Refund of tax on reinvestment of profits

By Daisy Ip

According to the Foreign Enterprise Income Tax (FEIT) Law and Implementation Rules, the foreign investor of a foreign invested enterprise (FIE), who reinvests its share of after tax profits from the FIE, as an increase in the registered capital of the same FIE or another existing FIE, or as the capital contribution for setting up a new FIE; is eligible for a refund of 40% of the FEIT previously paid on the reinvested amount, provided that:

	the operating term of the FIE receiving the reinvested profits (reinvested FIE) is not less than five years from the date of receiving the reinvestment;
	the foreign investor applies for a refund of the FEIT paid and receives approval from the relevant PRC tax authorities; and
	the application for the FEIT refund is made within one year from the day of making the reinvestment.

For foreign investors to enjoy the FEIT refund on the reinvestment of its share of profits, profits should have been realised at the time when the reinvestment application is approved by the authorities, irrespective of whether the reinvestment is carried out in one lump sum or by instalments. The FEIT refund incentive does not apply to the reinvestment of unrealised profits.

If the foreign investor reinvests its share of after-tax profits in the set up or expansion of an export-oriented or technically advanced FIE, or reinvests profits from an FIE in the Hainan SEZ in the infrastructure development and agricultural projects in the Hainan SEZ, the foreign investor is eligible for a 100% refund of the FEIT previously paid on the reinvested amount.

The foreign investor has to return 60% of the FEIT refunded to the tax authorities if the reinvested FIE no longer qualifies as an export-oriented or technically advanced FIE. Any FEIT refunded has to be returned to the tax authorities if the foreign investor disposes of its equity interests in the reinvested FIE in less than five years, unless the transfer of the reinvested FIE is due to a group restructuring for business purposes.

The foreign investor is required to provide evidence to verify the fiscal year to which the reinvested amount (i.e. the share of after tax profits) is attributable. Otherwise, the tax authorities may apply other methods as appropriate to verify the relevant fiscal year.

If the amount reinvested by the foreign investor is in foreign currency, it has to be converted into RMB applying the exchange rate published on the day when the reinvestment was made to the reinvested FIE.

Limit on the Reinvested Amount
If the foreign investor makes one or more reinvestments of its share of after tax profits in a single fiscal year, the cumulative reinvested amount for calculating the maximum amount of FEIT to be refunded cannot exceed the limit calculated as Table 2.

Qualified Foreign Investor
For the purpose of obtaining an FEIT refund on the reinvestment of profits, a foreign investor is defined in the tax circular, Guo Shui Han Fa [1995] No. 154, to also include a 100% foreign owned Chinese holding company.

Reinvestment of Pre-Acquisition Profits
When a foreign investor acquires equity interest in an FIE (acquired FIE) and reinvests its share of realised pre-acquisition profits from the acquired FIE, the foreign investor is not eligible for the FEIT refund incentive on the reinvestment of the pre-acquisition profits.

However, the foreign investor is eligible for the FEIT refund on the reinvestment of pre-acquisition profits from the acquired FIE provided that:

	The foreign investor and the transferor of the acquired FIE are related parties, they may directly or indirectly own each other, or are both directly or indirectly 100% owned by another entity.
	The equity interest in the acquired FIE is transferred at cost.

Implication of the Unification of Income Tax Law
The tax refund on reinvestment is governed by the Foreign Enterprise Income Tax Law and Implementation Rules, and is only available to foreign investors and their foreign-invested enterprises. With the unification of the income tax law in the mainland, which is speculated to become effective in early 2008, this tax incentive will most likely be adjusted and made available to both FIEs as well as domestic mainland enterprises, if not abolished altogether. It is likely that there will be a shift from regional to industrial-focused preferential tax treatment so that all regional-focused tax incentives will be discontinued. There will most likely be grandfather clauses to continue certain tax incentives for a transitional period before they are completely phased out.

Procedures and documents for applying for the Tax Refund, and for Reinvesting the After-tax Profits in establishing a new FIE

	The foreign-invested enterprise (FIE) must have realised profits and paid its foreign enterprise income tax (FEIT).
	Tax receipts should be obtained from the tax authorities to prove that the FIE has paid all its FEIT.
	The foreign investor reinvests its share of after-tax profits from the FIE in, say, setting up another FIE (reinvested FIE).
	The foreign investor submits an application for setting up a new FIE (i.e. the reinvested FIE) to the local Bureau of Foreign Trade and Economic Corporation (FTEC), supported by the tax receipts.
	The reinvested FIE should have an operating term of at least five years from the day of receiving the reinvestment.
	A confirmation letter should be obtained from the FTEC as proof that the after-tax profits would be reinvested as capital of the reinvested FIE.
	An application for the business registration certificate for the reinvested FIE should then be submitted to the local Administration for Industry and Commerce.
	The FIE should submit an application to the tax authorities for the 40% refund of the national portion of the FEIT paid.
	The application for the tax refund should be made within one year from the date when the after-tax profits have been reinvested into the reinvested FIE.
	Supporting documents including the approval from FTEC for setting up the new FIE, confirmation letter on reinvesting the after-tax profits as capital for the reinvested FIE, and the business registration certificate of the reinvested FIE should be submitted when the application for the tax refund is lodged.
	The tax refund application form and a calculation sheet verifying the fiscal year to which the reinvested profits are attributable, should be submitted to the tax authorities. Otherwise, the tax authorities may use the methods that they consider appropriate to determine the years to which the reinvested profits are attributable.
	The tax authorities have to approve the tax refund application by stamping the application form.
	The tax refund will be directly deposited to the bank account of the FIE.

daisy.ip@gthk.com.hk

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