The Standing Committee of the China State Council, in their meeting of 28 July, released a strong signal on the encouragement of foreign investment in China. The meeting resulted in several particular measures aiming to further improve the legal, tax and administrative environment for foreign investment in China, and requested implementation of these measures by end of September 2017.
Deferral of withholding income tax on reinvestment of dividend income
From a tax perspective, it was decided that withholding income tax on foreign investors’ dividend income from China should be deferred, if the dividend is directly reinvested in business areas encouraged for foreign investment (“Reinvestment Tax Deferral”). Details of this new Reinvestment Tax Deferral are yet to be clarified in the upcoming tax regulations (for example, whether a special certification procedure will be introduced for this purpose, how reinvestment in the encouraged business may be distinguished if the company engages in multiple lines of business and whether this new treatment may be applied to dividends related to years of and before 2016), but it may sound familiar to foreign investors that entered the Chinese market before 2008. Under the prior PRC Enterprise Income Tax Law for Foreign Invested Enterprises and Foreign Enterprises (“Prior Foreign EIT Law”), which was replaced by the current PRC Enterprise Income Tax Law in 2008, foreign investors were generally entitled to exemption of withholding income tax on their dividend income from China. In addition, subject to certain conditions, foreign investors may also enjoy a percentage income tax refund if the dividends were used for reinvestment in China. Based on the information available, this new Reinvestment Tax Deferral is unlikely to replicate the preferential treatment under the Prior Foreign EIT Law. However, it nonetheless stands for a great tax saving opportunity for multinational companies that would like to further invest and expand their business operation in China. This may also be viewed as an effort of the central government trying to retain business revenues within China. As you know, multinational companies have been experiencing difficulties in repatriating profits from their China operations, the reintroduction of tax policies to encourage reinvestment within China may be a more positive gesture to the same effect of limiting capital outflow.
Extension of preferential income tax treatment for Advanced Technology Service Enterprises (ATSE) to the entire nation
Starting from 2009, a qualified ATSE may enjoy a preferential income tax rate of 15 percent, which is a major tax incentive for foreign invested R&D and technological service companies. However, up until today this preferential treatment is only available in 20 major cities. The extension of this ATSE preferential treatment to the entire nation will in effect reduce tax costs for foreign investment in 2nd tier cities and west China.
Extension of pre-establishment national treatment and negative list mechanism to the entire nation
The pre-establishment national treatment and negative list mechanism for the administration of foreign investment have been tested in the pilot free trade zones for several years, and welcomed by foreign investors as a more open and efficient system. The Standing Committee has now decided to extend it to the entire nation, and further simplify the foreign investment legal procedures by combining registration with the commission of commerce into registration with the local administration of industry and commerce. It is yet to be established how such consolidated filings would be implemented in practice.
Relaxing or cancelling restrictions on foreign investors' shareholding percentage in certain industries
Under the 2017 Foreign Investment Catalogue, there are 35 categories of business where foreign investment are subject to restrictions (in comparison to 93 categories under the 2015 version), including restriction on foreign investors’ shareholding in some industries such as ship building, automobile manufacturing, and airplane manufacturing and value add telecommunication services. The Standing Committee has decided that the shareholding percentage restrictions on foreign investment in certain manufacturing and service industries should be further relaxed or cancelled. It is unclear at this stage which industries will be affected, but automobile manufacturing may be one of them.
Other than the above, foreign investment incentives decided in the meeting also include:
- Incentives by local government for multinational companies’ establishment and operation of regional headquarters
- More financial subsidies to foreign investment in technological and environmental construction in the national industrial parks of West China and North East China
- More administrative autonomies for national industrial parks in provision of local incentives
- Simplified working permit application procedures and longer validity term of working visas for attracting foreign talent to work in China
Although the regulatory details are still to be rolled out by the State Administration of Taxation and related Chinese authorities in the next two months, the above measures unquestionably represent a major incentive and will be welcomed by foreign investors in China. To maximize this opportunity, foreign investors may want to hold back dividend distribution from China in the third quarter until the relevant regulations are in place, and also take a look into the possibility of leveraging the other incentives that become available.