China: China Clarifies Rule On Foreign Tax Credits

Last Updated: 13 January 2010
Article by Fuli Cao

According to China Corporate Income Tax Law ("CIT Law"), a China resident enterprise is subject to China Corporate Income Tax ("CIT") on its worldwide income. A nonresident enterprise is liable for CIT on its income derived from China. If a nonresident enterprise has an establishment or place of business in China, the enterprise is subject to CIT on its income from China and overseas that is effectively connected to the establishment or place of business in China. A resident enterprise may claim foreign tax credit for foreign income tax paid on its taxable income from sources outside China. A nonresident enterprise may claim foreign tax credit for foreign income tax paid on its taxable income from sources outside China that is effectively connected with the establishment or place of business of such nonresident enterprise within China.

On December 25, 2009, the Ministry of Finance and the State Administration of Taxation issued the Notice on the Issues Concerning Foreign Tax Credits, Cai Shui [2009] No. 125 (the "Notice"). The Notice provides guidelines for claiming foreign tax credits by China resident enterprises and the establishment of nonresident enterprises in China. The Notice is retroactively effective to January 1, 2008.

Credit by Country

According to the CIT Law and its implementation rules, the amount of foreign tax credit cannot exceed CIT otherwise payable on the income calculated in accordance with the CIT Law. Such credit limitation is calculated by country (region) and not by income category; the calculation formula is as follows.

Tax credit limitation = Total tax payable on income derived from both within and outside China as calculated in accordance with China tax law x taxable income from the particular foreign country (region) ÷ total taxable income derived from both within and outside China.

The Notice clarifies that foreign source income, creditable tax, and credit limitation with respect to each country or region must be separately computed. In computing taxable income, common expenses must be reasonably allocated between China-source income and foreign-source income (by country). The losses of a branch in a foreign country cannot offset income derived from China or income from other foreign countries; such losses can be used to offset income from the same country in the current year and subsequent five years.

Creditable Tax

Creditable tax must be in the nature of corporate income tax and the actual amount paid by an enterprise in accordance with the tax laws and regulations of foreign countries or regions. Creditable tax does not include:

  • Tax paid by an enterprise or collected by a foreign country or region by mistake.
  • Tax in excess of the limitation as provided by applicable tax treaties.
  • Interest, late payment charges, and penalties for underpayment or late payment of tax
  • Tax paid and subsequently refunded.
  • Foreign tax on income that is exempted from CIT under the CIT Law.
  • Tax that has been deducted in computing taxable income.

However, if an enterprise is granted a tax exemption or reduction by a foreign country and if the applicable tax treaty provides that the amount of tax exempted or reduced is deemed to have been paid, then the deem-paid tax is creditable and the enterprise may claim a tax sparing credit.

Indirect Credit

If a resident enterprise operates abroad through a subsidiary, the income earned by the subsidiary normally is not taxable in China until the profits of the subsidiary are distributed to the resident enterprise. Upon the dividend declaration, the resident enterprise may claim foreign tax credit for the income tax paid by the subsidiary and attributable to the dividends. In order to qualify for the indirect foreign tax credit, a resident enterprise must directly or indirectly own at least 20 percent of equity interest in a foreign enterprise.

The Notice clarifies that an enterprise may claim indirect foreign tax credit for income tax paid by three tiers of foreign subsidiaries. In computing the direct or indirect ownership of 20 percent:

  • For a first-tier foreign subsidiary, the resident enterprise must directly own 20 percent or more of the subsidiary.
  • For a second-tier foreign subsidiary, one first-tier subsidiary must directly own 20 percent or more of the second-tier subsidiary, and the resident enterprise must directly or indirectly own 20 percent or more of the second-tier subsidiary.
  • For a third-tier foreign subsidiary, one second-tier subsidiary must directly own 20 percent or more of the third-tier subsidiary, and the resident enterprise must directly or indirectly own 20 percent or more of the third-tier subsidiary.

Foreign tax paid and attributable to the dividend received by a resident enterprise should be computed from the lowest tier of creditable foreign subsidiary. The following formula is used to allocate a portion of foreign income taxes paid by a foreign subsidiary to the dividend distribution:

Tax allocated to dividend = (Tax paid by a foreign company + tax paid by its subsidiary allocated to dividend received) x dividend paid to parent company ÷ the after-tax profits of the foreign company.

The formula basically requires that a foreign income tax pool and an after-tax profit pool are computed and maintained for each foreign subsidiary. When the subsidiary distributes dividends, foreign income tax will be allocated to dividend distribution and deducted from the tax pool. As a foreign subsidiary may not distribute all earnings each year, it will be important for taxpayers to obtain and maintain evidence to prove the actual payment of foreign income taxes and detailed computation of allocation of such tax to dividend distribution.

Simplified Methods

A taxpayer may adopt a simplified method to claim 12.5 percent of taxable income derived from a foreign country as foreign tax credit upon the approval of the tax authority in charge. To adopt the simplified method, the following conditions must be met:

  • The taxpayer can produce evidence issued by the foreign tax authority for the payment of tax; however, the amount of tax paid cannot be accurately identified for objective reasons.
  • The effective tax rate at an income source country is no less than 12.5 percent. This means that the foreign tax credit will be the lesser of 12.5 percent and the amount shown on the tax payment evidence.

The Notice has identified some countries whose statutory tax rate is obviously higher than that of China. These countries include Argentina, Bangladesh, Burundi, Cameroon, Cuba, France, Japan, Jordan, Kuwait, Laos, Morocco, Pakistan, Syria, the United States, and Zambia. Where income derived from these countries and the effective tax rate is higher than China's statutory rate, 25 percent, the following formula can be used:

Foreign tax credit = Taxable income from foreign source x 25%.

Unclarity

China's foreign tax credit rule requires that the foreign tax credit limitation be computed on a per-country basis. It is not clear how to compute such per-country limitation where the dividends received from a first-tier foreign subsidiary include dividends derived from lower-tier subsidiaries in different countries.

For example, suppose a resident enterprise receives an RMB100 dividend from a first-tier foreign subsidiary A in Country X. A has a total RMB300 of after-tax profit comprising RMB100 from its operations in Country X and RMB200 dividends paid by second-tier subsidiaries B (in Country Y) and C (in Country Z).

It is not clear whether the RMB100 dividend will be treated as originating all from Country X or from all three countries and, if the latter, how to allocate the dividend to each country.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions