Chinese International Tax Law

China’s international tax framework is governed by the Corporate Income Tax Law (Qiye Suodeshui Fa, 企业所得税法, 2007, amended 2017) and supplemented by an extensive network of bilateral tax treaties, Special Tax Adjustment (STA) regulations, and the State Taxation Administration’s (STA) guidance on cross-border tax matters.

Corporate Income Tax Law

The Corporate Income Tax Law applies to all enterprises established in China (resident enterprises) and to foreign enterprises with income derived from China. The standard corporate income tax rate is 25%. A reduced rate of 15% applies to: High and New Technology Enterprises; encouraged enterprises in the western regions; and certain types of qualified enterprises.

China taxes resident enterprises on their worldwide income and non-resident enterprises on their China-source income. The law provides for foreign tax credit relief where income is subject to tax in both China and another jurisdiction. The foreign tax credit is limited to the amount of Chinese tax attributable to the foreign income.

CFC Rules

China’s Controlled Foreign Corporation (CFC) rules are contained in the Special Tax Adjustment provisions of the Corporate Income Tax Law. A CFC is a foreign enterprise established in a jurisdiction with an effective tax rate below 12.5% (50% of China’s standard rate) and controlled by a Chinese resident enterprise.

Under the CFC rules, income of the CFC that is not distributed is deemed to be distributed to the Chinese controlling enterprise and is subject to Chinese corporate income tax. The rules target the deferral of Chinese tax through the retention of earnings in low-tax jurisdictions. Exceptions apply where the CFC is engaged in active business operations.

Transfer Pricing

China’s transfer pricing rules require that transactions between related parties be conducted at arm’s length prices. The Special Tax Adjustment regulations provide: the arm’s length principle as the fundamental standard; documentation requirements (contemporaneous documentation for transactions exceeding specified thresholds); acceptable transfer pricing methods (comparable uncontrolled price, cost plus, resale price, transactional net margin, profit split); and penalties for non-compliance.

The STA’s transfer pricing enforcement has become increasingly sophisticated. The STA has: conducted extensive transfer pricing audits of multinational enterprises; challenged transfer pricing arrangements in cases involving intangibles, cost sharing, and services; and imposed significant adjustments and penalties. The STA’s enforcement priorities have focused on: profit shifting through intangibles; service fee arrangements; and financial transactions.

Thin Capitalization

China’s thin capitalization rules limit the deduction of interest expense paid to related parties. The rules apply where the debt-to-equity ratio exceeds 5:1 for non-financial enterprises or 10:1 for financial enterprises. Interest on excess debt is not deductible and is treated as a deemed dividend distribution.

The thin capitalization rules are supplemented by general anti-avoidance rules that may recharacterize excessive debt as equity. The STA has applied the thin capitalization rules in audits of highly leveraged multinational enterprises and has disallowed significant interest deductions.

Tax Treaties

China has concluded over 100 bilateral tax treaties, based on the OECD and UN Model Conventions. China’s treaty network provides: reduced withholding tax rates on dividends (typically 5-10%), interest (typically 10%), and royalties (typically 10%); elimination of double taxation; non-discrimination provisions; mutual agreement procedures; and exchange of information provisions.

Recent Chinese treaties have incorporated: anti-treaty shopping provisions (Limitation on Benefits clauses); principal purpose tests; and mandatory binding arbitration. China has also signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), which modifies existing treaties.

Double Tax Relief

China provides double tax relief through both the foreign tax credit and treaty provisions. The foreign tax credit is available for: direct taxes paid by Chinese residents on foreign-source income; indirect taxes paid by foreign subsidiaries of Chinese companies (deemed paid credit); and withholding taxes paid to foreign governments. The credit is limited to the Chinese tax attributable to the foreign income.

China also provides for tax sparing credits in certain treaties, allowing Chinese taxpayers to claim credit for foreign taxes that would have been paid but for tax incentives in the foreign jurisdiction.

BEPS Implementation

China has actively participated in the OECD/G20 Base Erosion and Profit Shifting (BEPS) project and has implemented most BEPS recommendations. Implementation measures include: country-by-country (CbC) reporting requirements; anti-treaty abuse provisions; strengthened transfer pricing documentation; and improved exchange of information.

China has also been a strong supporter of the OECD’s Two-Pillar solution to the digital economy tax challenges. China has supported the formulation of global minimum tax rules (Pillar Two) while protecting its interests as a capital-exporting and capital-importing country.

Tax Information Exchange

China has established extensive tax information exchange mechanisms. The STA has: concluded bilateral tax information exchange agreements; implemented the Common Reporting Standard (CRS) for automatic exchange of financial account information; and participated in the OECD’s multilateral exchange of information. Tax information received from foreign authorities has been used in enforcement actions against Chinese taxpayers with undisclosed foreign assets.