China is one of the most popular destinations for inward investment by multinational corporations (MNCs).

Inward investment has long been subject to approvals, registrations and restrictions in China. In September 2013, however, China initiated a reform in the Shanghai Pilot Free Trade Zone to replace foreign investment approvals with a recordal system. Subsequently, three other pilot free trade zones in Guangdong, Tianjin and Fujian joined the reform. On 3 September 2016, the Standing Committee of the National People’s Congress passed a decision to implement on a nationwide basis a recordal system for the establishment and administration of corporate changes of foreign-invested enterprises (FIEs) in industries that are not subject to special administrative measures. The new recordal system has been effective since 1 October 2016. For FIEs in industries that are subject to special administrative measures for entry, namely restricted and prohibited industries as listed in the Catalogue for Guiding Foreign Investment in Industry (2017 version), the approval system continues to apply. In addition, effective from 30 July 2017, the recordal system has replaced the approval system for acquisitions of shares and assets of Chinese-invested companies by foreign investors in industries that are not subject to special administrative measures.

With regard to taxation, China provides tax incentives to promote both inward investment and domestic investment in high value-added sectors, including high-technology research and development, advanced manufacturing, clean energy technology and ‘modern services’.

MNCs have faced growing challenges from the Chinese tax authorities in recent years, including the taxation of indirect transfers of Chinese-resident enterprises; transfer pricing adjustment to intragroup payments such as royalties and service fees; and the use of transfer pricing methodologies that favour higher levels of source-country taxation.

The Chinese tax authorities have become more and more aggressive in tax enforcement and collection against MNCs. According to the State Administration of Taxation (SAT), the Chinese tax authorities collected 58 billion yuan in enterprise income tax (EIT) through tax anti-avoidance enforcement in 2015,2 representing an 11 per cent increase over 2014. At the same time, the tax environment is gradually becoming more transparent and rules-based, and taxpayers are beginning to have more effective avenues through which to appeal tax assessments.


i Corporate

Wholly foreign-owned enterprises (WFOEs) and Sino-foreign equity joint ventures (EJVs) are the corporate entities commonly used by foreign investors wishing to establish a business presence in China. WFOEs and EJVs are collectively known as FIEs.

A WFOE is a limited liability company wholly owned by one or more foreign investors. An EJV is a limited liability company established on the basis of a joint venture contract between Chinese and foreign parties. The WFOE is the most common form of inward investment to China, while the EJV has been the preferred form for foreign investors to enter industries with foreign ownership or control restrictions.

Since WFOEs and EJVs are Chinese-resident enterprises, they are subject to the same tax treatment as Chinese domestically owned corporate enterprises. In particular, they pay EIT. The taxation of resident enterprises is discussed in more detail in Section III.

ii Non-corporate

Partnerships and representative offices (ROs) are the two main types of non-corporate entities for inward investment into China.

China does not yet have laws or comprehensive rules regarding the taxation of partnerships. Some general guidance is available under a 2008 circular (Circular 159),3 which establishes that partnership profits are first allocated to the partners, who are subject to individual income tax (IIT) or EIT depending on whether they are individuals or enterprises. The Enterprise Income Tax Law (EITL) provides further confirmation of the pass-through nature of partnerships by stating that a partnership is not an enterprise that is subject to EIT.4 Circular 159 also provides that a partner is not permitted to deduct partnership losses against his or her other forms of income. Further, in a case reported in the China Taxation News in its 24 September 2014 issue, a foreign corporation acting as a limited liability partner in a foreign invested partnership (FIP) established in China was subject to 25 per cent EIT because the FIP’s fixed place of business was deemed to be the limited liability partner’s permanent establishment (PE) in China. Apart from these basic principles, partnership taxation is not well developed in China; this is one reason why foreign investors have not commonly used partnerships for inward investment.

An RO is the most common form of non-corporate entity used by foreign investors doing business in China. In general, ROs are not permitted to engage in profit-generating activities, and must confine themselves to, for example, liaison, market research and product promotion activities.5 An RO constitutes a PE in China of its non-resident head office unless the RO is confirmed by the Chinese tax authorities as not being a PE based on an applicable double taxation agreement (DTA). In principle, an RO of a non-resident enterprise is required to keep full accounting books and to pay EIT on its actual profits in the same manner as resident enterprises. In practice, however, the vast majority of ROs are taxed on deemed profits, which are determined using a statutory cost-plus or deemed profit formula.6


i Tax on profits
Determination of taxable profit

A Chinese-resident enterprise is subject to EIT on its worldwide income. A PE of a non-resident enterprise is subject to EIT on its China-sourced income and on its non-China-sourced income that is effectively connected to the PE.

The taxable profits of an enterprise are equal to its total revenue for the tax year less its non-taxable revenue, tax-exempt revenue, deductions and prior-year losses. Enterprise taxpayers are required to use accrual accounting, and taxable net income is calculated on this basis, except where the tax authorities adopt a deeming method for determining taxable income, as is common for ROs and other types of PE. Taxpayers need to take into account certain differences between the general accounting standards for enterprises and the tax accounting requirements under the EITL when preparing EIT returns.

In general, reasonable expenditures actually incurred by an enterprise in connection with the deriving of revenue are deductible. The main types of non-deductible items include dividends, EIT payments, tax surcharges, penalties, non-qualified donations, sponsorship expenses, unapproved reserves and other expenses that are related to the generation of non-taxable income.

The straight-line method is used in computing both depreciation of fixed assets and amortisation of intangible assets. Certain fixed assets may be depreciated using an accelerated depreciation method as an incentive to encourage activities such as technological development.

Capital and income

The EITL does not distinguish between the tax treatment of capital income and ordinary income. A capital gain derived by a taxpayer is subject to EIT as ordinary business income.


Losses may be carried forward for five years after the tax year in which they are generated. Loss carry-backs are not allowed. Since a capital gain is taxed as ordinary business income, the offset of income losses against capital gains, and vice versa, is allowed. There are no specific provisions preventing loss relief in the case of an ownership change, although the general anti-avoidance rule may apply where the change is among related parties. The losses of a Chinese enterprise’s foreign branches may not be set off against its domestic profits.


The general EIT rate is 25 per cent, but high and new technology enterprises (HNTEs) to which the state provides key support are subject to a reduced rate of 15 per cent, while qualified small-scale and low-profit enterprises are subject to a reduced rate of 20 per cent. Under several circulars, qualified technologically advanced service enterprises are also subject to a reduced rate of 15 per cent.


The tax year begins on 1 January and ends on 31 December. An enterprise must file a provisional monthly or quarterly tax return within 15 days of the end of each month or quarter and pre-pay provisional EIT at that time. The enterprise must file an annual tax return within five months after the end of the tax year, and the provisional tax already paid during the year will be credited to the annual tax payable.

The SAT is the central government tax authority in China. The SAT is responsible for the implementation of the tax laws and also has a role in creating tax policy, a role that it shares with the Ministry of Finance (MOF). At the provincial, city and district levels, other than in Shanghai and Tibet, there are two tax bureaux: the state tax bureau and the local tax bureau. The state tax bureau is responsible for the collection of taxes that generate revenue for the central government, as well as taxes that generate revenues that are shared between the central and local governments, such as EIT and value added tax (VAT). The local tax bureau is responsible for the collection of taxes that only generate revenue for the local government, such as IIT. Both the state and local tax bureaux must follow the direction of the SAT with respect to tax policy and the interpretation of tax laws and regulations.

Tax authorities are required to carry out tax audits in accordance with an audit plan that is formulated annually.7

There is as yet no formal procedure for advance rulings in China, although it is possible an advance ruling procedure will be introduced in the next couple of years. Chinese enterprises can consult the tax authorities on specific tax issues online8 or via a hotline.9 The responses of the tax authorities, however, are not binding on the tax authorities. It is also common in practice for taxpayers to consult informally with the tax officials responsible for the enterprise, although, again, the views obtained through such consultations are not binding on the tax authorities.

Under Chinese law, a taxpayer may challenge a tax assessment issued by a Chinese tax authority through the administrative review procedure after paying the tax. If the taxpayer is not satisfied with the outcome of an administrative review, it may bring a lawsuit in the courts.

Tax grouping

Currently, there is no consolidated tax-grouping regime in China. Each Chinese company is a separate taxpayer under the EITL, and should pay tax and bear losses separately.

ii Other relevant taxes

The sale of goods, repair and replacement services and the provision of labour services in relation to the processing of goods in China are subject to VAT. VAT is also levied on the import of goods into China, unless the imports are specifically exempted under special rules. Provision of other services and the transfer of immoveable or intangible properties are also within the scope of VAT under the VAT pilot programme. The standard VAT rates for general VAT taxpayers are:

  • a 17 per cent for the sale or importation of goods;
  • b 11 per cent for the transfer of immoveable properties and land use rights;
  • c 6 per cent for the transfer of intangibles other than land use rights; and
  • d 17, 11 or 6 per cent for the provision of services, depending on the nature of services.

General VAT taxpayers may utilise input VAT credits to offset against output VAT. The standard VAT rate for small-scale VAT taxpayers is 3 per cent, with an exception that small-scale VAT taxpayers will be taxed at a rate of 5 per cent on revenues from the leasing or sale of immoveable property. No input credits are available to small-scale VAT taxpayers. In general, exports are exempted from VAT, and the related input VAT may be wholly or partially refunded. The non-refundable portion is absorbed as a cost of export.

Stamp duty

Stamp duty is levied on the execution or receipt in China of certain documents, including contracts for the sale of goods, processing work, construction and engineering projects, leases and loans, as well as other non-trade contracts. Stamp duty is also levied on documentation effecting the transfer of property or shares, on business account books, and on certificates evidencing rights and licences. The rates of stamp duty vary. For the transfer of shares in a resident enterprise, the applicable stamp duty rate is 0.05 per cent of the contract value for each party.

Land appreciation tax

Land appreciation tax is levied on gains realised from real property transactions at progressive rates from 30 to 60 per cent, based on the land value appreciation amount, which is the excess of the consideration received from the transfer or disposition of real property over the total deductible amount, which mainly consists of the original cost of the land and the cost of improvements.


i Corporate residence

A company is a resident enterprise in China if it has been incorporated under Chinese law or if it has been incorporated outside China but has a place of effective management in China. A place of effective management refers to a place where overall management and control over business operations, staffing, finance and assets are exercised in substance.10 A tax notice issued in 200911 elaborates on this concept in relation to Chinese-controlled foreign companies. It provides that a Chinese-controlled foreign company should be regarded as a Chinese-resident enterprise if all of the following factors exist:

  • a the enterprise’s senior management personnel and the senior management bodies carry out the day-to-day management of the enterprise mainly in China;
  • b finance-related decisions (borrowing, lending, financing and financial risk management, etc.) and HR-related decisions (appointments, terminations and remuneration, etc.) are decided or approved by bodies or personnel in China;
  • c the major assets, accounting books, meeting records for shareholders’ meetings and directors’ meetings, etc., are located or kept in China; and
  • d at least half of the directors with voting powers or the senior management personnel are habitually resident in China.
ii Branch or permanent establishment

A non-resident enterprise with a place or establishment in China is subject to EIT on its China-sourced income and on its non-China-sourced income that is effectively connected to the PE. A ‘place or establishment’ is a domestic concept similar to that of a PE under DTAs.

The distinctive feature of the domestic concept of place or establishment is that the following are deemed taxable places or establishments:

  • a places of management or business organisation;
  • b places of business;
  • c branches;
  • d ROs;
  • e factories and workshops;
  • f places where natural resources are extracted or exploited;
  • g farms;
  • h places where projects such as construction, installation, assembly, repair and exploration are undertaken;
  • i places where labour services are provided;
  • j business agents; and
  • k other places or establishments where production and business activities are undertaken.

The PE definition under China’s tax treaties may override and serve to limit this broad definition of place or establishment under domestic law.

China has very limited domestic guidance on the attribution of profits to PEs. A non-resident enterprise with a place or establishment in China is required to keep complete accounting books and records to accurately calculate its taxable income in accordance with the principles of matching the functions performed and the risks borne.12 If a non-resident enterprise fails to accurately calculate its taxable income, the non-resident enterprise will be taxed using a deemed profit method. In practice, the deemed profit method is widely used, with profit rates ranging from 15 to 50 per cent.

A non-resident company may open a branch in China after obtaining approvals from the competent authorities, although in practice this has been limited mainly to the financial services sector. The EITL does not provide for a branch profits tax.


i Holding company regimes

A foreign investor may establish a Chinese holding company. Dividends received by a resident enterprise from another resident enterprise are exempt from EIT; however, there is no special tax regime for holding companies in China.

ii IP regimes

There are no special regimes for IP-derived income. Instead, there are several tax incentives related to R&D and other IP-related activities. The income derived by a resident enterprise from qualified technology transfer may be granted a tax exemption or a 50 per cent tax reduction.13 There is a 50 per cent ‘super’ deduction for R&D expenditures incurred on the development of new technology, new products and new processes. In addition, as noted above, qualified HNTEs to which the state provides key support are subject to a reduced EIT rate of 15 per cent instead of the headline 25 per cent rate.

iii State aid

The EITL provides specific tax incentives for a number of sectors. For instance, enterprises investing in the operation of infrastructure construction projects, environmental protection, energy-saving or water conservation projects may enjoy a three-year tax exemption followed by another three years with a 50 per cent reduction in the EIT rate starting from the tax year when production revenue is generated.14 In addition, the income generated from agriculture, forestry, husbandry and fishery is granted an EIT reduction or exemption.15

iv General

FIEs and domestically invested enterprises are treated equally under the EITL. The pre-2008 tax incentives that specifically targeted FIEs were phased out following the effective date of the EITL on 1 January 2008.


i Withholding on outward-bound payments (domestic law)

Dividends, interest and royalties paid by a Chinese-resident enterprise to a non-resident enterprise are subject to withholding tax at a statutory rate of 20 per cent on the gross amount.16

ii Domestic law exclusions or exemptions from withholding on outward-bound payments

The withholding tax rate on dividends, interest and royalties is reduced to 10 per cent under Article 91 of the Implementing Regulations. In addition, the following items of interest are exempt from withholding tax:

  • a interest income from state treasury bonds;
  • b interest income on loans made by foreign governments to the Chinese government;
  • c interest income on preferential loans made by international financial organisations to the Chinese government and to resident enterprises; and
  • d interest income on municipal bonds issued in and after 2009.17
iii Double tax treaties

As of November 2016, China is party to DTAs with 106 jurisdictions. An updated list of tax treaties that China has signed may be found online.18

China’s DTAs are based on the OECD and UN Model Conventions. Most of the DTAs that China has concluded provide a 10 per cent withholding tax rate, which is the same as the Chinese domestic rate. However, the dividend withholding tax rate is reduced to 5 per cent under certain DTAs, including those that China has signed with the following countries or regions: Barbados, Belgium, Denmark, France, Germany, Hong Kong, Ireland, Luxembourg, Malta, Mauritius, the Netherlands, Singapore, Sweden, Switzerland and the United Kingdom.

Previously, China’s domestic rules required tax authority approval for a non-resident enterprise to enjoy lower tax rates and other DTA benefits related to dividends, interest, royalties and capital gains.19 Starting from 1 November 2015, the approval procedure was replaced with a recordal procedure. However, the substantial requirements to enjoy treaty benefits remain the same, and a taxpayer that has enjoyed treaty benefits remains subject to challenge in a tax investigation or audit.20 The main focus with respect to dividends, interest and royalties is on whether the recipient of the income is the beneficial owner of the income.21 The review by the tax authority focuses heavily on whether the recipient has economic substance and is a conduit.

iv Taxation on receipt

Dividends, capital gains and other income derived by a resident enterprise outside China are subject to the general EIT rate of 25 per cent. The EITL allows resident enterprises to use foreign tax credits, including indirect tax credits, to avoid double taxation of income.

Foreign income taxes, including withholding taxes, actually paid by resident enterprises on non-China sourced income may be deducted from the total amount of EIT payable by the enterprise. A resident enterprise receiving dividends from a controlled foreign enterprise is also entitled to indirect foreign tax credits for the underlying taxes actually paid by the controlled foreign enterprise on the profits out of which dividends are distributed. A controlled foreign enterprise refers to a foreign enterprise in which the resident enterprise directly or indirectly holds at least 20 per cent share and that is within three tiers immediately below the resident enterprise.

The foreign tax credit is limited to the amount of tax payable on the non-China sourced income under the EITL. This limitation is calculated on a country-by-country basis. Excess foreign tax credits may be carried forward for five years.


i Thin capitalisation

Chinese thin capitalisation rules apply in respect of direct and indirect borrowings from related parties. The limit on the debt-to-equity ratio for financial enterprises is 5:1, while the limit for non-financial enterprises is 2:1.22 Excess interest expenses may not be deductible, but there is an exception that permits deduction if a borrower is able to prove that borrowings from a related lender are on arm’s-length terms or that the actual tax burden of the domestic borrower is no higher than its domestic related lender.23

ii Deduction of finance costs

Reasonable financing costs incurred by an enterprise during its production and business operation activities may be deductible as interest expense; however, financing costs incurred by an enterprise for the acquisition, construction or creation of fixed assets and intangible assets or of inventories with a production cycle of more than 12 months, will be treated as capital expenditure and recorded as part of the cost of assets.24 Similarly, acquisition finance costs incurred in M&A transactions must be capitalised rather than deducted as interest expense.

iii Restrictions on payments

A resident enterprise can pay dividends only from accounting profits and cannot distribute excess cash arising, for example, from depreciation of fixed assets. Under applicable corporate rules, a WFOE must allocate at least 10 per cent of after-tax profits to its statutory reserve fund until the reserve fund reaches 50 per cent of the WFOE’s registered capital. In the case of an EJV, its board of directors can decide the proportion to be allocated to the reserve fund.

iv Return of capital

Equity capital may be returned by means of reduction of registered capital. An FIE, however, can reduce capital only where it is necessary owing to a significant change in the scale of its production or operations. Regulatory approval used to be required for a capital reduction, and such approval was rarely granted in practice. Starting 1 October 2016, the regulatory approval for a capital reduction has been replaced by a recordal system for industries that are not subject to special administrative measures. However, as the recordal system is relatively new and some local government authorities may implement it as a de facto approval, it still remains to be seen how this recordal system will work out in practice.


i Acquisition

A foreign investor may directly acquire a Chinese company through a share acquisition or an asset acquisition, both of which are subject to government administration (either recordal or approval depending on the industry).

The seller in a share acquisition will be subject to EIT on capital gains at the applicable domestic rate, normally 25 per cent if it is a resident enterprise, or at a 10 per cent rate if it is a non-resident enterprise and the gain is not connected with a PE in China. Each party is also subject to stamp duty at 0.05 per cent of the contract value of the acquisition agreement.

The taxation of an asset acquisition is more complicated. The foreign investor needs to establish a WFOE or an EJV as the buyer of the assets from the Chinese seller (or use an existing WFOE or EJV). The seller is subject to EIT on capital gains at its applicable rate (normally 25 per cent), and may be subject to VAT or land appreciation tax (or all of these) depending on the nature of the assets to be transferred. The buyer is subject to deed tax at a rate of 3 to 5 per cent if it acquires real property. Both parties must pay stamp duty at a rate of either 0.03 or 0.05 per cent, depending on the type of assets.

If a foreign investor acquires a Chinese company, assets owned by a Chinese ‘place or establishment’ or real properties located in China through an indirect share acquisition (i.e., by buying the shares of the target company’s overseas holding company), the seller of the shares may be subject to EIT in China on capital gains based on China’s indirect share transfer rules.25 The current version of these rules has been in effect since 3 February 2015, but applies to indirect transfers that occurred before 3 February 2015 where a tax determination had not been made on the indirect transfer before that date. An indirect transfer generally will be ‘recharacterised’ as a direct transfer if it lacks reasonable commercial purpose and does not fall within any safe harbours, and the buyer should be the withholding agent. If neither the withholding agent nor the offshore seller withholds or pays the taxes due, the PRC tax authorities may impose a penalty ranging from 50 per cent to three times the amount of the unpaid tax on the withholding agent.

The recharacterisation of the share transfer as taxable in China focuses mainly on whether there is a reasonable commercial purpose for acquiring the overseas target instead of the Chinese company, and whether the target overseas holding company has economic substance.

ii Reorganisation

The income tax treatment of corporate reorganisations is governed by a tax notice that was jointly issued by the MOF and the SAT on 30 April 2009 (Notice 59).26 There are six types of corporate reorganisation under Notice 59: change of legal form, debt restructuring, share acquisition, asset acquisition, merger and demerger.

To qualify for tax-free reorganisation, the transaction must satisfy a number of baseline requirements:

  • a a bona fide business purpose;
  • b transfer of at least 50 per cent of assets or shares;
  • c 12 months’ continuity of business operations post-reorganisation;
  • d at least 85 per cent equity consideration (no more than 15 per cent cash); and
  • e 12 months’ continuity of ownership post-reorganisation.

For cross-border share or asset acquisitions, the transferor must also have 100 per cent direct share control over the transferee, and the continuity of ownership post-reorganisation is extended to three years. Technically, the procedure to obtain tax-free treatment is a recordal, but in practice it is an approval.

On 25 December 2014, China issued Notice 10927 to provide tax-free treatment for certain internal transfers of equity and assets provided the following conditions are met:

  • a the internal transfer is conducted between two PRC-resident enterprises where one enterprise directly holds a 100 per cent ownership interest in the other, or both enterprises are directly 100 per cent owned by the same PRC-resident enterprise or enterprises;
  • b the internal transfer is made at the net book value of the equity or assets in the hands of the transferor;
  • c the internal transfer has reasonable commercial purpose, and reduction, exemption or deferral of taxes is not a major purpose of the transfer;
  • d the original substantive business activities with respect to the assets transferred remain unchanged within the subsequent 12 consecutive months after the transfer; and
  • e no accounting gain or loss has been recognised by the transferor and transferee.
iii Exit

If a foreign investor exits an investment in China by selling its equity interest in a WFOE or an EJV, it will be subject to tax in China as the seller in an acquisition (see Section VIII.i).

The foreign investor may instead apply to the government authorities to dissolve and liquidate the Chinese company. The company will be subject to tax on the sale of its assets in liquidation as described above. The foreign investor will be subject to withholding tax at the rate applicable to dividends on liquidating distributions up to the amount of the company’s distributable profits, and at the rate applicable to capital gains on the remainder of the liquidating distributions.


i General anti-avoidance

General anti-avoidance rules (GAAR) were first introduced in Article 47 of the EITL, under which the Chinese tax authorities may recharacterise an arrangement that lacks reasonable commercial purpose. The Implementing Regulations define reasonable commercial purpose to mean that a main purpose of the arrangement is to reduce, exempt or defer taxation. Apart from this general definition, there is no clear guidance on the meaning of reasonable commercial purpose. Nonetheless, the Chinese tax authorities have been increasingly aggressive in using the GAAR to tax non-resident enterprises. On 12 December 2014, the SAT issued the GAAR procedural rules28 to provide procedural guidance on GAAR investigations.

ii Controlled foreign corporations (CFCs)

The profits of a CFC established in a low-tax jurisdiction will be included in the Chinese corporate shareholder’s taxable income in the current year if the CFC does not distribute profits without reasonable commercial need. A low-tax jurisdiction refers to a jurisdiction where the effective income tax rate is lower than 50 per cent of the EIT rate (i.e., lower than 12.5 per cent). An overseas company is treated as a CFC if each shareholder that is a Chinese resident enterprise or an individual that directly or indirectly holds at least 10 per cent of the voting shares of the foreign company, and those shareholders with 10 per cent or more of the voting shares jointly own more than 50 per cent of the shares; or the Chinese-resident enterprise or individual has actual control over the foreign company by virtue of shares, capital, business operations, or purchases and sales in any other situation.

However, the CFC regime does not apply if the CFC is established in a high-tax jurisdiction designated by the SAT, the CFC’s income mainly consists of active business income or the CFC’s annual profits are less than 5 million yuan.

iii Transfer pricing

The tax authorities may adjust the taxable income of an enterprise or its related party where the transactions between the related parties are not in accordance with the arm’s-length principle. All enterprises in China that are taxed on an actual-profits basis have an obligation to report related-party transactions as part of their annual EIT filings each year. In addition, all enterprises in China must prepare contemporaneous documentation for related-party transactions, unless specifically exempted.

China’s transfer pricing rules generally follow the OECD guidelines, but some departures from these guidelines are reflected in the China chapter of the United Nations Practical Manual on Transfer Pricing for Developing Countries. In particular:

  • a location savings and market premiums need to be reflected in the arm’s-length price;
  • b for MNCs that have multiple Chinese entities and each of them performs only a single function such as manufacturing, distribution and R&D, functions performed by these entities may have to be considered as a whole to determine the return these entities should earn in China;
  • c the usefulness of IP imported from overseas decreases over time in China and the Chinese licensee should pay less for it;
  • d if comparables are from developed countries, such as Japan and Korea, there needs to be a step-up in the profit;
  • e cost-plus should not be used for contract R&D where the Chinese enterprise has HNTE status; and
  • f the transactional net margin method (TNMM) is overused in China, and there should be more use of profit split or other alternatives, or comparability adjustments made to TNMM.
iv Tax clearances and rulings

There is no general advance ruling procedure in China. Although one exists on paper for certain very large enterprises, it has not been implemented. In practice, however, certain companies, such as large state-owned enterprises and giant MNCs, occasionally may be able to obtain written replies from tax authorities confirming the tax treatment and tax consequences of a specific transaction.


During the past year, there have been a number of significant tax developments in China.

i New transfer pricing adjustment rules

On 17 March 2017, the SAT issued the Bulletin on the Administrative Measures for Special Tax Investigation and Adjustments and Mutual Agreement Procedures (i.e., Bulletin 629). Bulletin 6 is the third and final bulletin in a series through which the SAT has comprehensively revised the transfer pricing regime under the former Circular 2.30 The first two bulletins in the series were Bulletin 4231 on transfer pricing documentation, and Bulletin 6432 on advance pricing arrangements. With Bulletin 6 taking effect on 1 May 2017, China has completed the revamping of its transfer pricing regime. Key provisions of Bulletin 6 are as follows.

Entitlement to intangible-related returns

Bulletin 6 requires value contribution analysis when determining the allocation of returns to intangibles. The key factors in the value contribution analysis include the functions of development, enhancement, maintenance, protection and exploitation as proposed under the BEPS Actions 8–10 final report, but marketing/promotion is introduced as a new value-contributing factor. Bulletin 6 further provides that a legal owner that does not contribute to value creation should not receive any intangible-related return. More specifically, it states that a capital-rich company that merely provides funds without actually performing relevant functions or assuming relevant risks is not entitled to intangible-related returns.

Outbound payments

Bulletin 6 replaces the controversial Bulletin 16 regarding the deductibility of outbound payments of service fees and royalties to related parties. It removes the confusion about whether the rules in Bulletin 16 were based on transfer pricing or on expense deductibility by providing that they are part of the transfer pricing regime. This clarification has implications for interest, penalties and the statute of limitations, among other things. Further, Bulletin 6 strengthens the applicability of the arm’s-length principle for all of the various types of outbound payments to related parties, not only for royalties.

Comparability analysis

As compared to the former rules under Circular 2, Bulletin 6 requires comparability analysis to consider two additional factors: (1) the enterprise’s ability to perform the contracts, its actual conduct of performing the contracts and the degree of ‘credibility’ of the related parties entering into the contract provisions; and (2) location-specific advantages, such as location saving and market premium. The ‘credibility’ factor, in addition to being vague, seems to go beyond what is contemplated in the BEPS Actions on contractual risk allocation.

Transfer pricing methods

In addition to the five traditional transfer pricing methods listed in Circular 2, Bulletin 6 introduces the asset valuation method and a catch-all ‘other methods that can align profits with economic activities and value creation’. Both methods must be applied consistently with the arm’s-length principle. Bulletin 6 also expressly provides that the TNMM generally should not be used to determine the arm’s-length profit of an enterprise with valuable intangibles.

Transfer pricing audits

Bulletin 6 reaffirms three long-standing transfer pricing practices of the Chinese tax authorities: (1) transfer pricing adjustments should be made on a yearly basis and, thus, no credit can be given to tax years with high profits; (2) single-function entities, in principle, must be profitable; and (3) the tax authority may determine a toll manufacturer’s profits by selecting enterprises engaged in a different business model (typically buy-sell contract manufacturers) as the comparable enterprises and the cost of the raw materials and equipment should be included into the toll manufacturer’s total cost base.

ii New rules on the administration of withholding tax on China-source income derived by non-resident enterprises

On 27 October 2017, the SAT released the long-awaited new rules on the administration of withholding tax on China-source income derived by non-resident enterprises (i.e., Bulletin 3733). With effect from 1 December 2017, Bulletin 37 will repeal a series of existing rules governing the same issue, including Circular 3,34 which is the comprehensive regulation governing the administration of withholding tax, and Notice 698,35 which specifically deals with share transfers by non-resident enterprises. Bulletin 37 will likely have a significant impact on non-resident enterprise taxpayers and their withholding agents in the following aspects.

Withholding obligation in a direct share transfer

Unlike Circular 3, Bulletin 37 no longer provides an exemption from withholding obligation for a non-resident buyer in a direct share transfer between two non-resident enterprises. As such, a non-resident buyer in a direct share transfer, technically, will be required to withhold tax. However, without a clear guidance under Bulletin 37, there are still uncertainties in terms of whether and how Chinese tax authority will enforce the withholding obligation on a non-resident buyer;

Timing of withholding obligation

Bulletin 37 keeps the general rule unchanged that withholding obligation arises on the actual payment date or the date when the payment is due (whichever is earlier). Meanwhile, MNCs will welcome two new provisions under Bulletin 37: (1) for dividends, tax withholding obligation only arises on the actual payment date rather than the dividends declaration date (which is normally earlier than the actual payment date); and (2) for asset or share transfers where the consideration is paid by instalments, payments should be first used to cover the cost of the assets or shares transferred and tax withholding obligation only arises when the total cost has been recovered.

Time limits for tax declaration by non-resident taxpayers

In the case of failure to withhold tax by the withholding agent, Bulletin 37 no longer requires the non-resident taxpayer to pay tax within seven days from the date when the payment is due or actually paid (or from the date when the tax liability arises for an indirect transfer). Instead, Bulletin 37 provides that a non-resident taxpayer should be viewed as having paid tax in a timely manner as long as it pays tax before being ordered by the tax bureau to pay tax.


The Chinese tax authorities have become increasingly aggressive about tax enforcement and collection, particularly with regard to non-resident enterprises. As mentioned in Section I, this is demonstrated, inter alia, by:

  • a the taxation of indirect transfers of Chinese-resident enterprises;
  • b the greater transparency required under the new transfer pricing documentation rules;
  • c transfer pricing adjustment to intragroup payments such as royalties and service fees; and
  • d the use of transfer pricing methodologies that favour higher levels of source-country taxation.

At the same time, it has been our experience in recent years that the Chinese tax authorities have become more open to discussing technical issues with taxpayers, and have taken measures to promote transparency and uniformity in tax administration and enforcement.

1 Jon Eichelberger is a senior counsel at Baker McKenzie.

2 Chinese anti-avoidance enforcement mechanisms include administrative mechanisms (e.g., voluntary special tax adjustments by taxpayers that are prompted by the tax authorities), service mechanisms (e.g., advance pricing arrangements) and investigative mechanisms (e.g., transfer pricing audits and indirect share transfer investigations).

3 Cai Shui [2008] No. 159.

4 Article 1 of the Enterprise Income Tax Law of the People’s Republic of China, adopted by the National People’s Congress on 16 March 2007 and effective from 1 January 2008.

5 Article 14 of Order of the State Council No. 584.

6 Article 7 of Guo Shui Fa [2010] No. 18.

7 Article 15 of Guo Shui Fa [2009] No. 157.

8 See hd.chinatax.gov.cn/consult.

9 The national hotline number is 12366.

10 Article 4 of the Implementing Regulations for the Enterprise Income Tax Law of the People’s Republic of China, promulgated by the State Council on 6 December 2007 and effective from 1 January 2008 (Implementing Regulations).

11 Guo Shui Fa [2009] No. 82.

12 Article 3 of Guo Shui Fa [2010] No. 19.

13 Article 90 of the EITL.

14 Articles 87 and 88 of the Implementing Regulations.

15 Article 27 of the EITL.

16 Article 4 of the EITL.

17 Cai Shui [2011] No. 76 and Cai Shui [2013] No. 5.

18 See www.chinatax.gov.cn/n810341/n810770/index.html, accessed on 22 November 2017.

19 Guo Shui Fa [2009] No. 124.

20 SAT Bulletin [2015] No. 60.

21 Guo Shui Fa [2009] No. 601.

22 Cai Shui [2008] No. 121.

23 Cai Shui [2008] No. 121.

24 Article 37 of the Implementing Regulations.

25 State Administration of Taxation’s Bulletin on Several Issues of Enterprise Income Tax on Income Arising from Indirect Transfers of Property by Non-resident Enterprises, SAT Bulletin [2015] No. 7, dated 3 February 2015, effective as of the same date.

26 Notice on Certain Questions Regarding the Enterprise Income Tax Treatment of Enterprise Reorganisations, Cai Shui [2009] No. 59, effective from 1 January 2008.

27 Cai Shui [2014] No. 109.

28 SAT Decree No. 32.

29 SAT Bulletin [2017] No. 6.

30 Guo Shui Fa [2009] No. 2.

31 SAT Bulletin [2016] No. 42.

32 SAT Bulletin [2016] No. 64.

33 SAT Bulletin [2017] No. 37.

34 Guo Shui Fa [2009] No. 3.

35 Guo Shui Han [2009] No. 698.