Business Tax on Banking Activities

This important rule for banking activity has been completed by the Relevant Issues Concerning the Levying and Collection of Business Tax on the Finance Industry Circular, August 11 1995 Cai Shui Zi No.79. The first article provides that financial institutions are temporarily exempt from business tax on their inter-institutional transactions. This exemption is confirmed by the Notice regarding the inter-bank loans in Renminbi.

Restrictions

The first restriction is about loan currency. According to the Circular Cai shui zi [1995] No.79, the Margin Taxation Regime only applies to 'foreign exchange loan transfer business'. This is defined as business operations that involve borrowing from overseas and re-lending the funds to domestic enterprises.

Alternatively, the Circular No.79 provides that the taxable turnover of 'ordinary loans' business shall be the total interest income. The meaning of the words 'ordinary loans' has already been given by Cai Shui Zi No.52 5 May 19971. Interest derived from loans in Renminbi is fully taxable, even in the case of re-lending. This is confirmed by the notice.

This taxation further restricts FIFIs who have been authorized since 1996 to operate in Renminbi in Shanghai and Shenzhen. They are required to have a special licence and their clients are largely limited to foreign-funded enterprises based in the city. In addition, restrictive rules apply to the ratio of Renminbi liabilities/foreign exchange liabilities.

Lastly, concerning financing lease business, the Notice confirms a previous text Business Tax Issues on Taxable Turnover of Financial Lease Circular Cai Shui Zi [1999] No 183: the interest paid on funds borrowed outside China by the taxpayer for the purchase of the object of the lease may be deducted from the taxable business turnover.

Direct Link Between Borrowed and Lent Funds

As it had been clearly stated by the PRC, Business Tax Tentative Regulations Implementing Rules issued December 25 1993 (the Implementing Rules), the Margin Taxation Regime requires a direct connection between borrowed and lent funds.

According to article 20 of the Implementing Rules, lending to others from deposits, or from the lender's own capital funds, is not regarded as re-lending business and shall not benefit the Margin Taxation Regime.

The Notice gives more detail about the notion of 'self-owned capital'. For loans granted to others, the portion of borrowed funds equal to the balance of their self-owned funds deposited with offshore affiliated banks, shall not be treated as a foreign exchange loan transfer. This means that the whole amount of interest income derived from the portion equal to the self-owned funds deposited with the offshore affiliated banks is subject to business tax.

This penalizing rule is based on the false hypothesis that self-owned capital is free of charges and does not need to be paid for.

In order to benefit from the Margin Taxation Regime, financial institutions engaged in lending and re-lending business shall account for these two businesses separately in accordance with Provisional Rules Article 7. This requirement was explicitly reiterated by Guo Shui Han Fa [1994] No.607. This is a relatively strict rule since the Margin Taxation Regime would not be granted if turnover has not been accounted for separately.

SEZ Exemptions

A preferential tax policy of five years exemption from business tax is granted for that portion of income sourced inside the Special Economic Zone (SEZ).2

The Notice extends the preferential system to the financial insurance arms of FIFIs and to foreign-funded insurance companies under the same conditions.

The Notice clearly reiterates the applicable business tax regime for FIFIs offshore activities. That is, the business of providing services to non-residents with funds raised from non-residents and it also provides that it is a taxable service provided within China where all interest income is subject to business tax. It is worth noting however, that such a case is relatively unusual.

Finally, the Notice does not bring really new elements but completes the legal framework of the business tax on banking activities, which scope of application was extended since 1993 varying according to at least seven texts.3

Michael Hautchamp and Gilbert Ladreyt
Gide Loyrette Nouel, Beijing

Endnotes:

1 Ministry of Finance, State Administration of Taxation and People's Bank of China Relevant Questions Concerning Taxation of Foreign Investment Financial Organizations Doing Renminbi Business Circular
2 State Council, Relevant Questions Concerning the Adjustment of Tax Policy Towards the Financial and Insurance Industries Circular (Cai Shui Zi March 14 1997 No.45)
3 PRC, Business Tax Tentative Regulations (November 26 1993); PRC, Business Tax Tentative Regulation Implementation Rules (December 25 1993); Issues Concerning Levying of Business Tax on Financial Institutions Circular Guo Shui Han Fa (November 12 1994) No.607; Relevant Issues Concerning the Levying and Collection of Business Tax on the Finance Industry Circular (August 11 1995) Cai Shui Zi No.79; State Council, relevant Questions Concerning the Adjustment of Tax Policy Towards the Financial and Insurance Industries Circular Cai Shui Zi (March 14 1997) No.45; Ministry of Finance, State Administration of Taxation and People's Bank of China, Relevant Questions Concerning Taxation of Foreign Investment Financial Organizations Doing Renminbi Business Circular Cai Shui Zi (May 5 1997) No.52; Business Tax Issues on Taxable Turnover of Financial Lease Circular Cai Shui Zi (June 24 1999) No.183