New Tax Credit Rule Promotes Outbound Investment

To solve the above issue, the new rule adds another option, i.e. the Comprehensive Tax Credit Method. In other words, the Jurisdiction-separate Tax Credit Method is still kept as an option. As early as 2011, MOF and SAT had issued the similar rule in the petroleum industry. After nearly seven years' trial, the new rule has proven to be effective enough to be extended to all of the industries. Therefore, every Chinese company doing outbound investment may consider this option according to its respective situation. If the tax rates of the jurisdictions in which the Chinese company has invested in are higher than the tax rate of China, the Chinese company would not need to convert from the old one to the new one.

1.3 The Comprehensive Tax Credit Method will also simplify the calculation of the tax credit

As for the reason for the conversion to the Comprehensive Tax Credit Method, in addition to the above one, i.e. to lower tax payment, some Chinese companies will likely opt for this due to its simplicity. Under the Jurisdiction-Separate Method, the Chinese company will have to calculate the limitation of the tax credit on a jurisdiction-by-jurisdiction basis and compare the limitations of the tax credit and the respective taxes which have been paid offshore on a jurisdiction-by-jurisdiction basis as well. While, pursuant to the Comprehensive Tax Credit Method, the Chinese company simply needs to add all of the offshoresourced income, which will be multiplied by 25% to get the total limitation of the tax credit. Then, it would be simple for the Chinese company to compare the total limitation of the tax credit and the total of the offshore-paid taxes to determine how much of the latter may be offset.

1.4 The new rule seems to allow the loss arising from one jurisdiction to offset the profit arising from another jurisdiction

The old rule expressly provides that, for an offshore branch, its loss may not be allowed to offset the profit of the Chinese headquarters or the profit of other incomes derived from other jurisdictions. But the new rule seems to provide otherwise, that the Chinese company may totalize all the offshore-sourced incomes to calculate the limitation of the tax credit. In other words, the loss from the negative income does not seem to be excluded. If the reading is correct, it will bring a better incentive to Chinese companies wishing to expand their outbound investments. Following the above example, we can assume a Chinese company has been operating and gaining large profits in the Netherlands for a long time. Right now, the Chinese company is hesitant to extend its business to other neighboring jurisdictions, such as Belgium, partly because it is concerned that the new business in the new jurisdiction will make a loss, especially in early years. If the new rule offers the incentive to offset the losses and the profits among different jurisdictions, the Chinese company will undoubtedly be encouraged to try it out.

1.5 The new rule also offers a two-way conversion

For the above two tax credit methods, the new rule offers a two-way conversion between them. The Chinese company may choose one of the tax credit methods, but the method should be used for at least five years. More importantly, when converting the tax credit method, the surplus of the offshore-paid tax which has not been credited under the original tax credit method may be credited further under the new tax credit method in the remaining period of the five years. Therefore, it is very necessary for the Chinese company to review the status of its tax credit as soon as possible. If the Chinese company happens to consider investing in a low-tax-rate jurisdiction or has invested in a low-tax-rate jurisdiction for a while, now is a good time for the Chinese company to choose the Comprehensive Tax Credit Method. This is because the surplus of the offshore-paid tax may be credited at the end of the five years.

2 . THE OFFSHORE DIVIDENDS DERIVED FROM UP TO FIVE LEVELS OF QUALIFIED FOREIGN ENTERPRISES MAY BE OFFSET

2.1 The old rule does not satisfy the real need of the outbound investment

Under the old rule, the offshore dividends derived from up to three levels of qualified foreign enterprises may be offset. However, in reality, it is very common for Chinese companies to establish more than three levels of intermediary companies for all kinds of reasons. In that case, if the law still only allows the dividends derived from up to three levels of qualified foreign enterprises to be offset, the dividends derived from real-operation companies of more than three levels would have to be excluded from the scope of the tax credit. In other words, the purpose of the old rule, i.e. tax credit, will come to nothing if the levels of qualified foreign enterprises are so limited.

2.2 The new rule shares the standards of the qualified foreign enterprises

Given the old rule just involves three levels of the foreign enterprises, it directly specifies the standards of the qualified foreign enterprises on a level-by-level basis. However, the new rule does not seem to follow this way but shares the standards of the qualified foreign enterprises. The standards cover two aspects, among which one is the ratio of equity that is held by the direct shareholder and the ratio of equity that is held by the Chinese company directly or indirectly, i.e. through other intermediary companies. Both equity ratios which are held by specific shareholders are 20%.

2.3 All equity ratios shall be taken into account

When designing the shareholding structure for the outbound investment purpose, in addition to the above 20% which should be kept in mind, we also need to consider the tax implications of the disposal of such equities. Generally speaking, when the Chinese company disposes its equity in a target company located in the foreign jurisdiction, the tax treaties provide that a Chinese company will not be subject to the tax in the foreign jurisdiction if the Chinese company does not hold more than 25% of equity in the target company in the past 12 months. Taking two ratios into account, the Chinese company needs to check the intention for its outbound investment and determine which ratio should be given priority when designing the investment structure.

In conclusion, facing the new rule, Chinese companies should review and redesign their tax credit strategy. The review shall include: (1) the status of the tax credit, such as in which jurisdictions the company has invested and is considering investing in; and (2) whether there is a surplus of the offshorepaid tax which has not been credited, etc.

Hu Zhiqiang, Partner Dai Guanchun, Partner Jingtian & Gongcheng