China’s Ministry of Finance and State Administration of Taxation jointly issued Notice on Issues Concerning the Enterprise Foreign Tax Credit [Caishui [2009] No. 125] (hereinafter referred to as the Notice) on 25 December 2009，which provides guidelines for resident enterprises and the offices established in China by non-resident enterprises to claim foreign tax credits. The Notice also applies to taxable income from Hong Kong, Macao, and Taiwan and have entered into force from 1 January, 2008.

Article 23 and Article 24 of the Enterprise Income Tax Law, on which the Notice is based, establish the general principle of the Foreign Tax Credit system. The Notice further interprets the regulation and specifically guides the enterprise to apply the regulation.  

About Creditable Foreign Taxes

Creditable Foreign Taxes is defined as foreign taxes of an Enterprise Income Tax in nature that are payable and also actually paid by an enterprise on foreign-source income. The Notice excludes the following from the scope of creditable foreign taxes:

1.    foreign income taxes that are paid or levied as a result of mistakes;

2.    foreign income taxes that should not be imposed according to an applicable tax treaty;

3.    interest, late payment fees, and penalties that are imposed because of failure to pay foreign income tax in a sufficient or timely manner;

4.    compensation and refunds of foreign income tax that are earned by an enterprise or its interested persons from a foreign competent tax authority;

5.    foreign income taxes attributed to foreign income that is already exempt from the EIT under the Chinese Law; and

6.    foreign income taxes that are already deducted from the foreign taxable income of an enterprise.

About Indirectly Credit

Unless otherwise stipulated, the expression of the foreign enterprises, which are stipulated in Article 80 of Regulation on the Implementation of the Enterprise Income Tax Law, in which a resident enterprise directly or indirectly holds an equity of 20% or more, are limited to those enterprises within the three tiers immediately under the resident enterprise. The criteria are as follows:

1.    the resident enterprise must directly hold at least 20 percent of the shares in foreign enterprise ;

2.    each first-tier foreign enterprise in that chain must directly hold at least 20 percent of the shares in the second-tier foreign enterprises and the resident enterprise must directly or indirectly hold an aggregate of at least 20 percent of the shares in each foreign enterprise in cases where indirect shares are held through one or more qualified foreign enterprises in the stock chain; and

3.    each first-tier foreign enterprise in that chain must directly hold at least 20 percent of the shares in the third-tier foreign enterprises and the resident enterprise must directly or indirectly hold an aggregate of at least 20 percent of the shares in each foreign enterprise in cases where indirect shares are held through one or more qualified foreign enterprises in the stock chain.

According to the Notice, foreign taxes deemed paid by a resident enterprise on foreign-source dividend income under article 24 of the Enterprise Income Tax Law will be calculated on a tier-by-tier basis from the bottom tier to the top tier, the formula is as follows: A foreign taxpayer’s taxes deemed paid by an immediate higher-tier enterprise = (taxes actually paid by the taxpayer on its profits and dividend income taxes deemed paid by the taxpayer under the Notice) x dividends distributed by the taxpayer to the higher-tier enterprise divided by after-tax profits of the taxpayer.

About Credit Limitation and Simplified Calculation

It is almost the same between the Notice and the former regulations stipulated in Enterprise Income Tax Law and its Implementation as to the method of calculating the credit limitation and the creditable amount. Further, the Notice adds the simplified calculation. It rules that:

Subject to approval from the competent tax authority, a foreign tax credit limitation on an enterprise’s foreign-source business profits and qualified foreign-source dividend income will be determined by using the following simplified methods:

• The foreign tax credit limitation will be 12.5 percent of foreign-source taxable income if foreign taxes that are payable and actually paid cannot be accurately confirmed for uncontrollable reasons, even if the taxpayer has a tax payment certificate or other written proof issued by the government authority of the foreign country. In that case, the foreign taxes appearing in the tax payment document would be allowed as a foreign tax credit to the extent of that limitation.

• The foreign tax credit limitation will be equal to the foreign source taxable income which is calculated under the Notice multiplied by the income tax rate which is stipulated by the Enterprise Income Tax Law and will be considered as creditable foreign tax if the statutory and effective income tax rates in the foreign country where the income relating to the foreign taxes paid or deemed paid is generated are apparently greater than the income tax rate in China.