying property and related costs are then matched against
this income and can be deducted for tax purposes. However, the depreciation
will reduce the basis of the property and therefore if later the
leased property is sold, the depreciation expenses will be recaptured.
In the past, there has been some uncertainties about the tax treatment
in the case where a foreign company sells the properties on behalf
of the developer. The Circular clarifies that if a foreign company
acquires the real property from the Developer and then on-sells
it to a final customer, the foreign company will be subject to tax
on the amount of gain on the sale . If the foreign company only
acts on the developer's behalf to sell the property, the Developer
will be subject to tax based on the final sales price (as required
by Guoshuifa (1999) No. 242.)
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New Individual Tax Treatment of Severance Payments
The State Administration of Taxation recently issued a circular
to reduce the individual income tax ("IIT") burden of severance
payments. Severance payment amounts not exceeding 300% of the last
year's average salary (for that location) can be exempted from IIT
calculations. The severance payment portion exceeding that exemption
limit is, however, subject to the tax rate mitigation scheme.
However, as the average salary of a city varies from locality to
locality, it is important for both human resources professionals
and taxpayers to be aware of the local variances in applying the
exemption right granted by the above circular.
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Tightening up of the Individual Income Tax Net
The State Administration of Taxation ("SAT") issued two circulars
relating to Individual Income Tax ("IIT"), which have an effect
of tightening up the IIT net. Firstly, the circular laid down restrictions
for IIT exemptions on home leave allowances and expenses. Prior
to this circular expatriates in China had to rely on the exemption
clause in a 1997 circular to exclude their home leave allowances
or reimbursement of home leave expenses incurred for overseas trips
from the IIT calculations.
The new circular, however, clarifies the situation allowing for
only two trips per annum; and these trips must be to the expatriate
employee's home country or that of his/her spouse or parents, if
different.
Furthermore, according to another circular, the tax authorities
at all levels were instructed to make a concerted effort to tighten
and prioritize tax collection procedures for selected high income
earners in view of the rising income disparity prevailing within
the country. Among the targeted industries are telecommunications,
finance, brokerage, insurance, real estate, transportation, petrochemical,
hi-tech, professional consulting and businesses conducted by foreign
investment enterprises, foreign enterprises, and representative
offices of foreign companies.
From an individual taxpayer's perspective, sole proprietors, marketing
and managerial personnel, contractors, directors, accountants, lawyers,
auditors, valuers and designers, etc., have been the identified
targets. In other words, these individuals, especially those working
in the aforesaid industries, will be closely monitored and may be
tracked under special files.
To pre-empt the upcoming queries from the tax authorities, foreign
investors in China should ensure that proper remuneration policies
together with relevant supporting documentation are in place to
defend their current IIT reporting and filing.
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