6. TAX INCENTIVES
6.1 Tax rate reduction and exemption
Since the normal tax rate (33%) consists of 30% state income tax rate plus 3% local income tax rate, the following tax incentives applies to the rate of 30% only. The exemption from or reduction of local income tax from any FIE which operates in an industry or undertakes a project encouraged by the State shall be decided under the discretion of local government or provincial government. In Special Economic Zones, FIEs qualifying for the 15% tax rate are normally given exemption from the 3% local government income tax.
A taxpayer may enjoy several kinds of incentives simultaneously if it meets the conditions. E.g. A taxpayer of FIE manufacturer can enjoy the following incentives (a) and (c) together. So a FIE manufacturer in Shenzhen is subject to 15% x 50% 7.5% income tax rate in the third to fifth profitable year.
a) Incentive applied to manufacturing units invested by foreigners:
Any FIE with a production nature scheduled to operate for a period of not less than 10 years shall, from the year in which it begins to make profits after offsetting the loss brought forward, be exempted from income tax in the first and second years and allowed a 50% reduction in the third to fifth years (so called ¡°2 years exempt and 3 years half¡¯). However, if the actual period of operation is less than 10 years, the amount of income tax already exempted or reduced shall be recollected.
A Joint Venture engages in food production. It started business in year 1988 and
was profitable in that year. The following years¡¯ taxable income, tax exemptions and
half reduction of the enterprise tax payable are set out in the table below (tax rate is
30% of the taxable income):
(*): the RMB 350,000 of taxable income in year 1992 will, in the first place, setoff
against 1991¡¯s RMB 250,000 loss and then the tax 30% * 100,000 * 50% 15,000.
Please note that the half reduction period will not be deferred even there is a loss in
1991.
If the production income is more than 50% of the total income derived from both

Year Taxable income Exemption, deductible Enterprise tax payable for
the year
0
1988 RMB 300,000 Exempted
Exempted
Half reduction
0
1989 RMB 700,000
1990 RMB 900,000 - RMB 135,000
1991
1992
1993 - RMB (250.000) - RMB 350,000 (*)_ RMB 1,000,000 Half reduction 0
Half reduction RMB 15,000
Fully taxable RMB 300,000
production and non-production activities, the total income is qualified for the incentive. If the production income is not more than 50%, the total income is subject to the income tax without any incentive.
b) Special industries
Any FIE engaged in energy, transportation, harbor and wharf infrastructure construction can enjoy a 15% income tax rate upon approval of the State Administration of Taxation.
Any FIE engaged in harbor and wharf infrastructure construction with an operating period of over 15 years can enjoy first 5 profit years full exemption and the following 5 years half deduction in FIET.
Any FIE established in Shanghai Pudong New Development zone and engaged in the construction of airport, harbor, railway, high way, power station, etc. with an operating period of over 15 years can enjoy first 5 profit years full exemption and the following 5 years half deduction in FIET. Any FIE with other kinds of business enjoys a 15% income tax rate.
Any FIE established in Hainan Special Economic Zone and engaged in the construction of airport, harbor, wharf, railway, high way, power station, coal mine, water conservancy facility, agriculture and the like, with an operating period of over 15 years, can enjoy first 5-profit year’s full exemption and the following 5 years half deduction in FIET. Any FIE with other kind of business enjoys a 15% income tax rate.
Any export-oriented FIE with an export output value of more than 70% of the total output value of the year, may enjoy a 50% reduction in income tax. However, the minimum income tax is 10% after enjoying all the tax incentives.
An approved advanced technology FIE, after the enjoyment of ¡°2 years exempt and 3 years half¡¯, can further enjoy 3 years of half reduction. However, the minimum income tax rate is 10% after enjoying all the tax incentives.
An enterprise dealing not only in the above industries but also in other industries must separately book and file income and expense for each line of industry to calculate the tax payable according to the different incentives policies and tax rates.
c) Specified location
A reduced income tax rate of 15% is applied to:
Any FIE located in SEZ (Special Economic Zones) i.e. the designated areas of Shantou, Shenzhen, Zhuhai, Xiamen and of the entire Hainan.
Any FIE engaged in production business in ETDZ (Economic and Technological Development Zones) in open coastal cities and Shanghai Pudong New Area.
Any FIE engaged in production business and located in the old urban districts of
SEZ, ETDZ and CEOZ (Coastal Economic Open Zone) and with:
(i) Technology intensive or knowledge intensive projects, or
(ii) Projects with foreign investment of US$30 million or above, and with long pay back period, or
(iii) Major construction projects in energy, communications and harbors.
Any FIE verified as enterprise with new high technology located in the [ HNTIDZs (High and New Technology Industrial Development Zones).
i. Any EJV verified as enterprise with new high technology located in the
HNTIDZs and an operating period of over 10 years enjoy the exemption for first 2 profitable years.
Manufacturing FIE with export processing located in approved bonded zones.
Any Approved FIE located in central or western of China can further enjoy years of tax reduction at a rate of 15% after other incentives have expired.
A reduced income tax rate of 24% is applied to:
Any FIE engaged in production business and located in the old urban districts SEZ, ETDZ and CEOZ (Coastal Economic Open Zone).
Any FIE engaged in production business and located in the approved capitals province.
Any FIE located in the National Sight-seeing Holiday Zone.
Any FIE engaged in service industries in the SEZ with investment of over USD5 million and an operating period of over 10 years enjoys first profitable year exemption and the following 2 years half reduction of income tax rate (effectively 10%).
(¨¤NA FIE engages in production business in SEZ (Special Economic Zone). The exp output value exceeds 80% of the total output value every year. Based on following information, calculate the total income tax for the enterprise.
Business Year 1 2 3 4 5 6 7 8 9 10 1
Taxable income -0.45 -0.75 0.6 1.2 1.5 2.25 1.8 -0.45 0.75 1.65 1.
(in RMB million)
Loss in year 1: no need to pay the income tax;
Loss in year 2: no need to pay the income tax;
The profit in year 3 can offset the loss in year 1 and the RMB 150, 000 loss in year no profit left after the offset, no need to paid the income tax;
The profit in year 4 can offset the remaining loss of RMB 600, 000 in year 2, after the offset, there is a RMB 600, 000 profit, this is the first profitable year, and full exemption is applied henceforth;
Year 5 is the second year having full tax exemption;
Year 6 is the first year having half deduction of tax: 2,250,000 x 15% x 50% RMB168,750;
Year 7 is the second year having half deduction of tax: 1,800,000 x 15% x 50% RMB 135,000;
Loss in year 8: no need to pay the income tax, it is the last year having half deduction of tax, even though it is a loss-making year.
Profit in year 9 can offset the loss in year 8, after the offset, there is RMB 300,000 profit, which can enjoy export-oriented FIE deduction: 300,000 x 10% = RN 30,000
Year 10 can enjoy export-oriented FIE deduction: 1,650,000 x 10% = RMB 165,00( Year 11 can enjoy export-oriented FIE deduction: 1,200,000 x 10% = RMB 1 20,00( Total income tax for the enterprise: 168,750 + 135,000 + 30,000 + 165,000 + 120,0 = RMB 618,750
6.2 Tax refund
(i) If the foreign investor receives the profits distribution from an FIE and directly reinvests into the FIE in the form of capital increment or reinvest in another FIE with an operating period of over 5 years, the foreign investor can be refunded 40% of the tax paid on the reinvested amount. Such profits must be reinvested for at least 5 years, otherwise, the refund must be paid back to the tax bureau.
Tax refund = Reinvestment amount / (1- original tax rate with local tax rate) x original tax rate without local tax rate x refund rate.
Note: The refund is for national income tax. The exemption or reduction of local income tax from any FIE which operates in an industry or undertakes a project encouraged by the State shall be decided under the discretion of local government or provincial government
(ii) If the foreign investor receives the profits distribution and directly reinvest into the FIE which is an approved as export-oriented or advanced technology enterprise in the form of capital increment with an operating period over 5 years, the investor can be refunded 100% of the tax paid on the reinvested amount.
If the investee enterprise is not an approved export-oriented or advanced technology enterprise at the time of refund application, it is refunded 40% first and the remaining 60% can be refunded if the enterprise is verified as an export-oriented or advanced technology enterprise within 3 years.
The local income tax paid is not refundable in the above cases.
@A foreign enterprise earned RMB 1.8 million from the original investment, and reinvested it in an advanced technology foreign enterprise. It consisted of RMBO.92 million from the profit in year 1996, RMBO.88 million from the profit in year 1997. Profit of original investment in year 1996 was taxed on 50% reduction at a 24% tax rate with local tax exempted. The profit in 1997 was taxed at 24% of tax rate and 3% local tax rate. Calculate the refund from the reinvestment.
Refund from reinvestment by using the profit in year 1996:
920,000 ¡Â (1 - 12%) x 12% x 100% = RMB 125,455
Refund from reinvestment by using the profit in year 1997:
880,000 ¡Â [1 - (24% + 3%)] x 24% x 100% = RMB 289,315
Total refund from reinvestment:
RMB 125,455 + RMB 289,315 = RMB 414,770
@A Equity Joint Venture started its business in July, 1994 with an operating period of 12 years. There was a RMB 750,000 loss in that year. In the second year the profit was RMB 1.2 million. At the end of year 1997, the foreign investor received the profits distribution of RMB 2.7 million and directly reinvested it into the business in the form of capital increment. At the end of the year 1999, the foreign investor received the profits distribution of RMB 3 million and reinvested it to form another advanced technology enterprise (the enterprise started its business at the beginning of year 2000, at the end of year 2001, the enterprise was no longer verified as an enterprise with advanced technology after investigated by the authority). Calculate the tax refund and the effect of the investigation.
Since the Equity Joint Ventureis a non-production foreign investment enterprise, it is
subject to a full rate of 33%. The tax refund of the reinvestment in year 1997 =
2,700,000 ¡Â [1 - (30% + 3%)] x 30% x 40% = RMB 483,582
The tax refund of the reinvestment in year 1999 on the advanced technology
3,000,000 ¡Â [1 - (30% + 3%)] x 30% x 100% = RMB 1,343,284
Since it was no longer deemed as an advanced technology enterprise, it had to repay the part of refunded tax in 1999 = 1,343,284 x 60% = RMB 805,970
6.3 Tax incentives for withholding tax
(a) Interest income is exempted from withholding tax for the loan to the government or the People's Bank of China by the International Monetary Fund, the World Bank, etc.
(b) Royalties obtained from the provision of high technology, environment protection technology, scientific research, energy conservation, development of transportation and communication, etc are taxed at 10%.
(c) Interest income, rent, royalties received by the FE without establishment from sources in SEZ are taxed at 10% income tax rate.
6.4 Treatment of loss
Same as domestic enterprises
6.5 Additional tax benefit for purchase of domestic made machinery
After satisfying certain conditions, a FIE can claim a refund of 40% of the purchase price of a domestic made machinery, subject to an annual limit which is equivalent to the incremental amount of income tax between the year of purchase and the immediate precedent year (PY). Any unused purchase credit can be carried forward for further refund in next 5 years (7 years in the tax exemption period) if there is an incremental amount of income tax compared with the PY. The purchase cannot be made in the form of capital contribution and paid in cash. For example, the income tax of a FIE:
In Year 2 , the enterprise purchased domestic made machinery at a cost of 8000
Step 1, to determine the amount and time limit for the purchase
Year 2 8000 x 40% = 3200 Valid in year 2 to year 6
Step 2, determine which years they can be offset,
Year 2 and 3 they cannot be offset because its income tax is less than that of

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
100 90 80 200 500 800

Current tax Year 1 Additional Offset Final tax payable______
Year 4 200 100 100 100 200-100100
Year 5 500 100 400 400 500-400100
Year 6 800 100 700 700 800-700100
their immediate previous year.
Please note that the remaining tax credit 3200-100-400-700=2000 cannot be carried forward anymore.
6.6 Foreign Tax credit
Same as domestic enterprise