Tax Regimes in China
There are three regimes under the tax law in China: real regime, estimated regime and simplified regime. Nowadays, In China maintains only two systems of taxation, the real regime and estimate regime.
The real regime applies to all entities that are registered with the GDT.
The estimate regime applies to entities and individuals that are not registered with the GDT.
In practice, these can include small-scale commercial activities, such aacs shop owners and street vendors.
In this concept, we discuss with real regime of taxation. The estimated regime is an informal system of levying taxes that applies only to those small businesses that choose not to enter the formal economy.
- Tax in China
1.1. History of Tax Law
China is a transition economy and the taxation system is involving to meet the needs of a rapidly growing economy by expanding the tax base and improving tax compliance.
Part of China’s historical legacy is that the country lacks experience with voluntary tax compliance. As we noted above, under the estimated regime, tax collection only occurs when the tax official comes in person to demand payment. However, real regime tax payers must voluntarily submit their tax payments to the tax administration. Because self-reporting is still relatively new in China therefore, tax evasion remains a problem in China. For more information, please refer to section.
1.2. Social Purposes of Taxation
China is still heavily reliant on overseas id to fund the budget of the government and a key objective would be to be more self-reliant in future. Taxation in China serves a number of purposes as well as economic ones. The primary social purpose is to fund social programs like health, education and poverty reduction. Taxes are mainly used to finance the expenses incurred by government to manage an economy. These expenses include: health care, education, garbage collection and operating government business entities. Taxation is also used by government for several other purposes.
- To reduce pollution by taxing offending firms
To discourage unhealthy lifestyle e.g. a tax on cigarettes
c. To protect local and infant industries by taxing imports
d. To achieve greater equality of wealth and income. Revenue from taxation is used to help the very poor e.g. providing food stamps.
e. To improve the balance of payments (BOP) by increasing the duties charged on imported goods.
f. To control spending in an economy thus reduce inflation
1.3. Taxation in Practice
China tax regulations were drafted on a piecemeal basis and were dependent of foreign technical assistance. The net result of this is a harmonious tax regime which contains a number of undeveloped grey areas. Not only can different interpretations exist between taxpayer and the GDT but there may also be differing interpretations among the different departments of the GDT. Taxes are subject to review and investigation by a number of different departments of the GDT. These facts create unusually substantial tax risks in China.
1.4. Types of Taxes
- a) Tax on Profit
The law on taxation (LOT) provides for a 20% tax on profit (TOP) rate on resident taxpayers for profit realized by a legal person and is applicable to the legal person’s worldwide income. A non-resident taxpayer will be deemed to be a China resident for tax purposes if such taxpayer is found to have a permanent establishment in China.
- b) Prepayment of Profit Tax
Taxpayers are subject to a prepayment of profit tax (PPT) calculated at 1% of monthly turnover. This payment is made monthly and is offset against the TOP due at the annual tax liquidation.
- c) Minimum Tax
The minimum tax (MT) a separate tax to the TOP and similar to the PPT, is calculated at 1% of turn over. The MT is calculated by year-end and is only payable if it is greater than the TOP. It should be totally liquidated by the monthly PPT.
- d) Withholding Tax
Withholding tax (WHT) imposed in China comprises resident WHT and non-resident WHT.
Service provided by a resident person 15%§
Interest payment 15%§
Rental payment 10%§
Interest paid by a domestic bank or savings institution on fixed term accounts 6%§
Interest paid by a domestic bank or savings institution on non-fixed term account 4%§
Non-resident WHT at the rate of 14% is to be deducted from the following payments to non-resident.
- e) Value Added Tax
Value added tax (VAT) is applicable to the taxable supply of goods and services. An entity registered under the VAT provisions is required to charge VAT at the rate of 10% on all sales of taxable supplies in China and at the rate of 0% on the sale of taxable supplies exported from China.
- f) Tax on Salary
Employers are liable to deduct tax on salary (TOS) from payments of salaries, wages and other remuneration made to all employees. The tax rates for China and expatriate employees are the same, with the TOS marginal rate of 20% on the portion of income in excess of KHR 12,500,000 per month (approximately USD 3,125).
- g) Fringe Benefit Tax
Fringe benefit tax (FBT) is payable at the rate of 20% on the market value of fringe benefits provided to an employee.
Fringe benefit includes:
– Private use of motor vehicle
– Meals and accommodation
– Payment of rent or the provision of rent-fee housing
– Electricity, water, telephone
– Domestic servants
– Loans with concessional interest rates
– Non-employment related educational expenses, including children’s education
– Life or health insurance, where the same insurance is not available to each employee, irrespective of position.
– Payment for expenses for entertainment and leisure that are not directly related to employment.
- h) Specific Tax
Specific tax (ST) is an indirect tax imposed on the supply of certain goods or services at rates of 3% to 25%. Supplies subject to ST include air ticket sole in China, entertainment services, tobacco products, beverages, telecommunication services, lubricant and beer.
- i) Public Lighting Tax
Public lighting tax (PLT) is an indirect tax imposed on sales of alcohol and cigarettes at the stages of supply, on both imports and domestically-produced goods at a rate of 3%. All types of cigarettes and alcohol are subject to PLT including beer, grape wine and spirits, with the exception of palm wine.
- j) Accommodation Tax
Accommodation tax (AT) is an indirect tax imposed on the supply of accommodation services at a rate of 2%. AT must be charged by hotels, hotel apartments, motel, lodges, guesthouses, campgrounds and similar, but does not include not include the rental of houses or apartments.
- k) Property Tax
Property tax is a direct tax imposed on the value of immovable property, including land and buildings, on property valued above KHR 100,000,000 (approx. US 25,000) at a rate of 0.1%. Property taxpayer maybe individual or companies. Owners, possessors or “final beneficiaries” of immovable property may be liable for the Property Tax. Property Tax is due on an annual basis by 30 September each year.
- l) Registration Tax
Registration tax is a tax imposed on the transfer of ownership or possession of certain types of property. It is payable by the person who receives the ownership and it is applied to the transfer value at rates between 0.1% and 4%. A flat rate of KHR 1,000,000 applies to the registration of certain legal documents.
Tax penalties are imposed for violations of the LOT and its regulations. The level of penalty dependent upon the nature of the violation, ranging from 10% to 40% of the tax amount due, to together with interest that is charged at 2% per month. Generally, ordinary negligence is a subject to a penalty of 10% of the unpaid taxes, while serious negligence is subject to 25%. Obstructing the operations of the tax administration, fraud or other criminal acts, carry more substantial penalties.
The purpose of imposing the interest and penalty:
To improve taxpayer’s compliance·
To avoid under declaring taxes and delaying the tax payments·
To increase the tax revenue·
1.6. Direct and Indirect Taxation
Direct Tax: Direct taxes are paid by individuals directly from income earned or on the value assets owned to the income tax department.Ø
Types of Direct TaxesØ
– Income Tax: this is a tax on earned income individuals pay a percentage of their income.
– Corporate Tax: this is a tax on the profits of companies
– Capital Gains Tax: this is a tax on the proceeds resulting from the sale of assets, e.g. houses, land etc.
– Capital Transfer and Estate Duties: this is a tax on the transfer of property (gifts) and on legacies (death duties)
– Other Direct Taxes: these include: stamp duties, motor vehicle duties land taxes, etc.
Indirect taxes are paid to the income tax department through the suppliers of goods and services. These taxes are levied on consumption and therefore are paid by individuals when purchasing commodities. They include VAT, ST and AT.Ø
Types of Indirect TaxesØ
– Value Added Tax: this is the tax levied on goods as each stage of production. This tax generally is known as a General Consumption Tax.
– Purchase Tax: this tax is placed on specific goods at retail outlets. Theses include gasoline, tobacco, rum etc.
– Excise Duties: a tax placed on goods manufactured within a country. This tax is paid by the manufacturer of the product.
– Customs Duties: this is a tax on imports i.e. goods entering the country.
1.7. Avoidance and Evasion
Tax Avoidance: is to reduce the amount of tax that is payable by means that are within the tax law. Many taxpayers seek to limit their tax burden to the greatest extent possible by law. This is called tax avoidance. Tools for avoiding taxes
include applying for QIP status, using expense and income recognition techniques and using tax neutral or tax limited investments.
A person or company may lower taxes by changing one’s tax residence to a tax haven·
Lowering tax by deferring revenues or escalating expenses·
Personal tax may be avoided by donating property to a separate legal entity such as a company or foundation.·
Tax Evasion: is the general term for efforts by individuals, firms, and other entities to evade taxes by illegal means such as producing fake documents, dishonest tax reporting. When a taxpayer fails to pay the taxes that they owe, or misrepresents their tax liabilities in order to reduce their tax burden, this is called tax evasion. Tax evasion is a crime and may result in fines and criminal sanctions.
1.8 . Professional Ethics
Tax advisor, accountants are trained professionals acting on behalf of their clients or employer. As such, it is their responsibility to provide the best possible services. However, as discuss above, there is a thin line that separates effective tax avoidance and improper tax evasion.
There are five fundamental principles that should guide all tax advisor/accountants.
– Integrity: members shall be straightforward and honest in all professional and business relationship.
– Objectivity: members shall not allow bias, conflicts of interest or the undue influence of others to compromise their professional or business judgment.
– Professional competence and due care: members have a continuing duty to maintain professional knowledge and skill at a level required to ensure that clients or employers receive competent professional service.
– Confidentiality: members shall respect the confidentiality of information acquired as a result of professional and business relationship and shall not disclose any such information to third parties without proper and specific authority or unless there is a legal or professional right or duty to disclose.
– Professional behavior: members shall comply with relevant laws and regulations and shall avoid any action that may discredit the profession and states that members shall behave with courtesy and consideration towards all with whom they come into contact in a professional capacity.
1.9. Taxpayer Obligation
As a tax professional or accountant, we will be responsible for actually paying the taxes of your clients/employer. This means we must understand the obligations of a taxpayer which includes the process by which taxes are paid, the relevant deadlines and the penalties that you and/or your client/employer may be subject to.
1.10. Principles of Tax payment
The real regime of taxation is based on the general principle that the taxpayer is responsible for identifying, calculating and remitting their tax obligations to the tax administration and the tax administration has the authority to verify that information.
Taxpayer is required to maintain books of accountants, supporting documents and other financial documents. Importantly for tax professionals, taxpayers can transfer their rights in written form to a person registered as a tax service agent.
1.11. Taxpayers’ Rights
Article 91 of the Law on Taxation (LOT) lays out taxpayers’ rights as listed below:
For the information they provide to the tax administration to be kept confidential·
To appeal as stated in this law (LOT) every decision made by the tax administration·
To pay no more tax than what is required·
To regularly receive information concerning the taxation system·
To receive information about the taxpayer’s rights, including the right to appeal·
1.12. Taxpayers’ Obligations
Article 91 of the Low on Taxation (LOT) lays out taxpayers’ rights as listed below
To register with the tax administration as stated in Article 101 of the LOT·
To submit their tax declaration and provide information as required by the tax provisions stated in Article 98 and 104 of the LOT·
To pay taxes according to the schedule as stated in the tax provisions·
To maintain books of account and supporting documents·
To pay various taxes, additional taxes and interest as determined by the tax administration·
If notified by the tax administration, to present themselves to the tax administration according to the date as stated in the letter of notification.·
- Value at Tax (VAT)
2.1. The VAT System
Function and purpose
VAT is only payable by VAT-registered taxpayers. Registered taxpayers collect and remit to the tax administration the VAT that they have charged on taxable supplies.
Note however that because the end consumer is liable for the VAT payment, the registered taxpayer is likely to be able to offset their VAT liabilities so that VAT paid to suppliers will offset VAT payments to the tax administration.
Overview and terminology
VAT applies only to goods and services, is charged by VAT-registered taxpayers, and is due on certain taxable supplies.
Taxable supplies: the supply of goods services or imports for taxable sale or for use in producing taxable supplies. Taxpayers must charge and collect VAT on taxable supplies.
o Supply of goods: The transfer of the rights to move-able property, meaning all property except land or money.
o Supply of services: Any supply that is not a supply of goods, land or money.
o Imports: Goods or services that enter into China and are properly processed by the customs administration.
VAT-registered taxpayer: Real regime taxpayers who have applied to the tax administration for VAT registration.
Taxable turnover: Turnover of the taxable supply of goods or services.
VAT Credits: Because VAT is designed to be a tax on the consumer, must producers can credit the VAT, they pay on purchases (inputs) against the VAT owed to the government based on what they have supplied (outputs).
2.2. VAT Registration
They are two kinds of VAT registration in China, compulsory and voluntary.
Compulsory VAT registration applies to any person subject to the real regime system of taxation who makes a taxable supply.
The following entities must always register as VAT taxpayers:
– All types of companies
– All import/export entities
– Investment enterprise (QIP)
Other taxpayers are required to register as VAT taxpayers if they meet any one of the following criterion:
– Any entity that has VAT taxable Turnover for a period of three consecutive month of over KHR 125 million for the supply of goods or over KHR 60 million for the supply of services.
– Any entity that the beginning of any three consecutive calendar month period has a basis to believe that for this period it will have VAT taxable turnover of over KHR 125 million for the supply of goods or over KHR 60 million for the supply of services.
– Any entity that at the beginning of any three consecutive calendar month period has a basis to believe that in such period it will have VAT taxable turnover of more than KHR 30 million derived from a government contract.
– Any entity that has an annual turnover of KHT 500 million from the supply of goods. KHR250 million from the supply of services, or KHR125 million from a government contract.
Obligations of a VAT-registered taxpayer
A VAT-registered taxpayer is required to do the following:
I. Display their VAT certificate of registration
II. Charge VAT to all customers from the date of registration
III. Issue valid VAT invoices to all VAT-registered customers
IV. Issue commercial invoices or properly record daily sales to all non-registered customers.
Taxpayers who are not compelled to register as VAT taxpayers may still do so. While it might seem unlikely that a taxpayer would want to pay additional taxes, there are reasons that estimated regime taxpayers would want to register. Remember that input VAT can be offset by output VAT. If an individual is required to pay VAT on inputs, they will only be able to claim these expenses if they are registered as VAT taxpayers.
2.3. Taxable Supplies
The supply of goods or services by a taxable person in China is considered to be the provision of taxable supplies, which are subject to VAT unless exempted.
Definition of taxable supplies
Any provision of taxable supplies may be subject to VAT. Remember that VAT-registered taxpayers must charge VAT on any taxable supply, except those exempted. The Law on Taxation (LOT) and Sub-Decree 114 define what is included in taxable supplies. Specially, the following supplies made within China are subject to VAT unless exempted, as discussed in section 3.3 below:
– Sales to staff or sales from vending machines
– Sales of business assets
– Hire or loan of goods to someone else
– Gifts to friends or business representatives
– Own use – goods which you or your family have taken from the business for your own use
– Commission received in return for selling something on behalf of someone else.
Tax rates for taxable supplies
The standard rate of VAT is 10% and 0%.
VAT is imposed at the rate of 10% on taxable supplies in China and 0% on taxable supplies export out of China or under specific exemptions for supply in China.
Zero-rated supplies are otherwise taxable supplies to which a tax rate of 0% is applied. Therefore, since technically supplies are still subject to VAT, the VAT-registered must submit a valid VAT return for such zero-rated supplies, although no tax will actually be paid.
The following is a general list of zero-rated taxable supplies in China:
- The supply of goods outside of China (exported goods), supported by valid documentation, approved by the tax administration
The supply of services outside of China (exported services), supported by valid documentation, approved by the tax administration.
III. The supply of international transportation services for passengers or goods
IV. Services in support of the supply of international transportation services for passengers or goods
Zero-rating the exported goods makes the China goods more cost effective to foreign buyers, who otherwise would need to bear the cost of China VAT as they would be unable to offset it.
International transportation is defined as any of the following:
- Transportation originating in China, but terminating outside of China
Transportation originating outside of China, but terminating within China
iii. Transportation originating and terminating outside of China, but passing through China territory
The different between a zero-rated supply and a non-taxable supply is that the taxpayer must still submit a VAT return for zero-rated supplies and as a result, can claim any resulting input VAT credits.
Zero-rate for supporting industry or contractor supplying export-oriented garment, textile and footwear industry
In order to promote certain industries, the government has provided a zero-rating VAT for supporting industries that directly supply goods or services to export-oriented companies in the garment, textile and footwear industries.
This zero rating applies only to supporting industry companies that supply to companies that are registered as QIPs with the Council for the Development of China (CDC).
If the supporting industry company is registered as a QIP, it must supply 100% of its local supply of products or services in support of exports in the garment, textile, and footwear industries. A QIP that directly supplies the export-oriented garment, textile industry, and footwear industry is referred to as supporting industry.
Supporting industry companies receive the following VAT benefits:
– Input VAT: the VAT levied on import of production input and equipment for use in manufacturing that will directly supply the export-oriented garment industry, textile, and footwear industry shall be considered as the burden of the state. The taxpayer is therefore not required to pay the VAT be considered as the burden of the state.
– Output VAT: zero-rating on supply of goods or service to serve the export-oriented purpose of garment industry, textile industry and shoe manufacturing industry.
VAT on the supply and export of rice
In order to promote rice production and the rice industry generally, domestic rice paddy, and agricultural inputs for rice growing and producing husked rice are all subject to zero-rated VAT. Rice exports are also subject to zero-rated VAT, which is consistent with the general zero-rating for all exported goods.
Domestic sales of domestic rice are subject to a standard VAT rate of 10%.
2.4. Non-Taxable Supplies
Certain supplies are specifically exempted from VAT obligations. These supplies are called non-taxable supplies.
In order to promote the provision of certain key public services, specific taxable supplies have been exempted from VAT. The following is a list of non-taxable supplies under the LOT:
- Public postal services
Hospital, clinic, medical and dental services, and sales of medical and dental goods incidental to the performance of such services
iii. Transpiration of passengers by a wholly state-owned public transportation system
iv. Insurance services
v. Primary financial services
vi. Imported articles for personal use that are exempt from customs duty
vii. Non-profit activities in the public interest that have been recognized by the Ministry of Economy and Finance
Those providing not-taxable supplies are not entitled to reclaim VAT input tax credits.
2.5. Calculating and Filing The VAT Return
VAT is to be paid on the 20th of each month for the VAT liabilities accrued during the previous month. The time at which VAT becomes due is not the same thing as the time that the VAT payment must be remitted to the tax administration.
Calculating input VAT and output VAT
In order to understand the VAT credit system, the first step is to have a clear grasp on input VAT and output VAT.
Input VAT refer to the VAT payments made on any good or service purchased by the taxpayer and output means the VAT due on any invoice issued by the taxpayer.
The equation used is output VAT – input VAT = VAT liability or VAT credit
- Withholding Tax
3.1. Scope of Withholding Tax
Purpose of Withholding Tax
In a developing country such as China, the reality is that a number of small businesses are not registered for tax as real regime taxpayers. Consequently, part of the onus of making sure those unregistered businesses transactions with those businesses.
In a typical WHT transaction the payee would be the unregistered business that is providing some kind of service or rental, for example, and the payer would be the party who pays for the aforementioned service or rental. For the WHT regime to apply, the payer would need to be a real regime taxpayer.
While the tax is collected on the income of the third party, the responsibility for calculating and submitting withholding taxes is placed on the party that makes the payment, the Withholding Agent.
WHT is payable when a payment is made.
A payment is defined as the actual exchange of assets or any payment that has been recorded as an expense for accounting purposes. (When an expense is “recorded” it is written down in the official accounting book of the company).
Therefore, WHT becomes payable when the first of the following events occurs:
The payment is actually made, or
The payment is recorded as an expense
Withholding Tax (WHT)
WHT is a monthly tax that is withheld before making payment in cash of kind.·
WHT is calculated on the amount to be paid to the person before withholding the tax.·
WHT is payable at the earlier of either, the date the payment is made, or the date the expense is recorded in the books of the company·
3.2. Withholding Tax Liabilities
WHT is only payable by resident taxpayers, acting as Withholding Agents. Withholding Agent bear responsibility for identifying, calculating and submitting WHT liabilities.
WHT is the legal responsibility of the Withholding Agent. For the purposes of applying WHT, the Withholding Agent is defined as follows:
a person (physical or legal) whom the tax provisions require to withhold and to pay the tax to the state budget on behalf of a third person.·
It is more useful to consider the characteristics that define a Withholding Agent:
Is a resident taxpayer, being a physical or legal person “obligated to pay tax”·
Is subject to the real regime system of taxation·
Makes a payment – as discussed above·
For certain purposes as defined by law- will discuss later·
To a resident or non-resident taxpayer·
3.3. Payment Subject to Withholding Tax
WHT applies to certain payments made to resident and non-resident taxpayers.
The types of payments subject to WHT and the rate varies depending on whether the payment is made to a resident or a non-resident taxpayer.
Note: Payments for goods are not subject to WHT.
Payment to a resident taxpayer
There are six kinds of payments to a resident taxpayer that are subject to WHT.
Payments made to a resident taxpayer for the following are subject to WHT.
Taxable Payment Rate
i. Payments made to a physical person for the performance of services 15%
ii. Royalties on intangible properties and on the refinement of mineral 15%
iii. Interest paid by non-bank resident taxpayers t oa physical person or
Entity, unless the third party is a domestic bank or savings institution 15%
iv. Payments made for the rental of movable or immovable property 10%
v. Interest paid by a domestic bank or savings institution to a resident tax 6%
Payer holding a fixed term account
vi. Interest paid by a domestic bank or saving institution to a resident tax 4%
Payer holding a non-fixed term savings account
Payment to a non-resident taxpayer
The WHT rate for all payments to non-resident is 14%, no matter the type of payment.
There are four types of payments subject to WHT, but they are defined inclusively.
i. Interest: Any interest payment made for any purpose to a non-resident that all payments including those from banks or saving institution, shareholder loan no exemptions
ii. Royalties and rental and lease payments:
iii. Payments for management and other technical services: unlike payments to real regime resident taxpayers, payments for management and technical services performed by non-resident
iv. Dividends: The payments of dividends to a non-resident. Note that dividends paid to residents are not subject to WHT.
3.4. Withholding Tax Exemptions
The law provides for specific exemptions to WHT.
i. Interest paid to a domestic bank or savings institution is not subject to WHT. Interest payments made to foreign banks and savings institutions are subject to WHT.
ii. Payment made to the government or any government institution are exempt from WHT under the following conditions:
– The payment is related to movable or immovable properties that have been recorded as state properties in the register maintained by the Ministry of Economy and Finance, and
– The payment is certified by the Ministry of Economy and Finance as state budget revenue
iii. Payments that constitute employment income for the third party and are therefore subject to TOS or FBT are exempt from WHT. Therefore, employers do not have to withhold WHT on salary payments. This makes sense if we consider the purpose of the WHT. The employer is already withholding taxes on the employee’s income, in the form of the TOS. Therefore, it would not make sense to also withhold WHT.
iv. Under the current draft Financial Lease Prakas, periodic rental payments made under a financial lease arrangement would exempt from WHT. This is a reflection of the fact that financial leases are used for the purchase of goods. Therefore, it is logical that WHT would not apply, even though the lease contains interest that would otherwise be subject to WHT.
Specific exemptions for real regime taxpayers
Income payments for the performance of services when the recipient has been registered under the real regime system of taxation are exempt. The income of real regime taxpayers will be taxed and paid directly to the GDT, and so no withholding is required to be made by a Withholding Agent.
It should be noted that this exemption only applies if a valid VAT invoice has been issued along with the payment.
Payments of interest (except to a domestic bank), royalties and rentals made from on real regime taxpayer to another real regime taxpayer are subject to WHT.
3.5. Calculating Withholding Tax
WHT is calculated using the value of the actual payment made and is deductible from the taxable profit of the Withholding Agent. The appropriate rate is applied to the value of the payment prior to the deduction of the WHT. WHT is an above-the-line tax, and as such, it is applied prior to the deduction of other taxes from that payment.
However, WHT only applies to the value of the actual payment made. Therefore, WHT is not applied to the value of any VAT paid in addition to the payment. If figures are presented as “inclusive of VAT”, the VAT amount must be taken out in order to arrive at the WHT base amount on which WHT is calculated. This can be done by dividing the total amount inclusive of VAT by 1 plus the VAT percentage, example:
Total amount, inclusive of VAT: US$110
WHT base: US$110/1.10 = US$100
When recording an expense in the accounts of the Withholding Agent, one should use the double entry which reflects payment consisting both of expense to the Withholding Agent, and remittance of the WHT tax on the service provider third party.
4. Tax on Salary and Fringe Benefit Tax
4.1. Scope of Tax on Salary
Purpose and function
Tax on Salary (TOS) is a tax on an individual’s income received in return for the performance of employment activities, however, the tax system in China – like in many other countries – places the duty to calculate, declare and pay this tax on the employer and not the employee. Payments that are defined as salary are taxed by TOS and for remuneration provided to employee outside the scope of salary, a tax on fringe benefits is levied.
Definition of Salary
Salary as defined by the LOT includes “remunerations, wages, bonuses, and overtimes, compensations and fringe benefits which are paid to an employee, or which are paid for the direct or indirect advantage of the employee for the fulfillment of employment activities.
The employer- employee relationship
Employer means any government institution, any resident legal person, any resident pass-through, any permanent establishment in China, any non-profit organization, or any resident physical person carrying on a business.
Employee means any physical person receiving salary from their employment activity including any responsible officer or director of an entity, any governmental officer, any elected official except for members of parliament and senate.
Whit regard to the employer-employee relationship, if an individual works as a subordinate and the for work at a designed place and perform the tasks that are part of a general employment agreement, whether written or not.
i. They are not at risk for non-payment of employment services rendered as long as they appear for work at a designated place and perform the tasks that are part of a general employment
ii. They are not able to fix the time and place for rendering employment services.
iii. They are not required to have a significant investment in the equipment necessary to render employment services.
iv. They do not supply services to several recipients simultaneously
How is an individual determined to be a resident?
For employees taxed in China, there are two regimes of ToS that are applied depending on the residency status of the individual; residents are taxed on progressive rates up to a maximum marginal rate of 20%, compared to a flat rate of 20% for non-residents. Further, a resident will be tax on their China sourced salary income.
An individual is considered a resident for tax purposes if they fulfill any one of the following criteria:
i. Their residence is in China
ii. Their principal place of abode is in China
iii. They are present in China for more than 182 days in any period of 12 months ending in the current tax year
Tax treatment of a resident individual versus a non-resident individual
Residents are subject to TOS on their salary income received from both China and foreign sources. TOS rates are incremental, ending with a top marginal rate of 20% of the taxable base.
Individuals that are not residents are taxes as non-residents. Non-residents are subject to ToS only on the salary income they receive from China sources, taxed at a flat rate of 20%.
Salary is deemed to be from a China source if the employment activity takes place in China. The location where the employee performs the activity is what determines this, and not the location of the employer or where the salary payment is made.
For non-residents, there is a TOS exemption available if all of the following conditions are satisfied:
i. The employee is not present in China for more than 182 days in the current tax year, and
ii. The remuneration is paid by a non-resident employer, and
iii. The employer does not have a permanent establishment (PE) in China. How a PE is determined.
4.2.Income Subject to Tax on Salary and Fringe Benefit Tax
When calculating TOS, the monthly taxable salary bas includes all payments in cash or in kind except those payments classified as fringe benefits as per the TOS Prakas:
For a resident employee, monthly taxable salary includes:
i. China-sourced salary, regardless of where it is paid
ii. Foreign-sourced salary, regardless of where it is paid
iii. Loans or cash advances made by the employer. The amount of the loan must be included in the employee’s taxable salary base in the month it is paid to the employee. Repayments of principle are deducted from the employee’s taxable salary base in the month the employee makes the repayment. Note that any payment of interest to the employer is not deducted from the employee’s taxable salary base.
The basis of assessment for salary income
Salary income is assessed on a monthly basis, with a TOS return filed by the employer each month, which must declare both the TOS and FBT payable for all employees.
For resident taxpayers, TOS is applied at progressive rates from 0% to 20%, which are applied by tranche of monthly taxable salary.
TOS rates for residents
Taxable salary (per month) Rate
From 0 800,000 0%
From 500,001 1250,000 5%
From 1,250,001 8,500,000 10%
From 8,500,001 12,500,000 15%
From 12,500,001 20%
+ Translated at KHR 4000 = US$1
Deduction from taxable salary for dependent family members
Deductions for dependent family members reduce the monthly taxable base on which TOS is calculated.
An allowance of KHR 75,000 per month may be deducted for dependent family members as follows:
i. Each minor dependent child
ii. An employee’s spouse whose only occupation is as a homemaker ( they do not outside home)
In order to claim a deduction for a child, the child must be under 14, or under 25 and a full-time student at an accredited institution. Each child may be used as a deduction once only. So if both parents work only one of them may claim the deduction for the child.
Fringe Benefit provided to employees
Some employers provide compensation to their employees in lieu or in addition to their normal salary as part of a salary and benefits package. These added benefits are often non-cash items, otherwise known as in-kind benefits, such as the use of a company car. The benefit may be provided to the employee, or to family members of the employee.
The scope of fringe benefits under the tax law is wide and encompasses “any goods, services, or other benefits in cash or in kind, provided directly or indirectly by an employer to a physical person for employment activities that the physical person has fulfilled for the benefit of the employer”.
Type of benefit
– A vehicle of any kind
– Food and drink
– Household personnel
– Loan provided with interest at less than the market rate
– Discounted goods
– Educational assistance to employee, non-employment related
– Children’s educational assistance
– Life and health insurance premiums, unless the same benefits are provided to all employees regardless of position
– Portion of expense allowance that is considered excessive
– Contributions to the social security fund in excess of the level provided in the law
– Contributions to a pension plan in excess of 10% of monthly salary
– Expense for activities that are not related to employment
Calculating Fringe Benefit Tax
FBT is a flat rate of 20% applied to the sum of the fair value of all fringe benefits received by the employee, either directly or indirectly, via the employee’s family member, inclusive of applicable taxes.
Payments from an employer to an employee exempt from tax
As previously mentioned, the scope of salary usually encompasses all amounts paid by an employer to an employee. However, there are some exceptions to this.
Certain payments an employee receives from their employer that are not in return for the performance of work duties are exempt from tax. They are as follows:
– Refunds for business expenses incurred by the employee when on a work assignment
– Indemnity payment made when an employee is dismissed, within the limit provided in the labor law. This will depend on the duration on the duration of employment, but varies from on weeks up to three month’s salary.
– Addition remuneration with social characteristics, NSSF contribution
– Special uniforms or professional equipment provided either free-of –charge or below normal costs. As these are required by staff in order to perform their duties, these are excluded from taxable salary.
– Flat allowance for travel expenses. This allowance should not overlap with the refund business expenses so as to avoid double payment
Fringe Benefit Tax Become Payable
FBT must be paid in the month when the benefit was provided to the employee and becomes a cost to the employer, that is, when the employer pays for the benefit either on behalf of or directly to the employee or the employee’s family.
4.3.Computing Tax on Salary and Fringe Benefit Tax
Computing tax on salary
Tax on salary calculation for a resident employee
TOS rates for residentsØ
Taxable salary (per month) Rate
From 0 800,000 0%
From 500,001 1250,000 5%
From 1,250,001 8,500,000 10%
From 8,500,001 12,500,000 15%
From 12,500,001 20%
+ Translated at KHR 4000 = US$1
Tax on salary calculation for a non-resident employee
When calculating TOS for a non-resident, the calculation is much more straightforward and 20% is applied to the monthly taxable salary amount in full – there are no tranches taxed at different rates.
Computing fringe benefit tax
As described above, the fair value of the fringe benefits received is subject to a single rate of 20%, regardless of the level of the benefit or the residency status of the employee.
Foreign tax credits
A resident taxpayer who has received salary from a foreign source and who has paid foreign taxes according to the laws of that country may receive a tax credit in China, given certain conditions relating to the supporting documentation which must all be provided to the GDT as follows:
i. An employment contract or statement of employment detailing the work performed, the dates and the amounts for any payments of salary for work in a foreign country must be provided.
ii. A copy of the form that the employer has submitted to the tax administration of the foreign country for the payment of taxes must be provded.
iii. A receipt of payment of foreign taxes issued by the tax administration of the foreign country must be provided
Computing of the foreign tax credit
The foreign credit claimed is limited to the lesser of:
i. The tax amount actually paid in that foreign country, or
ii. The amount obtained by multiplying the tax on the total of salaries from all sources for the same period, calculated according to the table of normal progressive rates by tranche applied to the salary of China residents, with the ratio of salary received in that foreign country to the total of salaries from all sources.
- TAX ON PROFIT
Tax on Profit (TOP) is an annual tax which is required to be paid by real regime taxpayers on their annual taxable profit. In additional to TOP, the tax regime in China also has what is known as a Minimum Tax (MT). The MT is calculated on the annual
turnover of a real regime taxpayer. Consequently, at the end of the tax year, a real regime taxpayer will be liable to pay either TOP or MT, whichever is higher.
In this chapter we will look at how these taxes are applied and the basic of assessment, what income is not subject to TOP and the special treatment of certain types of income. When calculating TOP, the tax base is generally not the same as the accounting profit, as certain rules under the real regime tax system differ from those under accounting standards, so we will learn what adjustments need to be made in order to reach the adjusted net profit or loss. We’ll also consider how TOP differs for a company that is a Qualified Investment Project (QIP).
5.2. Purpose and Function
TOP is a tax on the profits of real regime taxpayers doing business in China. This money is collected by the government to assist in funding the state budgets.
Although TOP is calculated on an annual basic, prepayment are made during the year base on monthly turnover. This system provides a more regular cash-flow to the tax administration as well as helping to mitigate the late payment of taxes at year-end.
5.3. Scope of Tax on Profit
TOP applies to both resident and non-resident legal person, but resident are taxed on their worldwide income, whereas non-resident with a permanent establishment (PE) in China are only taxed on their income from China source.
China Source IncomeØ
For income to be determined as China-sourced, it should be derived from China-based activities or assets located in China. Examples of China-sourced income are listed in the LOT as below:
– Interest paid by a resident entity (or resident pass-through or governmental institution).
– Dividend distributed by a resident entity.
– Income from service performed in China.
– Compensation for management and technical service paid by a resident person.
– Income from movable and immovable property, for property located in China.
– Royalties paid by resident, or paid by a non-resident through s PE in China.
– Gain from the sale, or transfer or any interest in immovable property located in China from the transfer of any interest in immovable property situated in China.
– Premiums from the insurance or reinsurance of risks in China.
– Gain from the sale of movable property which is part of the business property of a PE in China.
– Income from business activities carried on through a PE in China.
Foreign Source IncomeØ
Income that is not China Source income will be treated as foreign source income.
5.4. Profit Tax Rate
The standard corporate tax rate is twenty percent (20%). Profit obtained from oil or natural gas production sharing contracts or exploitation of natural resource are subject to thirty percent (30%) profit tax rate. Certain investment project may enjoy profit tax exemption upon registration with the CDC or PMIS.
Taxable profit is defined under China law as the net profit obtained from all result of all type of operations realized by the taxpayer, including capital gains from the sale of assets during the operation or at the close of the business, as well as income form financial or investment operations and interest, and rental and royalty income.
The Financial Act, 2007 extended the scope of the profit tax to include gains on immovable, financial, and investment property that are realized outside the scope of business of business transactions. The taxation of gains outside of business transaction, such as immovable gains realized by individuals, awaits implementation by prakas.
The following table shows the applicable corporate profit tax rates:
Tax Rates for Legal personØ
Tax Rate for Physical PersonØ
* Exchange rate: 4,000 Riel/ 1 USD.
5.5. Permitted Deductions
To be deductible the expense must meet 3 conditions:
a) The facts: proven by verifiable evidence (invoice…).
b) Result of economic performance (EP) related to that expense incurred, eg.
o Payment for the supply of property or service, EP occurs as the property or service is supplied.
o Expense arises through the used or property or service, EP occurs as the property/ the EP occurs when the property has been used.
EP occurs when one of the following payments occurs:
o For workers compensation, tort, or breach of contract claims’
o Rebates or refunds, prizes and rewards
o Under warranty or service agreements
o For taxes other than creditable foreign taxes, minimum tax, and the TOP.
c) Expense must be precisely determined:
o Must be recorded in the period.
o Must have proper proofs indicating clearly its amount (invoice….).
Deductible but subject to limitation and conditionØ
Interest expense: to a maximum equal to the sum of interest income plus 50% of net non-interest profit. The remaining can be carried forward as an interest expense to succeeding years until completely used.·
Charitable contribution: Cannot exceeds 5% of the taxable profit before taking charitable contribution deduction. The Remaining balance cannot be carried forward.·
5.6. Non- Deductible Expense
All non-deductible expense shall be added back for the calculation of taxable profit, they are including:
Any expense on activities of amusement, recreation, or entertainment·
Expense from previous period.·
Expense of subsequent period.·
Expense not related to business.·
Extravagant expense which is of no use for business.·
Personal or living expense (except fringe benefits subject of fringe benefit tax).·
Penalty, Additional Tax, and late payment interest imposed for violation of the LOT;·
Donation, grants, or subsidies;·
Payment of profit tax, minimum (profit) tax, profit tax pre-payment, withholding tax, and salary tax;·
Additional tax, interest for late payment, custom penalty.·
Accrual salary/Bonus not paid within 60 days.·
Accrual expense to related person not paid within 180 days.·
Losses on the sale or exchange of property directly or indirectly between related persons.·
Add: Taxable Income but not recorded in the Accounting Book
Supplies of goods and service free of charge.·
Granting Fixed Assets for use free of charge.·
Improvement of fixed assets made by lessee without charge to lessor.·
Donations, grants and subsidies not recorded in the accounting book.·
Gain on disposal of fixed assets as per LOT.·
Other income not record in the accounting book.·
Less: Income Recorded but not Taxable during the Period.
Dividend income received from resident tax payers.·
Gain on disposal of fixed asset (as per accounting book).·
Other income recorded, but not taxable during this period.·
5.8. Loss Carry – Forward
Losses can be carry forward for a maximum of five years, although cannot be carried back. Losses must be deducted from the first following year in which an enterprise make a profit. If the profit is not sufficient to deduct the loss, the remainder of the loss after deduction can be carried forward to deduct from the profit in the following year up to five year. If an enterprise incurs a loss in more than one year, the enterprise must deduct each loss in the order they arose.
Tax losses may be forfeited upon a change in ownership of the business, or if there is a change in business activity. Tax losses will also be forfeited in the event that a taxpayer is subject to a unilateral tax reassessment.
Depreciation must be calculated using the appropriate method, either straight line or declining balance as prescribed by the law and presented in the table below.
Asset in classes 2 to 4 are accounted for on a pooled basic, and therefore profits and losses on disposals are not directly recognized for tax purpose. Additions are depreciated for a full year in the year of acquisition.
The straight-line depreciation method applied to intangible property. The depreciation rate of intangible property with limited life must be calculated based on the life of that property. If the life of the intangible property cannot be determined, it must be depreciated based on a depreciation rate of 10% on the straight-line method.
All exploration and development costs of a natural resource, including interest payments, shall be capitalized and written-off the in accordance with the depletion of the resource recorded as a percentage of the estimated total production from the resource.
A special depreciation of 40% of the value of the new and used tangible property used in the production or processing is also available for qualified investors electing not to utilize the profit tax holiday. This special depreciation can be deducted in the first year of the purchase or in the tangible property.
Tax Depreciation RulesØ
For the of purpose of TOP, to be deductible, the depreciation must meet 5 conditions as follows
– It must be made only on FA (Fixed Asset) in the BS.
– It must be made only on FA subject to depreciation.
– It must be made on the basic and within the scope of the cost price.
– It must be calculated with the straight-line method of depreciation for class 1 or the declining balance method for class 2,3,4
– It must be made actually by the enterprise.
5.10. Pre-Payment of Profit Tax (PPT)
Taxpayer, except those subject to the zero percent (0%) profit tax rate, are subject to a PPT calculated at one percent of monthly turnover, inclusive of all taxes except VAT. This payment is due by the fifteenth day (15th) of the following month and is offset against the tax on profit due at the annual tax liquidation.
– The tax year in China is the same as the calendar year i.e. 1-January to 31 December.
– The annual Tax on Profit return is due three months after the end of the tax year – i.e. by 31 March the following year.
– Most taxpayer will be liable to either 20% tax on profit on taxable income or 1% Minimum tax, which is calculated on annual turnover, whichever is higher.
– The 1% Minimum tax is collected during the year in monthly installation = PPT.
Although TOP is calculated on an annual basic, prepayment are made during the year based on monthly turn over. This system provided a more regular cash-flow to the tax administration as well as helping to mitigate the late payment of tax year-end.
– PPT is not an actual tax.
– All enterprise registered as real regime tax payers are subject to PPT.
– PPT is calculated at 1% of monthly turnover inclusive of all taxes, except VAT.
– Turnover should be included when it is accrued.
– PPT paid can be deducted from the Tax on Profit /Minimum Tax at the annual tax liquidation.
– The PPT return and payment are due to be filed and paid to the General Department of Taxation (GDT) by the 15th day of the following month.
o A Qualified Investment Project (QIP) is not subject to 1% PPT during its Tax on Profit exemption period.
o However, other income (e.g. interest income, rental income, proceeds from the sale of fixed asset, etc.) that is not earned under QIP activities shall be subject to 1% PPT.
o Prakas No.988 issued by the Ministry of Economy and Finance, the suspension of monthly Prepayment of Tax on Profit (PPT) at the rate of 1% of the monthly turnover has been extend until the end of 2015 for garment and footwear factories.
- Minimum Tax
The minimum tax is separate tax to the Tax on Profit and, similarly to the PPT, is calculated at one percent of turnover. However, the minimum tax is only payable if it is greater than the tax on Profit. In other words, an enterprise will either pay twenty percent (20%) tax on profit on its net profit, or one percent (1%) on its turnover.
The minimum tax is calculated at year-end; however, it should be total liquidated by the monthly PPT.
6.1. Additional Profit Tax on Dividend Distributions
APTDD was introduced in 2003 to replace the advance tax on dividend distribution. By virtue of this new tax, the distribution of profits after tax is subject to the following tax rate:
Twenty percent (20%) of the distributed amount for enterprises subject to zero percent (0%) tax on profit.·
12.09 % of the distributed amount for enterprise subject to nine percent (9%) profit tax rate; and·
Zero percent (0%) for enterprise subject to twenty or thirty percent profit tax rate.·
The APTDD will not apply to the subsequent dividend payments made by a corporate shareholder to its shareholders. The APTDD must be filed and paid to the General Department of Taxation not later than the fifteenth of the month following the payment of dividends.