As China becomes part of the global economy and domestic demand for foreign products and expertise continues to grow, more and more businesses are deciding to establish a presence in China. In order to achieve an overall greater return on investment and minimize risks, investors need to fully understand the People’s Republic of China (PRC) tax system and the associated costs before making a final investment decision.

 

Below we provide an overview of the PRC tax system and administration to provide investors background information on the associated tax costs of doing business in China. We also discuss some of the business activities which do not involve direct investment within China and the applicable taxes triggered by these types of activities.

 

The information provided does not cover taxes levied in Hong Kong SAR and Macau SAR.

 

Tax Categories

 

The major taxes applicable to foreigners, foreign enterprises (FE), and foreign investment enterprises (FIE) doing business in China are as follows:

 

Value-added tax (VAT) – The sales or importation of goods, provision of services, sales of intangible assets or real estate, are subject to VAT. VAT rates depend on the business scope; sale of goods (13%), special sectors (9% – 10%), and services (6%). Businesses can also register as a small-scale VAT taxpayer and apply a flat VAT rate (3%) levied on total revenue but prohibit the use of input VAT deductions.

 

Customs duty – applies to imported goods and is based on the value of the transaction or specific duty (e.g. RMB 80 per unit or kg). The applicable duty rates depend on the category of goods and the country of origin.

 

Consumption tax – is levied on manufacturers and importers of specific consumer goods such as alcohol, tobacco, cosmetics, jewelry, fireworks, gasoline, automobiles, luxury watch, etc. The tax liability is computed based on the sales amount and/or the sales volume depending on the goods concerned. Consumption tax is imposed in addition to applicable Customs duty and VAT.

 

Corporate Income Tax (CIT) – is levied on the net profit of the company. Generally; The CIT rate is 25%. The qualified new/high tech enterprises are able to apply for a reduced CIT rate of 15%. For “Micro and Small-sized Enterprises” (MSE), CIT rates range from 5%-25% depending on the total revenue and profits.

 

Individual Income Tax (IIT) – China uses a progressive IIT rates ranging from 3% – 45% for individuals’ comprehensive income, 5% – 35% for individual’s income from operations (e.g. income derived by private industrial and commercial activity; sole proprietorship; etc.), and a fixed rate of 20% for other incomes (e.g. interest, dividend, incidental income, etc.). For comprehensive income, such as wages and salaries, China’s IIT law provides a standard annual deduction of RMB 60,000 and additional itemized deductions available to all individuals.

 

Other taxes: Resource tax, real estate tax, stamp tax, deed tax, urban construction and maintenance tax, educational surcharge, etc. – are a series of taxes or surcharges levied on specific types of transactions and business activities.

Tax Residency

All businesses and individuals, inside and outside of China, are classified either as PRC tax residents or non-PRC tax residents.

 

PRC Tax Resident Enterprise (TRE) refers to an enterprise established according to the Chinese law or an enterprise established according to foreign laws but with its effective management located in China.

 

TREs – are taxed on all sources of income – including income derived from overseas. The TREs will be allowed to deduct the tax paid overseas within limit from its tax liability in China provided that a Double Taxation Avoidance Agreement (DTAA) is in place. All registered legal entities in China are automatically classified as TREs. Overseas businesses without a registered legal entity in China can still be classified as TREs if they are determined to have effective management in China.

 

Non-TREs – are taxed only on China-sourced income. Overseas entities are generally considered to be non-TREs. Representative Offices (ROs) in China are also considered to be non-TREs as they are treated as an extension of oversea entities, and only perform liaison & promotional activities in China for their oversea head offices.

Withholding Taxes for non-TREs

Withholding taxes (WHT) are levied on payments made to overseas entities (non-TREs) and must be withheld by the Chinese entity before remittance can be made.

 

Passive income derived by Non-TREs – including dividend, royalty, rental, capital gain, and interest are subject to withholding taxes of VAT (6 – 13% per category) and CIT (20%, reduced to 10% under current provisions). Under a tax treaty, the WHT rates can be lower or even exempted depending on the destination country.

 

If the passive income is derived by a foreign individual of non-PRC Tax Resident, it’s subject to withholding taxes of IIT (20%) instead.

 

A “Tax Completion Certificate” is provided for deducting tax paid in China from the tax liability in the oversea home countries according to the tax treaties.

 

Double Tax Relief

Double tax relief is granted through Double Taxation Avoidance Agreements (DTAA) signed between China and other countries and provide relief from the double taxation of income, assets, or financial transactions. They allow for tax credits to be claimed in China up to the amount paid in tax to a foreign country within the same tax category – and vice versa. DTAAs effectively reduce the taxes withheld from income or other financial transactions between the two countries.

 

As of January 31, 2023, China has DTAA’s in place with 112 jurisdictions. It’s important to consider the implications of a DTA before deciding on a final investment structure for your new company.

 

Tax Filing Requirements

Businesses in China all have to meet monthly, quarterly, and annual statutory filing requirements. Reporting and tax declaration are mostly done online, through an online tax portal for the local municipality to which your business pays taxes to.

 

VAT – Value added tax is filed and collected monthly for general VAT taxpayers and quarterly for small-scale VAT taxpayers – due before the 15^th day of the following month or following the end of the quarter. Special circumstances may require VAT to be paid upon issuing the tax invoice (fapiao).

 

CIT – Corporate Income Tax is filed and collected quarterly for all businesses – due before the 15^th day following the end of the quarter. An annual CIT reconciliation return is filed once per year, due before the 31^st of May of the following year. Businesses should pay the tax shortage or claim back any overpaid taxes during their annual return. Any tax losses may be carried forward for a period of up to five years, subsequent to the year of the loss.

 

IIT – all individuals are required to file and pay individual income taxes before the 15^th day of the following month, either withheld by the withholding agents (e.g. the employers) or through self-declaration by the taxpayers. Individual PRC Tax residents who meet specific criteria must also file an annual tax reconciliation return between 01^st March and 30^th June of the following year for their comprehensive income.

Preferential Tax Treatments

China employs a “predominantly industry-oriented, limited geography-based” tax incentive policy, aiming at directing investments into those industry sectors, projects, or regions that are encouraged and supported by the state.

 

Industry-oriented:  agriculture, forestry, animal husbandry, and fishery projects; Specified basic infrastructure projects; Environment protection, energy conservative projects; qualified new/high tech enterprises, etc.

 

The tax incentive policies mainly include tax reduction and exemption, reduced tax rates, and additional tax deductions.

 

Integra Group is a fully licensed asia-focused accounting, taxation, and business advisory firm – with dedicated offices in Shanghai, Beijing, Singapore and Taipei. We’ve helped companies ranging from Fortune 500 companies to small to medium sized businesses establish and grow their presence in Asia.

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The cost of hiring in China consists primarily of mandatory expenses such as employee’s gross salary and social security contributions. It is also common practice in China to provide other incentives and bonuses to employees based on performance or other criteria – though this is entirely up to the discretion of employers.

When considering the total cost of employment in China, employers should first determine the gross salary using fair compensation for similar work in the designated city. Factoring in the various additional costs borne by the employer – such as mandatory social security benefits – and other voluntary benefits, employers can then begin to see the total cost of hiring employees in China.

Compensation and Benefits (C&B)

 

C&B is typically divided into three parts: wages and salary, incentives and bonuses, and mandatory social security contributions.

 

• Wages & Salaries are generally paid monthly and vary from 12-13 months. A 13th-month pay scheme is common practice – but not mandatory – in China, with the 13th month’s pay issued during the Chinese Spring Festival. Overtime pay according to PRC labor law is calculated as 150% of normal wages when performed on weekdays, 200% when performed on rest days (i.e. weekends), and 300% performed in public holidays.

   

• Incentives and Bonuses – are generally tied to individual performance and/or team/company overall performance. They can be paid monthly, quarterly, or annually and are normally not guaranteed. Examples include individual performance, team performance, profit sharing (payouts based on organizational profitability), comprehensive performance (awards based on the performance of the company, team, and individuals), sales bonuses, sales commissions, and special recognition awards.

   

• Social securities – refers to the 5 social insurances and 1 housing provident fund. Social security contributions are mandatory for both employers and employees and comprise a significant portion of the total employment costs. Generally, the employer portion ranges between 35-40 percent of the employee’s monthly gross salary up to a fixed limit.

 

Normally the contributions are based on the employee’s average monthly gross salary of the previous year and are limited to Maximum Base and Minimum Base. The Maximum and Minimum bases are typically 300% and 40% of the local average gross wages of the previous years. However, they differ between cities and are announced by the local government annually.

Individual Income Tax (IIT)

 

Individual income for wages and salary in China is taxed based on a progressive tax system with seven tax brackets ranging from 3%-45%.

 

China tax residents are taxed on their gross wages and salary (including base salary, bonuses, allowance, etc.) minus the employee portion of the social security contributions and allowed itemized deductions. All China tax residents are also allowed an additional RMB 60,000 standard deduction per year. 

 

In 2019, China implemented a series of special additional deductions aimed at alleviating the financial burdens associated with specific expenditures. These deductions were applicable to a variety of expenses, encompassing children’s education, continuing education, healthcare costs for severe illnesses, housing loan interest, support for the elderly, and housing rent.

 

Recently, the Chinese government announced plans to extend these benefits further by reducing individual income tax rates for people who are supporting children or elderly family members.

 

The IIT formula is:

Taxable Income = gross salary – employee social security contribution – standard deduction – additional itemized deductions – other allowable deductions

 

Expatriate employees currently enjoy more preferential policies when it comes to deductible expenses. Until December 31st, 2027, expatriates can fully deduct certain expenses items from their taxable income – without clearly defined limits.

 

IIT for expatriates

 

Expatriates who reside in China for cumulative 183 days or longer within a calendar year are considered PRC tax residents. After 6 consecutive years of PRC Tax Residency status, expatriate’s worldwide income will become subject to tax in China.

 

Expatriate in China who wants to avoid subjecting their worldwide income to taxation in China, can reset the 6-year requirements by exiting China for more than 30 days consecutively or 183 days cumulatively in any tax year during a 6-year period.

 

According to regulations issued by the PRC Ministry of Human Resources and Social Security, expatriates must also pay into the mandatory social security funds in China. As of Dec 31st, 2019, China has entered into Bilateral Social Security Exemption Agreementswith 10 countries providing exemptions from social security contributions for expatriate employees from these countries.

 

However, enforcement of social security contributions for expatriate employees varies between jurisdictions. In practice, many employers in certain cities choose to not make social security contributions for expatriate employees.

 

Holiday and Leaves:

 

Public holidays

Public holidays in China are arranged according to both the Lunar calendar and the Gregorian calendar. The central government will announce, typically in November, the public holiday schedule for the following year. In total, there are 11 fully paid public holidays. In addition, the government will typically provide additional “rest days” following the Chinese Spring Festival and Mid-Autumn festival public holidays to extend the holiday. Employees should work one or two rest days (i.e. Saturday or Sunday) to make up for the additional time off given to them.

 

Annual leave

By law, the minimum fully paid annual leave granted to full-time employees is 5 days following one year of employment and increases with the number years of employment as follows – up to 15 days after cumulative 20 years of employment.

 

Companies may provide more paid time off as part of their company policy or personal benefits for their employees at their own discretion.

 

Sick Leave

Employees are granted a fixed number of paid sick days per year depending on the seniority of the employee. The minimum number of paid sick days and pay varies by city/province – generally a percentage of daily wages.

 

Other Paid Leave

According to China labor law, employees are also entitled to various paid leave such as marriage leave, pre-maternity leave, maternity/paternity leave, funeral leave.

 

Termination of Employment Contracts

 

Terminating an employment contract according to China’s Labor Laws requires employers to give 30-days prior notice and pay severance to the employee. Severance pay is generally equivalent to one month’s salary per year of employment with the company – or half month salary if the employee worked for less than 6 months with the company.

 

Companies can avoid paying severance if;

a)    Termination of a labor contract is mutually agreed upon; or,

b)    The employee is fired for violation of the labor contract (breach of contract provisions or disciplinary rules) with solid documentation and supporting evidence.

It’s important to note that labor disputes in China generally favor the employee. The burden falls on the employer to provide solid documentation and evidence to assert its right to terminate a labor contract and penalty for wrongful termination is generally two times the amount of the original compensation.

 

Integra Group is a fully licensed asia-focused accounting, taxation, and business advisory firm – with dedicated offices in Shanghai, Beijing, Singapore and Taipei. We’ve helped companies ranging from Fortune 500 companies to small to medium sized businesses establish and grow their presence in Asia.

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When operating in overseas markets a key challenge is always navigating the various local tax laws and regulations that apply to the business and its activities. 

Tax planning is the means by which businesses regularly assess and strategically manage the tax liability arising from their business activities. Generally, this includes Corporate Income Taxes (CIT), Value-Added-Tax (VAT), and Individual Income Taxes (IIT). As the complexity of a business increases, so does the tax planning considerations. Here we share some of the key tax planning considerations for businesses of all complexities to guide foreign investors in China.

Company Setup Tax Planning

During the company setup, the business owners must make several decisions that affect the future tax payables of the business.

Taxpayer Status

Applying for small-scale VAT taxpayer status allows businesses to apply a flat 3% VAT rate for both products and services – as opposed to the standard 6% (servicing) and 13% (product trading) paid by General VAT Taxpayers. However, small-scale VAT taxpayers are not allowed to offset their VAT payable using input VAT deductions. Instead, they pay a flat 3% VAT on gross sales revenue.

 

Determining which taxpayer status is more efficient varies case by case depending on several factors including the amount of estimated input expenses, whom your suppliers are, the expected turnover of the company, and more. We suggest working with a professional tax accountant to determine the most efficient taxpayer status based on individual circumstances.

 

Business Scope

Tax rates vary between products (9% – 13%) and services (6%). Separating products and services allows businesses to apply a lower tax rate for revenue generated through services. Generally, both product and service business scopes can be applied for under a single business license. However, in some cases where it is difficult to separate the service from the product – such as certain hardware and software applications – the company may be required to register two separate companies to effectively apply a lower tax rate.

 

Additionally, in order to qualify for various preferential policies and incentives, businesses must meet a specified business scope. The business scope cannot be too broad, or it might affect their ability to apply for preferential treatment and incentives.

 

Preferential policies and incentives 

There are various preferential policies and incentives provided in China including – reduced tax rates, special “super deductions”, tax holidays, reduced interest rates, cash incentives, and other fiscal stimuli. Preferential policies follow the current economic agenda outlined in the various “Encouraged Catalogues” and can change frequently. Generally, they are awarded based on the following factors:

 

Business activities – such as infrastructure investment, high-new technology enterprises (HNTEs), and other industry sectors which meet the economic and social development needs of each region.

 

Location – such as Free Trade Zones (FTZ), High-Tech parks, Belt and Road Initiative (BRI) areas, Guangdong-Hong Kong-Macao Greater Bay Area (GBA), Hainan Free Trade Port and other areas outlined as “in-need” for investments (Example: China’s Western Regions).

 

The first stage of applying for preferential tax treatment and incentives requires you to engage with an advisor to determine whether your business meets the qualifications set out by local jurisdictions. In some cases, the criteria are clearly laid out and other times this involves liaising with the relevant regional authorities over the permissible business activities and incentives.

 

Micro- and Small Sized Enterprises

Micro- and Small Sized Enterprises (MSEs) are defined as “having a relatively small size in personnel and scope of business”. The standard for classification of MSEs is based on the industry, operating income, total assets, and the number of employees belonging to a company. Over 95% of all Chinese businesses classify as MSEs.

 

Various preferential tax policies are targeted to China MSEs and effectively reducing the tax payable up to prescribed limits, including;

 

• The first RMB 1 million of taxable income will be taxed at a preferential CIT rate of 20% for 25 percent of their income, with the remaining 75 percent tax-free (effective tax rate 5%).
• Taxable income for the next RMB 1 million to RMB 3 million will be taxed at a preferential CIT rate of 20% for 50 percent of their income, with the remaining 50 percent tax-free (effective tax rate of 10%). Till the end of year 2027, there is extra 50% tax exemption (effective tax rate 5%).
• Taxable income above RMB 3 million will be taxed at CIT rate of 25%.
• Small-scale VAT taxpayers with monthly revenue of less than RMB 100k will be exempted from remitting VAT on certain items. If monthly revenue is above RMB100K (monthly filing taxpayer) or quarterly revenue is above RMB 300K (quarterly filing taxpayer), all revenue of small-scale VAT payer will be taxed at VAT rate of 1% till the end of year 2027.

 

Daily Tax Planning

The transactions a business engages in on a daily business not only have an impact on the cash flow, but also the underlying tax liability of the business. Effectively managing the taxes you pay requires an understanding of how transactions are recorded and  their related bookkeeping procedures. Below are some tax planning matters to be considered:

 

VAT planning

China’s official VAT invoices (fapiaos) play an important role in the daily tax planning of businesses. Once a fapiao is issued, the resulting VAT payable is due upon the next VAT declaration.

 

Chinese businesses are required to self-declare and pay VAT monthly or quarterly depending on their taxpayer status. However, special transactions – such as overseas remittances – can sometimes require the business to pre-pay VAT.

 

Generally, businesses should be mindful when issuing fapiao and carefully monitor each invoice to avoid issuing duplicate fapiao. Good practice is to specify in sales contracts when a fapiao is issued and align those terms with the collection of sales revenues. Businesses should also be mindful of purchase contracts and request fapiaos be issued together with the payments made to those suppliers.

 

CIT planning

Taxable income is revenue minus qualified expense deductions. Regardless of whether the company made a profit, an unqualified deduction can result in the business paying CIT on some of its expenses.

 

Expenses entered into the financial records without an accompanied fapiao, or an unqualified fapiao attached are considered to be unqualified expenses. It is important the business maintains up-to-date financial records and implements procedures to ensured supporting fapiao are qualified to protect the integrity of their accounting records.

 

The deductibility for certain expenses is limited based on the thresholds set by the tax authority. Expenses beyond these limits are required to be “added back” for income calculation purposes and levy applicable CIT rates to said amount. It is important to monitor these tax-deductible thresholds and be mindful of the additional tax payable above these limits.

Benefits of tax planning

Tax planning has many benefits for companies of all sizes ranging from operational cash flow to a lower underlying tax liability. Companies are advised to consider the tax planning methods discussed and adopt policies to monitor their tax payable regularly. A majority of businesses, especially MSEs, can enjoy the benefits of tax planning using these methods.

 

In addition, the tax planning methods available to companies meet a certain degree of size and complexity go beyond those discussed here. These include businesses with large R&D expenditure, multinational companies with subsidiaries in China and overseas, and companies with a mix of both services and products. Companies that meet these general criteria should spend more time exploring the tax planning options available to them and how they can maximize their benefits.

 

For more information about tax planning in China and assistance with applying these methods, businesses are advised to speak with a professional tax accountant or advisor.

 

Integra Group is a fully licensed asia-focused accounting, taxation, and business advisory firm – with dedicated offices in Shanghai, Beijing, Singapore and Taipei. We’ve helped companies ranging from Fortune 500 companies to small to medium sized businesses establish and grow their presence in Asia.

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The China Market Entry Handbook (2023 Edition) was compiled by the professionals in Integra Group. This comprehensive guide provides a detailed roadmap for businesses planning to invest in the vibrant Chinese market.

The handbook covers crucial areas of interest for investors, including:

• How to Properly Set Up a Company in China
• An Overview of the PRC Tax System and Administration
• Accounting & Tax Compliance in China
• Hiring Employees in China
• The Cost of Hiring in China
• Tax Planning Strategies: Methods and Preferential Policies
• Profit Repatriation Strategies
• ICP Filing and ICP License in China

As you embark on your journey of doing business in China, we hope this publication serves as a valuable guide, equipping you with the knowledge and tools necessary to thrive in this dynamic market.

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About Integra Group

Integra Group is an established provider of company incorporation, accounting, tax, HR, and outsourced corporate services in Asia. We help multinational businesses tap into the rapidly expanding Asian markets through our cost effective and reliable corporate services. With our wide range of value-added services and personalized approach, Integra helps businesses unlock new efficiencies and easily navigate the unique regulatory, business, and cultural environment in which they do business.

We have helped companies ranging from Fortune 500 companies to small and medium sized enterprises across a wide range of industries grow their business in Asia. With dedicated offices in Hongkong, Shanghai, Beijing, Taipei, and Singapore, Integra Group is uniquely prepared to help businesses reach their potential in an increasingly global business environment.

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In this article, we have summarized the key takeaways from the webinar. If you are interested in obtaining a copy of the webinar slides, please reach out to us at info@integra-group.cn.

Examining Key Consumer Trends In China

As you consider your next steps in investing in China, be aware of the following trends in China:

• A Shift to Online Consumption

With the maturity of online buying habits due to the effects of COVID-19, the ability to sell products online is crucial.

 

• Selling to Lower-tier cities – major growth

Consider expanding your market beyond the saturated markets of top-tier cities like Shanghai, Beijing, Guangzhou, and Shenzhen. The less crowded second, third, and even fourth-tier cities can offer new opportunities.

 

• Selling on Digital platforms (live streaming)

With the increasing popularity of live streaming, digital platforms, such as Douyin、Taobao, are a critical route to reach customers.

 

• Growing C2M (Customer to Manufacturer) model

The Customer-to-Manufacturer model, which directly responds to customer demands, is on the rise.

 

• Generation Z’s Market Influence

Although Generation Z makes up 25% of the population, they drive 60% of the sales growth. Also, the rise of the middle class and Generation Z has led to a preference for individualistic, tailor-made products. These consumers prefer products that stand out and are not mass-produced.

 

• Sharp increase of spending on health and wellness products

A sharp increase in spending on health and wellness products shows a growing consumer focus on maintaining good health.

 

Lastly, Industries such as IoT, cloud computing, blockchain technologies, AI, 5G technology, and 3D printing are favored by the Chinese government. Investing in these sectors and those outlined in the 2022 edition of the Catalog of Industries Encouraging Foreign Investment could provide an advantage.

Common Pitfalls When Entering the Chinese Market:

 

The unique challenges of entering the Chinese market often stem from a cultural disconnect. It is insufficient to replicate business models that have worked elsewhere; they need to be tailored specifically for the Chinese landscape. Equally important is recognizing the significance of Chinese shopping culture and digital platforms like WeChat, Douyin, and Xiaohongshu. Ignoring these elements can limit your business’s reach and growth.

 

Appropriate allocation of financial resources and time is critical for successful market entry. Inadequate investment can leave companies struggling in this highly competitive market.

 

Over-reliance on local partners presents another potential pitfall. While collaboration is beneficial, excessive dependence without a deep understanding of the market can lead to setbacks.

 

Moreover, compliance with local regulations – such as advertising, data control, and privacy protection – is crucial. Insufficient understanding of local laws and lack of engagement with the government can lead to bureaucratic hurdles, becoming significant roadblocks to success. It’s also necessary to stay updated with policy changes to ensure long-term viability in the Chinese market.

 

At Integra Group, we are committed to working closely with foreign companies, guiding them through these challenges and helping them succeed in the Chinese market.

 

Doing Business Without a Company in China

 

When entering China, you may want to test the waters to ensure that your product is marketable before committing to a legal entity. One option is to engage a local partner or distributor. This, however, poses control issues. How do you maintain oversight when you’re hours away? If your product performs well and becomes popular in China, the local partner might desire a larger share of the profits. Your bargaining power can be significantly limited in such a situation. To safeguard your interests, having a robust distributor agreement is paramount. This agreement will outline each party’s responsibilities, protection of interests, and an exit plan. There’s always a risk that your local partner may take your product, imitate it, and become a competitor. Thus, it’s crucial to consider these potential challenges.

 

Another approach is to find local Chinese individuals to assist with promotion and lobbying. Payments to these individuals are typically made from overseas, meaning you don’t have to pay any taxes for these individuals in China. However, this strategy comes with tax risks and doesn’t entirely facilitate selling products since you still don’t have a company in China. This person only supports you in marketing your business, and there might be a lack of loyalty and a sense of belonging without a real company in China.

 

A growing trend is to use an Employer of Record (EOR) – a local HR agency that can help hire the individuals you need. This agency takes care of all the salary payments and social benefits that are required in China, ensuring the employee’s rights are protected. This solution is usually temporary, used while waiting for your own company to be established.

 

Setup A company in China

 

If you decide to set up a company in China, there are three primary business structures available to foreign investors: the Representative Office (RO), the Wholly Foreign-Owned Enterprise (WFOE), and the Joint Venture (JV). Each of these types comes with its own set of benefits, limitations, and best-use cases.

The choice between these types of entities largely depends on the business’s nature, the strategic goals, and the extent of control the foreign company wishes to maintain over its Chinese operations. It is highly recommended to seek legal and professional advice when making this decision.

 

To set up a company in China, you need a unique Chinese company name, business scope, registered capital, and a unique registered address for commercial purposes. Lastly, identifying key personnel within your organization is critical. These individuals include the 1) Legal representative; 2) Executive director; 3) finance responsible person, often a CFO, internal finance manager, or service provider. 4) Supervisor.

 

Some of the critical positions to consider in your company include the legal representative (or director), who is held most liable for the company, the financially responsible person who takes care of your books and tax filings, and a supervisor who oversees the activities of the management. 

 

These considerations provide a fundamental framework for setting up a company in China.

 

Overview of the China Tax System

Value Added Tax (VAT)

 

China employs a comprehensive Value-Added Tax (VAT) system that applies to both domestic and imported goods and services. The general VAT rates for trading and service companies typically stand at 13% and 6%, respectively. However, companies not operating on a large scale can choose to apply for a small-scale VAT status, which comes with a reduced rate of 3%. This option is available irrespective of whether you’re involved in the trading or service industry.

 

For small businesses that aren’t making a lot of sales throughout the year, opting for the small-scale VAT status can be beneficial. Despite the inability to offset with credits, from an administrative perspective, this status can reduce the burden of tax compliance. Small-scale VAT taxpayers are required to file VAT returns only on a quarterly basis, in contrast to general VAT taxpayers who must file more frequently.

 

Corporate Income Tax (CIT)

 

Corporate tax for companies is 25%. However, there are certain enterprises that can avail of lower rates, provided they meet four criteria:

If you’re engaged in high technology industries such as research and development or creating new products, you can apply for a reduced income tax rate of 15% instead of 25%.

 

Individual Income Tax (IIT)

 

China’s Individual Income Tax (IIT) regime employs a progressive scale, with tax rates ranging from 5% to 45% based on income brackets. While it’s common to calculate this tax monthly, a cumulative annual calculation method can also be applied under specific circumstances. This means if you’re earning above a certain threshold annually (in this case, 200,000), your tax rate may increase. However, you may be entitled to subtract the taxes paid in previous months from your current tax liability.

 

Addition to the IIT, it’s worth noting that participation in China’s Social Insurance System is generally obligatory for all employees. This system comprises five different insurance types: pension, medical, unemployment, work-related injury, and maternity insurance. Additionally, employees typically contribute to a Housing Provident Fund. The rates vary depending on the province or city your company is registered in.

Related Reading: An overview of the PRC Tax System and Administration

Profit Repatriation Strategies

 

Repatriating profits from China to your home country can be facilitated via several methods including dividends, service fees, royalties, and interest payments on foreign loans. Here are some specifics to consider:

 

Dividends: Companies can distribute dividends to their foreign parent companies, but this is generally allowed only after the annual audit confirms profitable operations. A restriction to note is that 10% of the profits must be allocated to a statutory reserve fund until the fund reaches 50% of the registered capital.

 

Service Fees: If services are provided by the parent company to the Chinese subsidiary, these services can be invoiced and repatriated as service fees. However, it’s important to note that these transactions are subject to withholding taxes. Before processing payments, you should ensure that any service agreement is appropriately documented and registered with the relevant tax authority.

 

Royalties: If technologies developed overseas are used by the Chinese subsidiary, royalty payments can be another way to repatriate profits. Royalty agreements should be accompanied by detailed supporting evidence – including the rationale for determining the price.

 

Interest on Foreign Loans: Interest payments on loans provided by foreign parent companies can be repatriated, but there are strict regulations surrounding foreign debt that must be taken into consideration. The amount of foreign debt should be calculated carefully, either as the difference between the total investment and the registered capital or as twice the value of the audited net assets from the previous year.

 

Please consult a financial advisor or tax professional to understand the nuances and choose the most efficient method for repatriating your profits from China.

 

Disclaimer

The insights shared in the webinar are intended to provide a general understanding of the subject matter and should not be relied upon as definitive professional advice. Before making any decision or taking any action, you should consult an Integra Group professional.

We are here to help make your business journey smoother and more successful. Please feel free to contact us if you require any assistance in doing business in China.

China has a unique system for determining the registered capital requirements for businesses. Although there are no mandatory minimum registered capital requirements specified for all intents business purposes, some specific industries maintain a minimum registered capital requirement in China. It’s important to note that while a minimum may not be required by law, businesses may choose to settle upon a higher registered capital to ensure that the business has sufficient funds to maintain the day-to-day activities of the Company.

Registered capital can be thought of as subscribed capital without any deadline for shareholders to inject said capital into the company.  Unless a minimum registered capital is specifically stated by laws and regulations, investors can determine a registered capital based on their business needs and provide said capital according to their cash requirements.  This is normally written in the Company’s articles of association the period to top-up the registered capital.

Ultimately, the registered capital’s purpose is to provide investors with the means to supply the necessary funds for the business to operate and fulfill its obligations. Thus, it is important to consider the business requirements when deciding on the amount of capital required at the setup stage of the company.

How much registered capital do I need?

The registered capital is the primary funding used to cover the costs of establishing and operating the business until it can be self-sustaining.

One important factor to consider is the type of business that the company will be engaged in as different types of businesses may require different amounts of investment. For example, a manufacturing company may require a larger amount of capital than a service-based business, as it will need to purchase equipment and materials. It is also important to consider the potential growth of the business and the amount of capital that will be needed to support this growth.

As a general rule of thumb, we recommend a minimum budget of 6 months of operating expenses as the registered capital.

Industry Specific Minimum Registered Capital Requirements in China

In the case where certain industries require, by law, to maintain a minimum registered capital, these requirements are in place to ensure that businesses have sufficient funds to operate and fulfill their obligations. They generally include industries with numerous stakeholders across supply chains and those with important roles in society and the economy.

Other Minimum Capital Requirements

Additionally, the registered capital requirement will also be influenced by the size and structure of the company. For example, a business with operations at the provincial or state level may title their company name “Province”, or “China” in it. As this type of company has businesses spanning different cities and provinces, the minimum capital requirement as set by the Administration for Market Regulation will be higher.  In addition, specific industries like labor dispatching or headhunting service companies have certain minimum capital requirements and certifications to be met before businesses can be carried out.

Example:

XYZ Group Textile Manufacturing (Jiangsu) Co. Ltd.

or

XYZ Group Textile Manufacturing (China) Co. Ltd.

Types of Capital Contributions

Normally, there are two methods that investors can use to contribute capital. These methods are cash contribution and contribution in-kind.

Cash contribution 

Cash contribution is the most common method of contributing capital in China. In this method, the company’s investors provide the required capital in the form of cash paid to a special capital account belonging to the company. This capital can then be freely used to cover business expenses such as purchasing products, paying staff, rental expenses, and advertising.

Notably, the monetary capital contribution of all shareholders shall not be less than 30% of the registered capital of the limited liability company.

In-Kind Capital Contribution

Contribution in-kind refers to the company’s investors providing assets or property to the business in lieu of cash. These assets or property are then used by the business in its operations and/or to generate revenue.

To provide in-kind capital contributions in China, the company must determine the fair value of the property, goods, or other assets being contributed by the shareholder. This is typically done by a professional appraiser or using other methods such as market value, cost value, or net asset value. The value of the capital contribution in-kind must also be recorded in the company’s articles of association and the shareholder must provide proof of ownership.

Total Investment and the Foreign Debt Quota

In China, companies are permitted to register foreign loans in addition to the registered capital

up to a prescribed limit known as the ‘foreign debt quota’. In order to register a foreign loan, the company should state a total investment that is greater than the registered capital on the article of association. The difference between the total investment and the registered capital is the amount to be registered as a foreign loan.

Total Investment = Registered Capital + Foreign Loan

The foreign debt quota for companies in China is interlinked with the registered capital amount. In other words, the debt-to-equity ratio for foreign invested enterprises in China is limited by law. As the amount of registered capital increases, so does the debt-to-equity ratio according to the following table

Macro-prudential Method

Additionally, enterprises can choose to apply the Macro-prudential Method for calculating the upper limit of the amount of foreign debt they are permitted to register (Yingfa [2017] No. 9). The Macro-prudential Method may allow the enterprise to register a foreign loan greater than what is permitted under the standard Foreign Debt Quota and must be submitted to the SAFE for approval.

The Macro-prudentual Method uses the following formula to determine the upper limit of the amount of foreign debt allowed for registration.

Can I decrease my registered capital in China?

Should the investor(s) of a company in China decide they would like to decrease their investment in China, they are able to do so. The company can return part of the capital investment to the shareholders and decrease the registered capital.

To decrease the registered capital of a business in China, the company must submit a request to the Administration for Market Regulation (AMR). This involves completing and submitting a registered capital decrease application together with supporting documents including the shareholder resolution, a balance sheet and a list of assets, and other relevant materials. The AMR will review the request and, if approved, issue a certificate of registered capital reduction and updated business license. The company must then complete the additional steps required, such as making changes to its articles of association and updating the business license with the bank and other institutions.

Important considerations when deciding the registered capital

Shareholder liability for unpaid capital

In China, shareholders are typically liable for their registered capital in a company limited by shares, up to the amount of their registered capital contribution. This means that the shareholders are personally responsible for the amount of capital they have agreed to contribute towards the company’s registered capital, and they may be required to pay this amount if the company is unable to fulfill its obligations. However, the liability of shareholders for their registered capital in China is not without limitation and may vary depending on the specific circumstances of the company.

Statutory Reserve Fund

The statutory reserve fund refers to the mandatory fund which companies must pay into when distributing dividends. When the company pays a dividend, it must set aside 10% of the total amount into a statutory reserve up to an amount equal to 50% of the registered capital.

The statutory reserve can be freely injected back into the company at any time by means of increasing the registered capital, however, it’s mandated by law as a “rainy day” fund for companies in China.

Beginning in 2022, foreign nationals with tax residency status in China will no longer enjoy special tax deductions for benefits including housing rental, language training, and children’s educations. It’s widely expected that the policy change will increase the tax burden for a large number of foreign nationals in China.

For a long time, foreign nationals in China have enjoyed tax-exempt benefits such as housing rental, children’s education, and language training. However, according to the Notice on Converging Preferential Policies Following IIT Law Update (Caishui [2018] No. 164), foreign nationals will cease to enjoy the tax-exempt benefits on the aforementioned benefits, starting January 1st, 2022. 

Housing rental, children’s education, and language training for foreign nationals will be taxed together with the basic salary. However, foreigners with taxpayer status in China will still be able to utilize the additional itemized deductions available to all resident taxpayers in China. 

Note: Tax resident refers to individuals who reside in China for more than 183 days within a calendar year. 

Tax Exempt Benefits for Expats in China (Preferential Policy)

Under the Notice on Implementation Issues for Individual Income Tax Collection on Subsidies Obtained by Foreign Individuals (SAT [1997] No. 54), foreign nationals with tax residency status in China can enjoy 8 tax-exempt benefits for the purpose of individual income tax.

The 8 categories of tax-exempt benefits for expats include: 

• Housing rental
• Language training 
• Children’s education 
• Meal expenses
• Relocation expenses
• Laundry expenses
• Business travel
• Home travel

Notably, the 1997 notice by the State Administration of Taxation does not specify a limit to the amount of expenses that can be deducted within the 8 categories of tax-exempt benefits for expats. Foreign nationals have been allowed to fully deduct the aforementioned 8 categories of tax-exempt benefits based on their actual cost, provided the amount is “reasonable” and accompanied by a corresponding fapiao or other proof of payment. 

In practice, a reasonable amount according to tax authorities has been known to extend up to 30-50% of the expat’s total salary. 

However, starting in 2022 foreign tax residents in China will cease to enjoy the first 3 categories of tax-exempt benefits, namely housing rental, language training, and children’s education.

Tax authorities have not yet specified whether the remaining 5 categories (meal, relocation expense, laundry, business travel, and home travel) will continue to enjoy their tax-exempt status or not. 

What are the additional itemized deductions?

All tax residents in China, including both foreign and Chinese nationals, can enjoy the following 6 categories of additional itemized deductions for the purpose of individual income tax, including:

• Children’s education expenses
• Continuing education expenses
• Housing mortgage interest
• Housing rental
• Healthcare costs for serious illness
• Expenses for supporting the elderly

However, unlike the tax-exempt benefits for expats, the additional itemized deductions are subject to deduction limits. Tax residents can only deduct an amount up to the limit for each of the 6 expense categories.  

While several of the expense categories under the preferential policy for foreign nationals and the standard itemized deductions overlap, the key difference is with the amount that can be deducted. 

Housing rental and children’s education are naturally high-cost items for foreign nationals living in China. Under the old policy, allowing foreign nationals and their employers to deduct these costs based on the actual expense so long as it was within a reasonable amount meant that employers could treat the cost as a staff welfare expense without significant tax liability. 

Example 1: Standard Employee

The following example demonstrates a standard employee hired in China. This employee does not receive any special benefits or allowances from the company as part of the terms of their employment. The employee provides their housing rental and language training contracts and corresponding fapiao to the employer to claim the income tax deduction under the old policy.

In the above example above for a standard employee, the foreign national is making use of the preferential policy primarily as a personal tax planning measure. Under the given circumstances, the foreign employee tax liability will increase by RMB 3,450 or 75.2%.

Example 2: Senior Management

The following example demonstrates a foreign national dispatched to China together with their spouse and two children to serve in a senior management position. The company shall provide housing and education for the two children as part of the terms of their employment. 

As demonstrated by the example above, for someone earning enough income to pay tax in the 35 or 45% tax bracket with kids going to private school, the foreign national’s tax liability will increase by RMB 26,775 or 97%.

Without the tax exemption for costs like children’s education, employers will likely more carefully consider relocating foreign nationals with children to China to serve in senior management positions. Moreover, foreign nationals with children in China may consider the competitiveness of their total compensation under the new policy or consider making lifestyle changes to adjust to the new policy. 

Tax Planning for Expatriates in China

Come January 1st, 2022 foreigners have fewer tools at their disposal for tax planning purposes and are likely concerned about the impact to their total compensation or the competitiveness of their employment. It’s widely expected that with the current situation many foreign nationals will see an increase in their tax payable following the policy change.  

For standard employees without substantial tax-exempt benefits, the policy change may be bearable by either the employee or the employer. Foreign nationals with high income and significantly larger tax-exempt benefits will find the higher tax payable more difficult to accept. 

Relocating to a more favorable tax jurisdiction

Employers may consider moving part of their business activities and certain employees to areas that provide more favorable tax incentives for individuals, such as the Greater Bay Areas (Guangdong, Hong Kong, and Macao) or the Hainan Free-trade Port, where income tax is capped at 15% or below. 

Given China’s relatively high tax ceiling of 45% for individual income tax, some individuals may consider looking for more favorable employment opportunities in the Greater Bay Area themselves or even relocating to another country where they may find better job opportunities. 

Registering a new company

reIn China, the tax ceiling for individual income tax is 45% whereas the tax ceiling for dividends paid to foreign individual shareholders is 0%. Foreign shareholders may choose to pay profits as a dividend rather than a salary. High-income foreign nationals may also consider registering a new company to collect service fee’s which can be paid as a mix of dividends and salary.

Registering a new company introduces new compliance and statutory requirements. Please seek the advice of a tax professional or corporate service provider. 

How employers and employees in China should prepare 

It’s firstly important to determine whether the tax liability should be borne by the employee or employer according to the labor contract. If the contract states an after-tax salary amount with benefits paid by the company, the company will be responsible for the tax payable. On the other hand, if the contract states a before-tax amount the employee shall be responsible for the tax payable.

In many cases, benefits or allowances such as housing rental, children’s education, and language training do not specify whether the amount is before- or after-tax. In this case, employees and employers can treat it the same as salary in relation to the tax liability. 

Many foreign nationals in China will find the higher tax liability difficult to come to terms with. Employers who do not show concern for their employees’ livelihood are likely to lose favor with their employees in the long term.  Employers can choose to act proactively and renegotiate the terms of the employment contract and total compensation package under the new policy to retain their foreign employees. 

Employers may also enlist a tax specialist to assist expatriate employees in utilizing their available tax planning methods and provide guidance to the organization on steps it could take to help employees manage their tax liability.