September 29, 2018, Ministry of Finance, State Administration of Taxation, National Development and Reform Commission and Ministry of Commerce has jointly issued the Circular on Expanding the Applicable Scope of the Policy of Temporarily Not Levying the Withholding Tax on Distributed Profits Used by Overseas Investors for Direct Investment (Hereinafter referred to as No.102 Circular). According to No.102 Circular, the policy under which profits received by an overseas investor from a resident enterprise in China will temporarily not be subject to the withholding tax, if such profits are used for direct investment in China, they will be applicable to a larger extent, covering not only the encouraged category of foreign-invested projects but also all projects and fields from which foreign investments are not banned.

Please see below the summary of the critical information of No. 102 Circular:

  1. Conditions for an overseas investor to enjoy the policy of temporarily not levying the withholding tax:

1.1. Direct investments made by an overseas investor with distributed profits cover equity investments made by such overseas investor with the profits it receives, including capital increase, the new incorporation and acquisition of equities, but excluding the increase in, the conversion to, and the acquisition of, a listed company’s shares (except for qualified strategic investments). To be specific,
(1). The increase of, or the conversion to increase, the paid-in capital or capital reserves for a resident enterprise in China;
Enterprises invested in by overseas investors through the above investment activities are generally called invested enterprises.

1.2. Profits received by an overseas investors shall be the returns from equity investments, such as dividends and bonuses, that are actually distributed by a resident enterprise in China from its realized retained earnings to investors.

1.3. Where the profits used by an overseas investor for direct investment are paid in cash, the relevant payments must be directly transferred out of the account owned by the enterprise distributing the profits into the account of the invested enterprise or of the equity seller, and shall not be circulated between or through any other domestic or overseas accounts before the direct investment is delivered; where the profits used by an overseas investor for direct investment are paid in kind, in negotiable securities, or in any other non-monetary forms, the ownership of relevant assets must be directly transferred by the enterprise distributing profits to the invested enterprise or the equity seller, and shall not be held by any other enterprise or individual on a commission or temporary basis before the direct investment is delivered.

  1. Where an overseas investor is eligible for the policy of temporarily not levying the withholding tax, but does not enjoy the tax incentive in essence, is it possible to trace back to the previous year to enjoy the tax incentive?

Where an overseas investor is eligible for the policy of temporarily not levying the withholding tax, under the provisions hereof, but does not enjoy the tax incentive in essence, it can file an application to enjoy this preferential policy within three years of the date on which the relevant tax payments are made and receive a refund of tax paid.

  1. Where an overseas investor substantially withdraws from its direct investment that has enjoyed the policy of temporarily not levying the withholding tax, through an equity transfer, repurchase, liquidation or otherwise, whether is it required to make up the tax that has been enjoyed under the policy of temporarily not levying the withholding tax.

Where an overseas investor substantially withdraws from its direct investment that has enjoyed the policy of temporarily not levying the withholding tax, through an equity transfer, repurchase, liquidation or otherwise, it shall, within seven days of it having recovered the relevant payments, file a return for the deferred income tax under the applicable procedures with the tax authority.

  1. Where an invested enterprise’s reorganization satisfies the requirements to be regarded as a special reorganization, after the overseas investor has enjoyed the policy of temporarily not levying the withholding tax as provided hereof, whether it is possible to continue to enjoy the preferential tax policy.

Where an invested enterprise’s reorganization satisfies the requirements to be regarded as a special reorganization, after the overseas investor has enjoyed the policy of temporarily not levying the withholding tax as provided hereof, and the reorganization is handled for tax purposes as a special reorganization in fact, the investor may continue to enjoy this preferential tax policy and does not have to pay the deferred income tax as required under Article VI hereof.

  1. Where an overseas investor has enjoyed the policy of temporarily not levying the withholding tax, what will be the consequences if the tax authority subsequently verifies that the overseas investor does not meet the given conditions?

Where the tax authority establishes in the follow-up regulation that an overseas investor does not meet the given conditions, after it has enjoyed the policy of temporarily not levying the withholding tax, such overseas investor will be deemed as failing to file the tax return for enterprise income tax purposes as required, unless the liability goes to the enterprise distributing profits; and such overseas investor’s liability for late tax payments will be pursued and the delay in tax payments will commence from the date when relevant profits are paid.

  1. What do the terms “overseas investor” and “resident enterprise in China” refer to respectively in No. 102 Circular?

For the purposes of No. 102 Circular, the term “overseas investor” refers to a non-resident enterprise as specified in the third paragraph of Article 3 of the Law on Enterprise Income Tax; and the term “resident enterprise in China” refers to a resident enterprise legally established within the territory of China.

  1. When shall No. 102 Circular take effect?

No. 102 Circular shall take effect retrospectively from January 1, 2018.

It is foreseeable that this policy will greatly promote foreign investment in China and reinvestment in China and it is an important force multiplier for foreign investment in expanding its business and scope in China.