China has relatively limited guidance on tax classification
The Chinese State Tax Administration (STA), in its ongoing efforts to improve tax security and the general business environment, recently made several clarifications on the implementation of Corporate Income Tax (CIT) rules (STA Notice No. 17 (2021)) that are effective for the filings are from 2021.
tax
Treatment of cross-border hybrid financial instruments
China has relatively limited guidelines for that
tax classification and treatment of hybrid financial instruments, i.e.
with characteristics of debt and equity. China, for example, has the
BEPS-Action-2-Rules (2015) for dealing with tax planning for hybrid arrangements.
The main guide, STA
Announcement No. 41 (2013) contains a list of criteria that must be met for
the payments from a tax-deductible financial instrument
Interest (instead of non-deductible distributions). That includes it
are periodic interest payments in the amount of the respective
Contracts in which the investing company is not involved
the net worth of the investee; and other factors.
However, it was assumed that the existing
Regulations inadequate to cross-border situations, especially those
Tax arbitrage possible when a foreign company invests in an instrument
issued by a Chinese company. Under the existing guidance it was possible for one
the terms of the instrument can be adjusted so that the Chinese company
its payments were treated as deductible interest, but the foreign company was
treat the payment as a tax-exempt dividend under the tax law of its jurisdiction.
According to the latest guidelines, the STA offers this
if the two companies are related (i.e. 25% and more of the share capital)
Relationship or effective control relationship) and if the return on investment
(Capital gains or dividends) would be tax-free in the hands of the foreign company,
then no tax deduction will be granted in China.
CIT deduction for donations in kind
During the COVID-19
Downtime period many taxpayers donated with their self-produced or
purchased goods.
The STA has now clarified which documents can be
used to support CIT deductions, including government-issued receipts
Agencies and social organizations.
tax
Treatment of debt converted into equity
China's CIT law exempt
Dividend income from domestic companies, but taxes on interest. The SDA has now
clarified how convertible bonds are to be treated before and after conversion.
Has an investor in convertibles
accrued interest, but before disbursement the bonds (plus unpaid interest)
Converted to equity, the STA states that this interest is still taxable.
This is true regardless of whether the interest rate is below sales
the accounting rules. For the purpose of future sales of this
Equity, the tax cost base consists of the acquisition
Price of the convertible bond, the amount of interest not received and the
related tax.
For an issuer of
Convertible bonds can amount to the interest from the convertible bonds
deducted for CIT purposes. When the issuer both converts the bonds and accrues
Interest payable on shares, the accrued interest counts as
paid and deductible.
Chinese companies with no robust
Accounting systems are allowed to calculate their CIT on an assumed basis
rather than on an accounting basis, which can lead to higher tax burdens.
With China's continued economic
Development, many companies have adopted or improved their accounting systems
and processes and have moved from the assumed basis to the account books
Base. For companies making this transition, the STA has now made it clear how they
Determination of the tax base of the acquired assets for depreciation and
Purposes of capital gains tax.
Separated from these STA Clarifications in Announcement 17, a simplified one
The procedure for cross-border payments was introduced on June 29th
2021. Previously the STA and the state foreign exchange administration
(SAFE) sought public opinion on the draft (see previous article for more details). No significant compared to the draft version
Changes have been made.
Lewis Lu
Partner, KPMG China
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