Withholding Tax Deferral for Foreign Investment in China

On December 21, 2017, authorities clarified the criteria for withholding tax (WHT) deferral treatment on dividends for foreign investment in encouraged sectors in China. The Notice Regarding the Provisional Deferral Treatment for Withholding Tax on Distributed Profits used for Direct Re-investment by Foreign Investors (Caishui [2017] No.88, or Circular 88) subsequently came into effect on January 1, 2018.

Released by the Ministry of Finance (MOF), State Administration of Taxation (SAT), National Development and Reform Commission (NDRC), and Ministry of Commerce (MOFCOMMOC), the WHT deferral treatment should be welcomed by foreign investors. The treatment aims to encourage long-term foreign investment in China.

Foreign investors interested in WHT deferral treatment should  study the criteria closely, ideally with experienced local tax advisors who can liaise with authorities in China.  Furthermore, foreign investors should work closely with the Chinese Tax Resident Enterprises (TRE) to ensure that they satisfy the necessary conditions for smooth record filing.

Tax deferral treatment criteria

Under China’s Corporate Income Tax (CIT) Law, dividends are generally subject to a 10 percent withholding tax, unless a more favorable rate is available through a relevant tax treaty.

Foreign investors seeking to enjoy the WHT deferral treatment on dividends paid by Chinese TREs must satisfy all of the following conditions:

Direct investment

Foreign investors are required to use the profits distributed from the Chinese TREs to directly invest or re-invest in the following ways:

• Increase, or increase by transferring, paid-up capital or capital reserves in Chinese TREs;
• Establish new Chinese TREs;
• Equity acquisition of Chinese TREs from non-related parties;
• Other methods acceptable to the authorities.

Investment in publicly listed companies is not permitted except where the foreign investor and the A-share listed company meet the requirement of a “strategic investment,” as stipulated in Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors (the MOFCOM Order [2005] No. 28).

Nature of the distributed profits

The nature of the profits distributed must be equity investment income such as dividends. The dividends must be distributed by Chinese TREs to foreign investors from their realized retained earnings.

Direct payment

The profits – both cash and non-cash forms – must be transferred directly to the new investment. Transfers to any intermediate parties before being passed onto the new investment will not qualify.

Encouraged projects

“Encouraged projects” for foreign investors refer to projects under the “‘encouraged catalogue” category in the 2017 Catalogue for the Guidance of Foreign Investment Industries or projects prescribed in the 2017 Catalogue of Priority Industries for Foreign Investment in Central and Western China.

Record filing procedures

The Chinese TRE that distributes the dividends should perform record filing procedures with the relevant in-charge tax authority for the purposes of deferring the WHT.

This should be done after the Chinese TRE affirms that the foreign investor is eligible to receive the WHT deferral treatment by submitting relevant documents.

Retrospective treatment

Dividends received by foreign investors on or after January 1, 2017 are eligible for the WHT deferral treatment and a refund for the tax already paid could be applied.

Eligible foreign investors can also apply for the treatment retrospectively within three years from the date the tax payment was made and claim a refund.

Deferred WHT settlement

If a foreign investor who availed WHT deferral treatment recoups their direct reinvestments – through equity transfer, equity buyback, liquidation, or other means – they should report to and settle the tax deferral payments with the relevant in-charge tax authority within seven days from the receipt of the relevant payment.

However, if the invested enterprise restructures, and this restructuring meets all the conditions for “special restructuring” and for tax treatment based on special restructuring, the foreign investor may continue to enjoy the preferential deferred tax treatment and will not be required to pay the deferred withholding tax.

Local guidance advised

Foreign investors in China are welcoming the clarifications on WHT deferral treatment in Circular 88. Circular 88 grants more stability for foreign investors in China, who can now plan their long-term China investments with greater certainty.

However, new tax reforms require a fair bit of diligence and planning on the part of foreign investors. Foreign investors interested in availing themselves of WHT deferral treatment need to ensure that they meet eligibility requirements, liaise with the appropriate tax authorities, and work closely with the TRE to ensure that record filing is executed properly.

Accordingly, foreign invested enterprises should consult with trusted local advisors before attempting to take advantage of this beneficial reform. Local advisors ensure your business employs best practices when coordinating between foreign headquarters, China-based businesses, and local tax authorities.

About the author: This article first appeared in China Briefing by Dezan Shira & Associates, a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory, and compliance, accounting, payroll, due diligence, and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email [email protected] or visit www.dezshira.com.