China Tax Administration Guide (3) - Taxable Income

3.1 Basic Regulations

3.1.1 For enterprises with foreign investment and foreign enterprises with establishments and sites in China, the amount of taxable income on the total income each year from those establishments and sites, shall be the amount remaining from gross income for that year after costs, expenses and losses have been deducted.

(ZHU XI LING [45] 1991.4.9)

3.1.2 The losses incurred in a tax year by an enterprise with foreign investment or by the organizations or sites established by a foreign enterprise in China for production or business operations, may be offset against income in the following tax year. Where the income of the following year is not sufficient to offset those losses, the balance may be offset against income of subsequent years, over a period not exceeding 5 years.

(ZHU XI LING [45] 1991.4.9)

3.1.3 Where the financial and accounting principles adopted by an enterprise with foreign investment or organizations or sites established by a foreign enterprise for production or business operations, conflicts with relevant tax provisions of State Council, the tax payment due shall be calculated according to the relevant provisions of State Council.

(ZHU XI LING [45] 1991.4.9)

3.1.4 Where an enterprise with foreign investment goes into liquidation, and where the net balance of its assets or the balance of its property after deduction of its undistributed profit, various funds and liquidation expenses exceeds the enterprise¡¦s paid in capital, the excess shall be considered liquidation income on which Income Tax shall be paid according to provisions of this Law.

(ZHU XI LING [45] 1991.4.9)

3.1.5 Where an enterprise with foreign investment invests in another enterprise within China, the profit (dividends) obtained from the enterprise receiving the investment may be excluded from its taxable income; however, expenses and losses incurred in the investment process may not be deducted from its taxable income.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.6 Unless otherwise stipulated by the State, the following items shall not be itemized as costs, expenses or losses in the calculation of taxable income:

A.expenses connected with the acquisition or construction of fixed assets;

B.expenses connected with the transfer or development of intangible assets;

C.interest on capital;

D.various Income Tax payments;

E.fines for illegal business operations and losses due to the confiscation of property;

F.surcharges and fines for overdue payment of taxes;

G.that part of losses due to natural disasters or accidents for which there has been compensation;

H.donations and contributions other than those used in China for public welfare or relief purposes;

I.royalties paid to the head office;

J.other expenses not related to production or business operations.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.7 For foreign enterprises with an establishment or site in China, reasonable administrative expenses paid to its head office in connection with production or business operations of that establishment or site, may be itemized as expenses following agreement by the local tax authorities after their examination and verification of documents issued by the enterprise¡¦s head office in respect of the scope of the administrative expenses, total amounts and the basis and methods of allocation; these documents shall be provided together with an accompanying verification report by a certified public accountant.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.8 Reasonable interest payments incurred on loans connected to production and business operations may be itemized as expenses following agreement by the local tax authorities after their examination and verification of documents with respect to loans and expenses, which documents shall be provided by the enterprises.

Interest paid on loans used by enterprises for purchasing or constructing fixed assets or transferring or developing intangible assets prior to the assets being put into use, shall be included in the original value of the assets.

′Reasonable interest′, refers to interest calculated at a rate not higher than normal commercial lending rates.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.9 Entertainment expenses incurred by enterprises in connection with their production and business operations, when supported by authentic records or invoices and vouchers, may be itemized as expenses subject to the following limitations:

A.Where annual net sales are 15 million yuan or less, such expenses may not exceed 0.5% of net sales; for that portion exceeding 15 million yuan, such expenses may not exceed 0.3% of that portion of net sales;

B.Where annual gross business income is 5 million yuan or less, such expenses may not exceed 1% of gross business income; for that portion which exceeds 5 million yuan, such expenses may not exceed 0.5% of that portion of annual gross business income.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.10 Exchange gains or losses incurred by enterprises during pre-construction or during production or business operations shall be appropriately itemized as gains or losses for that period, except as otherwise provided by the State.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.11 Salaries and wages, allowances and benefits paid by enterprises to their employees may be itemized as expenses following agreement by local tax authorities after their examination and verification of the submitted wage scales, supporting documents and relevant materials.

Foreign social security premiums paid by enterprises for their employees working in China may not be itemized as expenses.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.12 Where enterprises engaged in such businesses as credit and leasing operations, if there is actual need and following approval by the local tax authorities of a relevant submitted report, such enterprises may make yearly provision for bad debts, the amount of which shall not exceed 3% of the year end loan balance (not including inter-bank loans) or the amount of accounts receivable, notes receivable and other receivables, and which may be deducted from taxable income for that year.

The portion of bad debt losses actually incurred by an enterprise which exceeds the bad debt provisions of the preceding year, may be itemized as loss in the current year; if the portion is less than the bad debt provisions of the previous year the balance shall be included in taxable income for the current year.

′Bad debt losses′ referred to in the preceding paragraph shall be subject to examination and approval by the local taxation authorities.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.13 ′Bad debt losses′ refers to the following accounts receivable:

A.due to the bankruptcy of the debtor, collection is still not possible after the use of the bankruptcy assets for settlement;

B.due to the death of the debtor, collection is still not possible after use of the estate for repayment;

C.after the failure of the debtor to fulfill repayment obligations for over 2 years, collection is still not possible.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.14 Accounts receivable already itemized as a bad debt loss, but which are recovered in full or in part by an enterprise in a subsequent year, shall be included in taxable income for the year in which they were recovered.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.15 Where enterprises have establishments or sites in China, unless otherwise provided by the State, they may deduct as expenses foreign Income Tax which has been paid on profits (dividends), interest, rental income, royalties and other income received from outside China and actually connected with those establishments or sites.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.16 ′Net assets or remaining property′ in Article 18 of the Tax Law refers to the amount remaining after various liabilities and losses have been deducted from all assets or property, when an enterprise is liquidated.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.17 The formula for the computation of taxable income is as follows:

A.Manufacturing:

a.taxable income = (profit on sales) + (profit from other operations)+(non-business income) - (non-business expenses);

b.profit on sales = (net sales) - (cost of products sold) - (taxes on sales) - {[selling expenses] + [administrative expenses] + [financial expenses]};

c.net sales = (gross sales) - {[sales returns] + sales discounts and allowances]}

d.cost of products sold = (cost of products manufactured in the period)+(inventory of finished products at the beginning of the period) - (inventory of finished products at the end of the period);

e.cost of products manufactured in the period = (manufacturing costs for the period) + (inventory of semi-finished products and products in process at the beginning of the period) - (inventory of semi-finished products and products in process at the end of the period);

f.manufacturing costs for the period = (materials directly consumed in production for the period) + (direct labour costs) + (manufacturing expenses);

B.Commerce:

a.taxable income = (profit on sales) + (profit from other operations)+(non-business income) - (non-business expenses);

b.profit on sales = (net sales) - (cost of goods sold) - (taxes on sales) - {[selling expenses] + [administrative expenses] + [financial expenses]};

c.net sales = (gross sales) - {[sales returns] + [sales discounts and allowances]};

d.cost of sales = (inventory of merchandise at the beginning of the period) + {(purchases of merchandise during the period) - (purchase returns) + (purchase discounts and allowances) - (purchasing expenses)} - (inventory of merchandise at the end of the period);

C.Service industry:

a.taxable income = (net business income) + (non-operating income) - (non-operating expenses);

b.net business income = (gross business income) - {[taxes on business income] +[operating expenses] + [administrative expenses] + [financial expenses]};

D.Other Types of Business; calculations shall be made by referring to the above formulae.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.18 In principle, the calculation of an enterprise¡¦s taxable income shall be on an accrual basis.The income from the following business operations of an enterprise may be determined by period, and used as the basis for calculation of taxable income:

A.where products are sold by installment payments, income from the sales may be itemized according to the invoice date when the products are delivered; income from such sales may also be determined according to the date on which payment is made by the buyer, as agreed on in the contract;

B.where construction, installation and assembly projects and provision of labour services extends beyond one year, the income may be determined according to the progress of the project or the amount of work completed;

C.where processing or manufacturing of heavy machinery, equipment and ships for other enterprises extends beyond one year, the income may be determined according to the progress of the project or the amount of work completed.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.19 Where Chinese-foreign joint ventures operate on a product sharing basis, the partners shall be deemed to have received income at the time of the division of the products; the amount of income shall be calculated according to the price at which the products are sold to third parties or with reference to prevailing market prices.

Where foreign enterprises engage in cooperative oil exploration projects, the partners thereto shall be deemed to have received income at the time when the crude oil is divided; the amount of income shall be calculated using a price which is adjusted periodically with reference to the international market price of crude oil of a similar quality.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.20 With respect to an enterprise¡¦s income which is in the form of non-monetary assets or rights or interests, such income shall be calculated or appraised with reference to prevailing market prices.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.21 Where an enterprise cannot provide complete and accurate vouchers and documents for costs and expenses, and cannot correctly calculate taxable income, the local taxation authorities shall determine the profit rate and calculate taxable income by referring to the profit level of other enterprises in the same or a similar trade. Where an enterprise cannot provide complete and accurate certificates of revenues and cannot report income accurately, the local tax authorities shall calculate taxable income by the use of methods such as cost-plus-expenses plus a reasonable profit margin.

Where taxation authorities have to determine profit rates or revenues with reference to the provisions of the preceding paragraphs, but where other stipulations are provided by laws, regulations and rules, then these other stipulations will apply.

(GUO WU YUAN LING [85] 1991.6.30)

3.1.22 Where foreign transportation and ocean shipping enterprises engage in international transportation business, they shall use 5% of their gross revenues from passenger and cargo transport and shipping service arising within the borders of China as their taxable income.

(GUO WU YUAN LING [85] 1991.6.30)

3.2 Specific Regulations

3.2.1 Calculation of Income Tax on the income received during the setting-up period of an enterprise with foreign investment

The remaining amount obtained by deduction of the cost, expense and loss related to non-production operation income from the non-production operation income achieved by a production enterprise with foreign investment during the preparation period shall be calculated into the taxable income of the enterprise for the period, and the enterprise with foreign investment shall calculate and pay Enterprise Income Tax according to the tax rate in Article 5 and Article 7 of the Tax Law, however the preparation period need not be calculated into the profit-earning years for which preferential policies are valid regarding tax exemption and reduction.

(GUO SHUI FA [140] 1995.7.24)

3.2.2 Tax payment for investment with non-monetary assets by an enterprise with foreign investment.

If, upon approval of relevant government bodies, an enterprise with foreign investment invests in another enterprise with assets, intangible assets or other non-monetary assets, the difference between the former net book value and the value recognized in the investment contract regarding the investment assets shall be regarded as the income from the asset transfer, thus being calculated into the taxable income for the period. If there is a large amount of net proceeds, and it is difficult for the enterprise to pay the tax when the difference is calculated into the taxable income for the period, the enterprise with foreign investment may pay the tax by dividing it evenly over no more than 5 tax years, after approval by the responsible taxation authorities.

(CAI SHUI ZI [083] 1995.1.13)

3.2.3 Calculation of taxable income of an enterprise with foreign investment engaged in the investment business

A. An enterprise with foreign investment engaged in investment business shall, separately, calculate fairly and accurately the income from the investment and the income from the business operations as well as the costs, expenses and losses related to each of them.

B. The profit (dividends) obtained by an enterprise with foreign investment from investment in another enterprise in China may be excluded from the taxable income of the enterprise with foreign investment, however, expenses in the implementation of the investment project such as that for a feasibility study, for interest on investment loans and for investment management, and losses which cannot be recovered at the end of the investment period, are not permitted to be deducted from taxable income.

C. The enterprise with foreign investment shall pay tax, according to the provisions of the tax laws and regulations, on all income obtained by the enterprise with foreign investment engaged in investment business, in addition to the investment profit (dividends) in China mentioned in the above paragraph.

(CAI SHUI ZI [083] 1995.1.13)

3.2.4 On The Matter of the Listed Expenses for Repairs

The expenses for maintenance and repair generally refer to the expenses involved in restoring the fixed assets to their original state or to maintain their original functions. Such expenses may be those for the regular maintenance and repair of fixed assets, those for replacement of parts or major components by complete dismantling of vehicles and machines, those for yearly or regular major repair of kilns and furnaces and those for the overhaul of buildings or part of the buildings rebuilt.

(CAI SHUI WAI ZI [331] 1986.12.31)

3.2.5 Classification of industries based on the calculation of enterprise expenses for business entertainment according to sales revenue and business income.

Business entertainment expenses shall be calculated in proportion to sales revenue, net sales and business income of the enterprise according to Section 9 of Article 9 in the "Detailed Rules and Regulations for Implementation of the Income Tax Law on Joint Ventures" and Article 13 in the "Detailed Rules and Regulations for Implementation of the Income Tax Law on Foreign Enterprises". To facilitate the calculation of the limit of the business entertainment expense, the industries listed below are where the calculation shall be made according to the sales revenue and business income:

A. The industries where the limit of the business entertainment expense shall be calculated according to sales revenue and net sales are: manufacturing, farming, acquiculture, building, commerce, etc.

B. The industries where the limit of the business entertainment expense is calculated according to business income are: hotel, food service, recreational service, transportation, construction, installation, banking, insurance, leasing, repair, design, consultation and other service industries.

C.The limit of the business entertainment expense for the enterprises whose business is distributed in more than one industry shall be calculated according to the sales revenue and the net sales or business income respectively. If the different types of income cannot be distinguished clearly from each other, the limit of the business entertainment expense shall be calculated with reference to the enterprise¡¦s major business.

(CAI SHUI WAI ZI [331] 1986.12.31)

3.2.6 Categorization of the expenditure for the board of directors and expenditure for directors

The expenditure for the board of directors of the enterprise refers to such fees paid for the board of directors or its members to perform their functions such as traveling expenses, board and lodging expenses, and other necessary expenses of the directors during the period of the board meeting. The expenditure for the board of directors and the expenditure limit are usually decided by the board of directors. The expenditure for directors refers to a reasonable

compensation decided by the board of directors to be delivered to the directors. All the expenditures decided by the board of directors may be calculated into the expense for the period, if they actually occurred during the period. However, expenditure on receptions, gifts and other business entertainment carried out in the name of the board of directors shall not be listed in expenditure for the board of directors, but in business entertainment expenses.

(CAI SHUI WAI ZI [331] 1986.12.31)

3.2.7 Categorization of the expenses for training of the enterprise¡¦s employees

The expenses for training of employees, arranged by the enterprise, to meet the need of production and operation may be categorized according to the following principles:

The expenses for training of employees before the enterprise opens for business shall be listed in preliminary expenses, and shall be amortized after the enterprise starts production or operations according to tax laws.

The expenses for training of employees after the opening of the enterprise shall, in principle, be listed in the expenses for the period. For large single expenses, the local responsible taxation authorities may confirm them as deferred expenses according to the actual amortization situation.

The expenses on fixed assets or intangible assets purchased or built for training of employees shall be dealt with according to relevant provisions regarding fixed assets or intangible assets in the tax laws, whether or not the expenses occur before or after the opening for business.

(CAI SHUI WAI ZI [331] 1986.12.31)

3.2.8 The expenses for washing clothes offered by the enterprise with foreign investment to its employees in the form of reimbursement by vouchers may be listed in the expenses for payment of Enterprise Income Tax, and shall not be calculated into the salary of the employees, thus there is no need for the employee to pay Individual Income Tax on expenses for washing clothes.

(CAI SHUI WAI ZI [088] 1988.4.1)

3.2.9 On the matter of levying relevant tax on the business entertainment costs an enterprise with foreign investment incurs from direct supply of service in tourist hotels and restaurants it owns

A. If an enterprise with foreign investment invites guests to dinner at a restaurant belonging to the enterprise, the Industrial and Commercial Consolidated Tax shall be paid according to the taxable income from the dinner calculated at the sales price, and shall not be written off from the operating cost of the restaurant.

B. If goods such as cigarettes and alcoholic drinks sold by the enterprise with foreign investment are used to receive guests, they shall be listed in goods sold, the Industrial and Commercial Consolidated Tax shall be paid according to the taxable income at their sales price, and shall not be written off from the stock of goods at cost price.

(GUO SHUI WAI ZI [081] 1989.3.25)

3.2.10 On the matter of making provision for bad debts

A. The section regarding making provisions for bad debts in Article 25 of the Detailed Rules of the Tax Law mainly applies to enterprises engaged in such business as credit and leasing (referring to financial leasing). For enterprises engaged in business other than credit and leasing, strict policies are adopted, if there is actual need, such enterprises may make yearly provision for bad debts on the basis of the year-end balance of receivables such as accounts receivable, notes receivable, etc., upon approval by the local taxation authorities.

B. Enterprises engaged in banking may make provisions for bad debts on the basis of the year-end loan balance (excluding inter-bank loans). The enterprises in other industries shall make provisions for bad debts on the basis of the year-end balance of such receivables as year-end accounts receivable and notes receivable (referring to financial credit instruments, excluding notes at sight). Provisions made for bad debts shall be limited to overdue bills. Provisions for bad debts shall not be made for unmatured credit and receivables for goods sold on a commission basis.

(GUO SHUI FA [165] 1991.10.15)

3.2.11 The adoption of the accounting year as the tax year by enterprises with foreign investment

According to the provisions in Article 8 of the Detailed Rules of the Tax Law, enterprises with foreign investment shall, in principle, adopt the calendar year from January 1 to December 31 as the tax year. If it is difficult to calculate the tax payment according to the tax year mentioned above because of the nature of the industry, the enterprise may adopt an accounting year with 12 full months suitable to itself as the tax year, after approval by the local taxation authorities.

(GUO SHUI FA [165] 1991.10.15)

3.2.12 Such expenses as management service charges paid by the enterprises with foreign investment, in proportion to sales revenue, to relevant government bodies for non-existent service, or the unreasonably high service charge paid to relevant government bodies by enterprises with foreign investment, since these expenses belong to those unrelated to production and operation, they shall not be deducted from taxable income according to Section 10 Article 19 of the "Detailed Rules and Regulations for Implementation of the Income Tax Law of the People¡¦s Republic of China on Enterprises with Foreign Investment and Foreign Enterprises".

Expenses which may be deducted from the taxable income are those such as single service charges paid by the enterprise with foreign investment for services actually provided by relevant government bodies for industrial consultation, market information, and purchase & sales of products, etc., according to the relevant stipulated standard service charges or according to the normal price for a similar service in the market.

(GUO SHUI HAN [469] 1993.12.15)

3.2.13 The listed expenses paid for land use rights of a site rented by an enterprise with foreign investment

The land use fee for factory buildings, sites, hotels, guesthouses, etc., rented by enterprises with foreign investment as sites for production or operations shall be paid by the lessors according to relevant regulations, and the land use fee shall be regarded as one of the factors in determining the rentals for the sites. The land use fee paid by enterprises with foreign investment, as lessees of the sites, directly to relevant government bodies shall be transferred into expenses of the lessors, the lessors shall provide a corresponding invoice for receipt of the rental, and the lessees may deduct the rental from their taxable income according to the amount listed on the invoice.

(GUO SHUI HAN [080] 1994.3.26)

3.2.14 Actors or athletes shall pay tax, according to the following provisions, on the income earned by a performance organization, and by the actors or athletes as individuals, from theatrical performance and sports activities conducted in China (Mainland) by actors or athletes from abroad, Hong Kong, Macao or Taiwan in the name of the performance organization:

A. The organization providing performances shall pay Business Tax of 3% on business income, i.e., the remainder obtained from the deduction of fees paid to the providers of performance sites, performance organizers or brokers from the total ticket income or from the income for theater bookings according to the relevant provisions in the "Provisional Regulations of the People¡¦s Republic of China on Business Tax" (hereinafter referred to as ′Regulations on Business Tax′).

B. The organization setting up performances shall pay Enterprise Income Tax at the rate of 30% and local Income Tax at the rate of 3% on the remainder obtained after deduction of the actual paid fees from the total revenue earned by the organization according to the relevant provisions of the "Income Tax Law of the People¡¦s Republic of China on Enterprises with Foreign Investment and Foreign Enterprises" (hereinafter referred to as ′Enterprise Income Tax Law′) if the organization can provide complete and accurate vouchers for expenses. Actors or athletes as individuals shall pay Individual Income Tax for the compensation actually paid by the organization setting up performances according to the "Individual Income Tax Law of the People¡¦s Republic of China" (hereinafter referred to as ′Individual Income Tax Law′).

C. The organization setting up performances shall pay Enterprise Income Tax and local Income Tax at the tax rate stipulated in the Enterprise Income Tax Law according to the remainder obtained after deduction of the compensation offered to actors or athletes as individuals and the performance fee, amounting to 30% of the total revenue, from the total revenue on the basis of the principles in Article 16 of the Detailed Rules and the Regulations on Enterprise Income Tax Law if the organization setting up performances cannot provide complete and accurate vouchers for expenses, and the accurate taxable income is not available. The organization setting up performances shall withhold individual income tax for the compensation offered to actors or athletes according to the provisions in the Individual Income Tax Law at the time when the compensation is offered. The organization setting up performances shall pay Enterprise Income Tax and local Income Tax according to the Enterprise Income Tax Law on the basis of the taxable income obtained from deduction of the other performance fee, of 30% of the total revenue, from the total revenue if the organization setting up performances fails to declare the compensation amount offered to actors or athletes or fails to withhold individual Income Tax. Actors or athletes shall not pay individual Income Tax in this case.

(GUO SHUI FA [106] 1994.4.21)

3.2.15 How to calculate the levy of Enterprise Income Tax on over-reimbursed tax

The enterprise with foreign investment shall calculate and pay enterprise Income Tax on the taxable income for the year including tax actually refunded, regardless of which tax year the overpaid tax belongs to, according to the relevant provisions in the "Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises".

(GUO SHUI FA [145] 1994.6.27)

3.2.16 Taxation on the medical and educational business of enterprises with foreign investment

The enterprise with foreign investment engaged in education shall calculate and pay Business Tax on business income collected from students and from other sources except that stipulated to be tax free in Item 4, section 1, Article 6 of Business Tax Regulations regarding exemption from Business Tax. The enterprise shall calculate and pay Income Tax on the taxable income, i.e. the remainder obtained from deduction of costs, expenses and losses from total income (including income on which Business Tax has been reimbursed). A school established with investment from a foreign enterprise shall calculate and pay tax on business income from the interest received from pledge money which may not be dealt with as business income if, according to the school regulations or the entrance contracts, the school collects the pledge money first and returns it upon graduation and uses the interest from the pledge money as the tuition fee. If it is stipulated in the school regulations or entrance contracts that high tuition fees shall be collected first, and part of the fees shall be returned to students upon their graduation or to the students who leave school before graduation, while the other part is retained in the enterprise, then, the part of the fee to be returned to students shall be regarded as pledge money but not as business income, and tax shall only be calculated and paid on the interest derived from the tuition fees and on the part of the fees to be returned to students.

The enterprise with foreign investment engaged in medical services shall calculate and pay Business Tax on all income except for that as mentioned in Item 3 of Section 1 in Article 6 of the Business Tax Regulations regarding Business Tax exemption. The enterprise shall calculate and pay Enterprise Income Tax on the remainder (as taxable income) obtained by deduction of relevant costs, expenses and losses from the total income.

(GUO SHUI FA [152] 1994.7.4)

3.2.17 Taxation on public accumulation funds drawn on and spent for residential housing by enterprises with foreign investment and their hired personnel

A. Tax payment on housing allowances and public housing reserve funds (including voluntary public housing reserve funds) reserved by enterprises or individuals is made according to the relevant regulations in State or local government housing policies.

a.The housing allowance reserved by enterprises according to the original regulations issued by the financial authorities or the labor administration may be categorized as period costs and expenses which shall be deducted from the enterprise¡¦s taxable income for the period, in regions where there has not been any reform of the housing system.

b.When enterprises in regions where there has been reform of the housing system reserve all kinds of public housing reserve funds according to the proportions stipulated by central or local governments, the account balances obtained when expenses for uses other than housing of employees, are deducted from the annual employee housing welfare fund reserve of those enterprises who reserve all kinds of employee¡¦s welfare funds according to the relevant regulations before calculating and paying income tax, shall be transferred into the public housing reserve funds. Any deficiency shall be calculated into the costs and expenses for the period, before calculation and payment of Income Tax, only when there is no account balance or the account balance is not large enough to be reserved for public housing reserve funds for the year.

c.The public housing reserve funds reserved by enterprise or individuals according to the proportion stipulated by the central or the local government and actually paid to the appointed organizations, shall not be calculated into individual wages or salaries for payment of Individual Income Tax.

B. Tax payment procedures by enterprises or individuals for use of housing allowances or public housing reserve funds mentioned are as follows:

a.The fees actually paid to individuals by the enterprises for expenses such as house purchase or construction, house repair and house rental shall be categorized in and drawn from the housing allowance or the public housing reserve funds for the individuals.

b.Individual Income Tax shall be calculated and paid on the wages or salaries for the period including the public housing reserve funds actually drawn by the individuals (including the part drawn by the enterprise or the part drawn by the individuals). All kinds of fees actually paid by individuals for housing (including those for house purchase or construction as well as for house rental) may be deducted from the amount of public housing reserve funds actually drawn, if the fees are used in the way stipulated by the central or the local government and if the individuals can provide valid and legal vouchers for examination and approval by the responsible taxation authorities. The portion exceeding the actually drawn amount of funds shall not be deducted from the wages or salaries for the period.??

C. Tax payment on the housing allowances or the public housing reserve funds used by enterprises or individuals at a rate greater than that stipulated by the central or the local government.

a.All kinds of housing allowances or the public housing reserve funds reserved by enterprises at a rate greater than that stipulated by the central or the local government shall not be categorized in and drawn from the costs and expenses for the period.

b.If the fee actually paid to the individuals by the enterprise for expenses such as house purchase or construction, house repair and house rental is greater in value than the housing allowance or the public housing reserve funds for individuals reserved according to the regulations of the central or the local government, the excess part may be listed as costs and expenses of the enterprise for the period, according to valid and legal vouchers, if the board of the directors of the enterprise decide to pay for it. However the enterprise¡¦s expenses for the excess part shall be calculated into the individual wages or salaries for the period on which Individual Income Tax shall be paid by the individuals.

c.The excess part of the public housing reserve fund reserved by individuals at a rate greater than that stipulated by the central or the local government shall not be deducted from individual wages or salaries for the period for payment of Individual Income Tax.

(GUO SHUI FA [165] 1994.7.26)

3.2.18 Taxation on the contract operations and leased operations of enterprises with foreign investment

A. If an enterprise with foreign investment appoints employees within the enterprise to carry out target-related contracted responsibilities or appoints another management service company to be responsible for the management of part or all of the business operation, and pays compensation to the appointed employees or the service charges to the appointed company based on work quotas, operation profits or management results, even if the commercial activities are still carried out in the name of the enterprise with foreign investment, the enterprise with foreign investment will still be regarded as the

taxpayer, who shall calculate and pay turnover tax and Enterprise Income Tax, and, who shall enjoy the corresponding preferential policies for tax payment according to relevant tax laws and regulations. The fee paid for compensation to the individuals or for service charges to the appointed company may be listed as expenses for calculation of Enterprise Income Tax of the enterprise with foreign investment.

Calculation and payment of tax for compensation or for the service charges collected by the individuals or the appointed company mentioned above may be carried out according to the following principles:

a.Individual Income Tax shall be calculated and paid on the wages or salaries of the employees within the enterprise including compensation, and the enterprise with foreign investment shall withhold Individual Income Tax.

b.The appointed management service company shall pay Business Tax and Enterprise Income Tax according to relevant regulations on business income including the service charge from the enterprise with foreign investment.

B. If the enterprise with foreign investment is wholly or partially operated by shareholders of the enterprise, employees from another enterprise or within the enterprise, or by other individuals (hereinafter referred to as ′operators′), but the enterprise with foreign investment has not changed the registered industrial and commercial contents such as legal person status, name and business scope, etc., and its commercial activities are still carried out in the name of the enterprise with foreign investment, while the operators undertake the operation risk independently and enjoy the remainder of the business income left over after delivering a certain proportion of the income or a certain amount of money stipulated in the contract to the enterprise with foreign investment; in this case, the calculation and payment of tax shall be carried out according to the following principles whether the operation stipulated in the contract is a contractual operation or leased operation:

a.Turnover tax

The enterprise with foreign investment shall still be taken as the taxpayer in calculation and payment of turnover tax for the part of the income from production and the operator¡¦s part of the operations.

b.Income Tax

Ⅰ. If the operators are a company, the enterprise with foreign investment shall still be the taxpayer, and the income allocated to either side according to the contract cannot be deducted from taxable income. The calculation and payment of Enterprise Income Tax shall be made on the larger of the total income from the operator¡¦s part of the operations within the enterprise with foreign investment or the income obtained by the enterprise with foreign investment from the operators according to the contract, and the enterprise with foreign investment shall still enjoy the tax incentives. Tax shall be paid on income obtained by the enterprise with foreign investment from the operators¡¦ own capital according to the contract if the operators suffer a loss in their part of the operations. The amount of money supplemented by the operators to make up for the loss shall not be calculated into taxable income. If the operators apply the excess part, obtained by deduction of the amount to be paid to the enterprise with foreign investment according to the contract, from the total income from the business operator¡¦s part of the operations,to make up for losses in previous years, the excess part may be deducted from the taxable income derived from the operator¡¦s part of the operationsfor the year.

If the operators are an enterprise with foreign investment or a foreign enterprise, Income Tax shall not be levied on income after tax paid to the operators. However, if the operators¡¦ own funds are used to make up for the losses when the operators suffer a loss in their part of operations or the operations income is not large enough to cover the amount to be paid by the operators to the enterprise with foreign investment according to the contract, such funds shall not be written off from other taxable income of the operators¡¦ own enterprise. If the operators are local enterprises, the relevant regulations shall apply.

II. If the operators are individuals, the enterprise with foreign investment and the operators are both regarded as the taxpayers. Enterprise Income Tax and Individual Income Tax shall be calculated and paid respectively according to the actual incomes enjoyed by either side. If the operators suffer a loss in their part of the operations, the principles described in Item 1 above shall apply. The operators shall calculate and pay individual Income Tax on income achieved by the operators ( income is regarded as that from contractual operations or leased operations by individuals from enterprises or institutions) to the responsible taxation authorities of the enterprise with foreign investment.

C. The following principles apply to calculation and payment of tax in the case below: an enterprise with foreign investment rents out all or part of its assets (factory, workshop, house, place, counter, equipment, etc.) to other enterprises or individuals (hereinafter referred to as ′lessees′) for their production and operations; the lessees have their industrial and commercial registration made independently, have their own business certificates, conduct commercial activities in the name of the lessees, and only pay rentals to the enterprise with foreign investment in the form of monetary quota or monetary quota plus a certain percentage drawn from the operating income.

a.The turnover tax and Income Tax on the production and operations income derived from the rented part shall be calculated and paid according to the relevant tax laws with the lessees as the taxpayers, and the relevant tax incentives shall still be enjoyed. The rentals paid by the lessees to the enterprise with foreign investment may be calculated into expenses before the lessees¡¦ calculation and payment of Income Tax.

b.Rentals obtained by enterprises with foreign investment shall be regarded as their income from leasing on which calculation and payment of Business Tax and Income Tax shall be made.

c.An enterprise with foreign investment shall not enjoy the tax incentives applying to production enterprises with foreign investment stipulated in the "Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises" on income collected by the enterprise with foreign investment derived from renting out all its assets to lessees to conduct production or operations, since such income belongs to income from leasing but not to income from production. The tax incentives shall be implemented according to provisions in GOU SHUI FA [209] 1994, issued by the State Administration of Taxation for an enterprise with foreign investment who rents out part of its assets to the lessees to conduct production and operations.

(GUO SHUI FA [045] 1995.3.7)

3.2.20 Taxation on gifts of a public benefit or relief nature given by enterprises with foreign investment

Donations by an enterprise with foreign investment for welfare and relief within China may be categorized into and drawn from the enterprise¡¦s costs for the period. In the opinion of the State Administration of Taxation, the above donations refer to those offered by an enterprise with foreign investment for public welfare, such as education, civil administration and for relief in regions of natural disasters or poverty, via government bodies or non-profit social organizations in China (including China Development Foundation for Young Boys and Girls, Project Hope Foundation, Song Qingling Foundation, Disaster Reduction Committee, Red Cross Society of China, China Federation of the Handicapped, the National Foundation for Old Age, Promotion Society for Old Revolutionary Base Area and other welfare organizations established upon approval of the civil administration departments), but do not refer to those directly offered to beneficiaries.

(GUO SHUI HAN [175] 1995.4.27)

3.2.21 Advance collection of Enterprise Income Tax for the advance payments collected from sales of real estate

A. The local responsible taxation authorities may calculate in advance the estimated taxable income, according to the estimated profit margin or according to other appropriate methods, from the advance payments collected by an enterprise with foreign investment engaged in development of real estate from its sales of real estate, and shall collect in advance Income Tax on a quarterly basis. The amount of tax to be refunded or made up shall not be calculated on the basis of the actual taxable income and the Income Tax payable according to the relevant provisions of the Tax Law, until the transfer of the property rights of the real estate and the sales revenue are realized.

B. The responsible taxation authorities in the provinces, autonomous regions, municipalities as well as municipalities separately listed on the State plan may formulate the implementation rules for advance collection of Income Tax from enterprises with foreign investment engaged in the development of real estate, and may formulate the rules to determine the estimated profit margin, and then report these to the State Administration of Taxation to be put on record.

(GUO SHUI FA [153] 1995.8.3)

3.2.22 How to calculate the Enterprise Income Tax levy on lump sum membership fees received by enterprises with foreign investment

A. Enterprise Income Tax shall be calculated and paid on the income, which shall be calculated into the enterprise¡¦s income for the period, from lump sum payments for membership or for security of membership, etc., collected by clubs or club-like enterprises established with investment from foreign enterprises.

B. That part of the above mentioned fee returned to members who retire from the club may be written off from the income for the period when Enterprise Income Tax is calculated and paid.

(GUO SHUI FA [146] 1995.7.27)

3.3 Tax levy on the resident representative offices of foreign enterprises

A. The resident representative office shall not pay Industrial and Commercial Consolidated Tax and Enterprise Income Tax if it has not obtained business income and service charges from work for its head office such as market surveys, information and data supply, liaison, consultation, etc.

The resident representative office shall not pay tax on income from agency activities which are mostly carried out outside China, upon entrustment by enterprises within China.

B. The resident representative office shall pay tax on the following income:

a.agency commissions, other commissions and service charges collected by the resident representative office for its service work such as liaison, negotiation and introduction within China carried out for the agency business entrusted by other enterprises to its head office outside China.

b.compensation paid to the resident representative office by clients regularly in fixed amounts or according to the business volume of the agency activities for its work such as market survey, liaison, business information and data collection, consultation, etc. within China for the clients (including the clients of the head office);

c.agency commissions, other commissions and service charges collected by the resident representative office for agency business within China entrusted by other enterprises or for the liaison, negotiation, and go-between work in China entrusted by other enterprises.

C. Calculation and payment of tax shall be made according to the monetary amount in the contract for the commissions to be collected by the resident representative office for its liaison, negotiation, go-between service if the commission amounts are written into the contract. Calculation and payment of tax shall be made according to the commission amount determined by the local taxation authorities on the basis of the transaction volume with reference to usual commission rates if there is no commission amount written in the contract, and accurate documentary evidence is not available or the office fails to declare the commission amount accurately. As written in (a) of (B) in Article 3.3, if part of an item of agency work is carried out by the head office outside China, the resident representative office shall present relevant vouchers to the local taxation authorities for examination and approval of the taxable income to be declared in China.

D. Payment of tax may be made at the reduced tax rate of 5% for income from agency commissions, other commissions and service charges collected by the resident representative office for agency business or for go-between service it has carried out, if such income is covered in the List of Taxable Items and Tax Rates for Industrial and Commercial Consolidated Tax. Unless the taxable income can be calculated correctly on the basis of accurate cost and expense vouchers which are presented by the office, Enterprise Income Tax shall be calculated and levied, with 15% of the business income as the taxable income, on the basis of a profit margin appraised and determined according to Article 25 of the "Detailed Rules for Implementation of the Income Tax Law of the People¡¦s Republic of China on Foreign Enterprises".

E. ′Enterprise′ in the Regulations refers to both ′company′ and ′economic organization′.

(CAI SHUI ZI [110] 1985.5.15)

3.3.1 Calculation and payment of tax by the resident representative office on business income of which part is settled and obtained in China and part settled and obtained outside China

The income collected by the resident representative office of a foreign enterprise in China for go-between services, etc., is income derived from within China. For such income, tax shall be declared and paid to tax authorities according to the Provisional Regulations whether the payment is settled and made in China or outside China and whether the payment is settled and made to the resident representative office or to the head office.

(CAI SHUI ZI [122] 1985.5.13)

3.3.2 Calculation and Payment of tax for agency commissions, other commissions and service charges

Calculation and payment of tax shall be made for consolidated income from the agency commissions, other commissions and service charges collected by the resident representative office of foreign enterprises for go-between services, etc., in China, whether they are paid by one client or more than one client.

Tax shall be levied according to the Provisional Regulations on income from the other commissions collected by the resident representative office in China for go-between services, etc., whether or not the other commissions are included in the calculated price.

(CAI SHUI ZI [122] 1985.5.13)

3.3.3 Reply to the question whether or not the payment of tax shall be made with reference to the Provisional Regulations for income from go-between services and the like carried out by foreign enterprises, other economic organizations and individuals, who have not been approved for registration

Foreign enterprises, other economic organizations and individuals who have not been approved for registration by the Industrial and Commercial Administration shall not be permitted to conduct such business as introductions, consultations and liaisons in China. But for their previously collected income from agency commissions, other commissions and service charges, tax shall be levied according to the Provisional Regulations.

(CAI SHUI ZI [122] 1985.5.13)

3.3.4 Taxation on the intermediary fees received by the representative offices in China of foreign enterprises

A. According to the Provisional Regulations, all local taxation authorities shall calculate and levy tax on income from go-between services and the like conducted by the resident representative office of foreign enterprise in China, either on the basis of the actual declared income if the tax collection may be made according to the actual income, or on the basis of the appraised tax amount if the signed contract and commission rates, etc., are available.

B. To simplify tax collection, after approval by the taxation authorities, calculation and payment of tax may be made according to the amount of expenses on income collected by the resident representative office of foreign enterprise from go-between services and the like for other enterprises or for clients of the head office, if the resident representative office cannot present accurate documentary evidence or cannot distinguish between self-operated commodity transactions and agent commodity transactions.

a.The expenses of the resident representative office cover wages, salaries, bonuses, allowances, welfare fees given to the employees in or outside China, and fees for purchase of goods (including automobiles, office equipment and other fixed assets), for telecommunications, for travelling, for house rentals, for rentals of equipment, for communications and for business entertainment, and such expenses.

The resident representative office must declare the actual expenses mentioned above to the local taxation authorities and present relevant documents. For expenses occurring outside China, the resident representative office shall present documentary evidence signed by the head office and a certified accountant, to the taxation authorities for examination and approval.

b.The formula for calculation and payment of tax according to expenses:

Calculation of Enterprise Income Tax

income¡Ñ15% (determined profit margin)=taxable income

taxable income¡ÑEnterprise Income Tax rate for foreign enterprises=Income Tax payable

(CAI SHUI WAI ZI [200] 1985.9.19)

3.3.5 Taxation on ′commissions′

A. ′Commissions′ refers to the income obtained by the intermediary in go-between services for the conclusion of a transaction. In business contracts, the commission is obtained in two ways, i.e., the commission is included in the commodity price called price including commission, or the commission is not included in the commodity price, and is therefore calculated and collected independently according to the transaction volume in relation to go-between services. Since the commodities in transactions involving go-between services vary widely and the commission rates also vary, to solve the problems which arise in tax collection, the calculation and payment of tax for commissions collected by the resident representative office for the liaison, negotiation and go-between services may be made on the basis of a commission of 5% of the transaction volume of go-between services, if there is no commission amount written in the contract (or in some of the contracts there is a commission amount listed, while in others there is no commission amount listed, and all the contracts are implemented by the same resident representative office) or if the office cannot present accurate documentary evidence and cannot declare the commission amount. With few exceptions, the local taxation authorities shall make decisions according to the actual individual situation.

B. If the resident representative offices can present relevant vouchers and documentary evidence such as entrustment agreements or other similar documentary evidence showing that part of the business has been carried out by the headquarters outside China, they shall be allowed, provisionally, to file tax returns at 50% of total income upon the examination and verification by the local taxation authorities; with few exceptions, the local taxation authorities shall make decisions according to the actual individual situation.

(CAI SHUI WAI ZI [198] 1985.9.19)

3.3.6 According to Notice No. 198 concerning foreigners issued by the State Administration of Taxation and the Ministry of Finance (85), the " calculation and payment of tax for the commissions collected by the resident representative office for liaison, negotiation and go-between services may be made on the basis of a commission of 5% of the transaction volume of go-between services, if there is no commission amount written in the contract (or in some of the contracts there is a commission amount listed while in others there is no commission amount listed, and all the contracts are implemented by the same resident representative office ) or if the office cannot present accurate documentary evidence and cannot declare the commission amount". To further encourage the resident representative office to develop business, Industrial and Commercial Consolidated Tax shall be calculated and levied on the basis of the commission rate mentioned above being reduced from 5% to 3% although the commission rate is usually not high for resident representative offices. This Notice shall take effect on October 1, 1986.

(CAI SHUI WAI ZI [273] 1986.11.4)

3.3.7 The ′Enterprise Income Tax′ to be collected from the resident representative office, ′shall be calculated and paid on 15% of business income as the taxable income, on the basis of a profit margin determined according to Article 24 of the "Detailed Rules and Regulations for the Implementation of the Income Tax Law of the People¡¦s Republic of China on Foreign Enterprises", except when the resident representative office can present accurate Cost and expense vouchers, and the taxable income can be calculated correctly.′ To further encourage the resident representative office to develop business, after approval by State Council, it has been decided to reduce the determined profit margin for resident representative offices to 10% from 15% considering that the profit margins vary among resident representative offices.

(CAI SHUI ZI [290] 1986.10.6)

3.3.8 Tax collection based on the separation of taxes on income for self-operated commodity transactions from those on income, for the go-between services carried out by the resident representative office of a foreign enterprise, for its head office

A. According to Article 1 of the "Provisional Regulations on Collection of Industrial and Commercial Consolidated Tax and Enterprise Income Tax from Resident Representative Offices of Foreign Enterprises" (hereinafter referred to as ′Provisional Regulations′) issued by the Ministry of Finance, if the resident representative office only conducts activities for preparation and assistance (such as liaison, negotiation and collection of business information) for self-operated commodity transactions for the head office in order to fulfill the commodity transaction contract signed between the head office and the enterprise in China, and if the resident representative office can present a commodity purchase contract signed by the head office and the manufacturers outside China as well as invoices to show that the head office has sold the commodities to enterprises in China, that office may enjoy an exemption from tax, after approval by the local taxation authorities, on income from the difference between the import price and sales price and on other income.

B. The resident representative office shall pay tax on income from the difference between the sales price and the import price, which shall be regarded as a commission or service charge, if the resident office contributes to the conclusion of transactions in China by providing go-between services for the commodity transaction agency business entrusted by other enterprises outside China to the head office, or if the resident office conducts commodity import agency business for other enterprises in China.

(CAI SHUI WAI ZI [197] 1985.9.25)

3.3.9 Tax exemptions on that part of the income paid to domestic Chinese enterprises by the resident representative office of a foreign enterprise engaged in go-between services carried out in China, from its commission income.

That part of the income paid to domestic Chinese enterprises from the commission income of the resident representative office engaged in go-between services in China, may be deducted from the taxable income of the resident office who collected the commission income if, according to the contract, the commission income is to be shared by the resident office and the domestic Chinese enterprise, and the resident office can present relevant receipts and vouchers.

(CAI SHUI WAI ZI [197] 1985.9.25)

3.3.10 Determining the methods of tax levy on resident representative organizations

A. Calculation and payment of tax may be carried out according to the actual declared revenue and income, upon approval by the local taxation authorities, if the resident representative office can present all documents and vouchers such as signed contracts, commission rates, etc., and the office keeps account books, conducts business accounting on financial income and expenses, costs and expenditures, and if the office is able to present documentary evidence by a certified accountant at the place outside China where the expenses occurs.

B. Tax may be calculated and paid according to the amount of revenue or income examined, agreed to and approved by the local taxation authorities, if the resident representative office engaged in go-between services in China presents all the contract materials for the services, but there is no commission amount written in the contracts (or in some of the contracts there is a commission amount listed while in others there is no commission amount listed, and all the contracts are implemented by the same resident office) so no accurate documentary evidence for, and accurate declaration of, income can be supplied; or if accurate documentary evidence for costs and expenses cannot be supplied so taxable income cannot be accurately calculated.

C. Tax liability may be calculated and paid according to income calculated on the basis of expenses, after the State Administration of Taxation approves such an application by the resident office to the local taxation authorities, and after the situation has been reported, level by level, to the State Administration of Taxation, and if the resident office cannot present relevant contracts, agreements, or vouchers on which the revenue amount may be correctly calculated, or if the resident office cannot present accurate documentary evidence to distinguish between self-operated commodity transactions and agent commodity transactions, when conducting go-between services and agent services, etc., for the clients of the head office or when providing services for the parent company and its subsidiaries (excluding the subsidiary to which the resident office belongs).

(CAI SHUI WAI ZI [055] 1986.3.3)

3.3.11 The expenses of the resident representative office on its own business shall be regarded as expenses of the resident office. Those not regarded as the expenses of the resident office consist of the following expenses paid out as a loan by the resident office for the head office, on the business activities which are not within the business scope of the resident office:

A. expenses for air travel tickets paid as a loan by the resident office, for the visit of relevant personnel invited by the head office;

B. expenses paid as a loan by the resident office for the board, lodging, travel and business entertainment of a delegation organized by the head office to visit China; but such expenses for a delegation engaged in business negotiations and contract signing in China is not included;

C. expenses paid as a loan by the resident office on exhibition preparations, Customs Duty for samples, transportation in China, etc., for large exhibitions held by the head office in China.

(GUO SHUI WAI ZI [333] 1988.12.5)

3.3.12 On the matter of taxation of the commission and administration fee income received from engagement in the advertising industry by the resident representative offices of foreign enterprises

A. According to the "Provisional Regulations on Collection of Industrial and Commercial Consolidated Tax and Enterprise Income Tax from Resident Representative Offices of Foreign Enterprise" issued by the Ministry of Finance upon approval of State Council, Industrial and Commercial Consolidated Tax and Enterprise Income Tax shall be paid by the resident representative office of foreign enterprises on income from service for clients provided by the resident office in China. The Industrial and Commercial Consolidated Tax and Enterprise Income Tax shall be declared and paid on income received from the services mentioned above in China carried out by the resident office engaged in advertising agency business, whether or not the payment is made in China, and whether the payment is made to the resident office or to the head office outside China.

B. ′The income collected by the resident office of foreign enterprises for advertising agency business′ refers to the service charges paid by the entrustees to the resident office (or the head office outside China) according to provisions in the contracts or agreements. The income received by the resident office of foreign enterprises shall be regarded as 15% of the transaction volume written in the contracts or agreements, if there is no service charge written into the contracts or agreements, or if the taxpayer cannot present accurate documentary evidence to show the actual amount of income.

C. Income of the resident office shall be calculated according to Article 2 of CAI SHUI WAI ZI [198] 1985, concerning foreigners, issued by the Taxation of Foreigners Bureau and the Ministry of Finance, if a part of the agency transaction is carried out outside China by the head office.

D. The resident office of a foreign enterprise engaged in advertising business shall use 10% of its income for the year as its taxable income for the 1988 taxation year, if the resident office cannot present accurate account books and vouchers for costs and expenses.

(GUO SHUI WAI ZI [337] 1988.12.12)

3.3.13 Income shall be calculated on the basis of the fact that the actual business entertainment expenses are calculated into total expenses, if the resident representative office of a foreign enterprise calculates and pays tax according to income calculated on total expenses. In this case, the business entertainment expenses shall not be calculated and limited according to Article 13 of the "Detailed Rules and Regulations for the Implementation of the Income Tax Law on Foreign Enterprises".

(GUO SHUI WAI ZI [338] 1988.12.12)

3.3.14 Taxation on fee conversions of resident representative organizations in China

A. The following expenses may be excluded from the expenses of the resident representative office:

a.the rentals paid by the resident office as a loan for sites to hold seminars organized by the head office in China, if such seminars are unrelated to commercial negotiations or commercial contract signing;

b.where the head office sells certain special goods requiring registration (such as pesticides) and that registration was carried out according to relevant Chinese laws and regulations, the registration fees paid for the head office, as a loan, by the resident office in China and the advertising expenses paid for companies other than the head office paid by the resident office in China as a loan, need not be calculated into the total expenses of the resident office, if documentary evidence can be provided of repayment of the above two kinds of expense made by the head office or by the other companies;

c.the indemnity paid by the resident office in China (to be repaid later) caused by a breach of a contract signed by the head office with relevant organizations in China;

d.the pledge and guarantee deposit paid to Customs by the resident office in China (to be repaid later) for the appliances transported into China by the head office to provide labor services;

B. The total expenses of the resident office in China shall include the following expenses, mentioned in letters, paid by the resident office in China such as expenses for purchase and transport of samples in China for the head office; warehousing expenses and Customs clearance charges occurring in China for the transportation of foreign samples into China; expenses for employing interpreters for visitors to China from the head office; expenses for purchase of bid specifications by the resident office for tendering on a project in China, etc..

(GUO SHUI WAI ZI [140] 1989.5.22)

3.3.15 Surcharges for overdue tax payments and fines paid by resident representative offices of foreign enterprises in relation to tax payments shall not be calculated into expenses when calculation and payment of taxes are made according to income calculated on expenses.

(GUO SHUI HAN [726] 1991.6.3)

3.3.16 When tax liability is determined according to income calculated on expenses paid by the resident representative office of the foreign enterprise, the tax payments shall be paid according to income calculated on actual expenses, and income from interest cannot be used to offset the expenses.

(GUO SHUI HAN [1303] 1991.10.10)

3.4 Tax levy on offshore oil development

3.4.1 Regarding the date to decide the pre-contract fee of the foreign side in a contract involving Chinese-foreign cooperative exploration, development and production of offshore oil.

The effective date stipulated in the official contract approved by the Ministry of Foreign Economy and Trade of the People¡¦s Republic of China shall be taken as the date for determining tax payment on the pre-contract fee.

(CAI SHUI YOU ZHENG ZI [2] 1985.1.17)

3.4.2 The following decisions are made regarding reasonable expenses occurring before the signing of a contract (hereinafter referred to as ′precontract expenses′) by foreign companies engaged in cooperative exploration, development and production of offshore oil (hereinafter referred to as ′foreign companies′)

A. The precontract expenses occurring before the contract is signed between the foreign company and China Offshore Petroleum Corporation regarding cooperative exploration, development and production of offshore oil in China¡¦s first round of invitations for bids regarding the development of offshore oil, may be regarded as expenses for exploration, and may be amortized into income from the oil (gas) field where the commercial production of the foreign company has already started. The period for amortization shall be not less than one year, according to the provisions in Section 2 of Article 22 of the "Detailed Rules and Regulations for the Implementation of the Income Tax Law of the People¡¦s Republic of China on Foreign Enterprises."

The above precontract expenses consist of:??

a.expenses to implement the geophysical prospecting agreement signed with China Petroleum and Gas Exploration and Development Company in 1979;

b.expenses occurring in treatment and explanation of the geophysical prospecting materials;

c.expenses for signing the contract on cooperative exploration, development and production of offshore oil.

The foreign companies shall present relevant vouchers or documents to the tax authorities for the above precontract expenses. If, upon examination and verification, they are reasonable and relevant to the operation within China, the above precontract expenses paid by foreign companies may be calculated into the expenses for exploration.

B. The precontract expenses occurring before the signing of a contract, mentioned above in the second round of invitations for bids regarding cooperative exploitation of offshore oil resources with China, shall also be treated according to the present Regulations.

(CAI SHUI ZI [313] 1985.11.24)

3.4.3 In some Chinese-foreign cooperatively explored and developed oil fields, upon completion of preliminary appraisal operations, temporary oil production for experiments (hereinafter referred to as ′appraisal trial production′) must be carried out with temporary production facilities to determine the commercial value of the oil field, and to draw up the overall development plan. When regular production begins in the oil field, such trial production shall stop. The decisions below were made to correctly deal with tax problems in the appraisal trial production.

A. (omitted)

B. The remainder after trial production expenses paid by the company for the year are deducted from the income derived from trial production each year, and which is allocated to companies engaged in cooperative exploration and development of oil, shall be calculated into the exploration expenses of the contract field.

C. The ′trial production expenses′ in the above section includes expenses for temporary production facilities used for appraisal trial production. For its own temporary production facilities, depreciation shall be calculated and drawn according to the "Detailed Rules for Implementation of the Income Tax Law on Foreign Enterprises", and depreciation shall last not longer than 6 years. The rental of the temporary production facilities shall be categorized as trial production expense for the period, if the temporary production facilities are rented.

(CAI SHUI ZI [311] 1986.10.27)

3.4.4 Clarification is given as follows on tax payment of Chinese-foreign equity joint ventures (hereinafter referred to as ′joint ventures′) who provide services for the exploration and development of offshore oil

A. The fee paid by the joint venture to its Chinese and foreign mother companies

The Chinese and foreign mother company of the joint venture shall collect service charges by receipts for their supporting services to the joint venture in accordance with service items and service quantity actually provided. The service charges shall be collected on the basis of the transaction price between independent companies, but not on the basis of a fixed sum or a proportion of the operation income. If for some service items it is really difficult to do so, the joint venture shall provide reasons to the local taxation authorities to request flexible treatment.

B. The joint venture¡¦s provision for capital repair funds

The joint venture shall not make provision for capital repairs funds, according to CAI SHUI WAI ZI [10] 1984, concerning foreigners issued by the Tax Bureau of the Ministry of Finance. The fee on capital repairs or on technical innovation in their own fixed assets may be calculated into the cost for the period according to the amount actually spent. If the amount is large, it may be amortized.

Calculation and payment of taxes shall be made on the total income from rentals and repairs collected by the lessors, where the lessors are responsible for the repair of the assets rented by the joint venture.

C. Accounting treatment of the materials purchased by the joint venture

For purchased materials, the consumed part shall be calculated into the cost for the period according to the actual consumed amount and the unit price. For materials already calculated into the cost at purchase but not consumed at the end of the year, these expenses shall be transferred to the following year and shall be written off as material expenses for the period.

D. The price of the materials or equipment purchased by joint ventures from its Chinese or foreign mother company or from their associated enterprises

The price of the materials or equipment purchased by joint ventures from its Chinese or foreign mother company or from their associated enterprises shall not be higher than that of the materials or equipment purchased from a company which has no relation to the joint ventures. The taxation authorities have the right to make adjustments. The excess part of the price shall not be categorized as expenses when tax is calculated and paid.

(CAI SHUI YOU ZHENG ZI [27] 1986.11.27)

3.4.5 The calculation and payment of tax on the signing fee and contribution fee paid by the foreign contractual side to China Offshore Petroleum Corporation

A. The contract signing fee paid by the foreign petroleum company to China offshore oil (gas) field can be listed as exploration fees for the contract field in question, in accordance with stipulations in Paragraph 2 of Article 22 of "Detailed Rules for Implementation of the Enterprise Income Tax Law of the People¡¦s Republic of China". Where the company has already started commercial production, the period for amortization shall not be shorter than one year.

B. The fees contributed according to the petroleum contract by the foreign petroleum company for scientific research and personnel training etc. related to the development of China¡¦s oil resources may be regarded as expenses for exploration, development and production. Such fees may be deducted when calculating income tax:

a. The contribution fees actually occurring in the exploration phase may be regarded as an exploration expense in the contract area. It may be amortized in the income from oil (gas) field. Where the company has already started commercial production, the period for amortization shall not be shorter than one year.

b. The contribution fees actually occurring in the development phase may be regarded as capital expenditure in the development phase in the contract area, which shall be depreciated from the month when the commercial production starts in the oil field in the contract area. The period for depreciation shall not be shorter than 6 years.

5c. The contribution fees actually occurring after the oil (gas) field in the contract area comes into the production phase may be regarded as a production expense in the oil (gas) field in the contract area and shall be deducted that year.

(CAI SHUI ZI [341] 1986.12.11)

3.4.6 All the regulations made by the Ministry of Finance, the State Administration of Taxation and the Offshore Oil Tax Administration Bureau concerning Income Tax on foreign enterprises engaged in cooperative exploitation of offshore oil resources, apply to foreign enterprises engaged in exploitation on land oil resources, except when there are other specific regulations.

(GUO SHUI FA [20] 1990.2.13)

3.4.7 The expenses for medical care of employees in foreign petroleum companies

The expenses for medical care of employees in foreign petroleum companies paid by the foreign petroleum companies which have already drawn medical insurance fees and dental care insurance fees, shall not be regarded as expenses at calculation of the Income Tax of the enterprise.

(GUO SHUI YOU HAN [100] 1990.12.27)

3.4.8 The contract interest stipulated in the contract for Chinese-foreign cooperative exploration, development and production of oil is a method of allocating investment and products between the cooperative sides, but not the loan interest actually paid by the foreign oil companies. Therefore, contract interest shall not be categorized into the expenses when the foreign oil companies declare and pay foreign Enterprise Income Tax.

(GUO SHUI YOU HAN [003] 1991.1.28)

3.4.9 For the tax payment on insurance expenses paid outside China by foreign oil companies

Foreign oil company shall insure its assets in China for cooperative exploitation of oil resources at PICC, according to the insurance regulations and relevant regulations. If the amount insured by all sides together is small, and a certain company engaged in cooperation needs to increase the insurance amount, the company shall also take out insurance with PICC. The insurance expenses occurring outside China paid directly by foreign oil companies or by its mother company cannot be categorized into the total expense on calculation and payment of tax.

(GUO SHUI YOU HAN [093] 1991.8.20)

3.4.10 Examination and verification of loan interest paid by enterprises

A. Enterprises engaged in exploitation of oil resources in China shall present the official text of the loan contract or agreement to the responsible taxation authorities within one month from the date when the loan contract is signed and comes into force if the enterprise receives the loans from foreign banks or its associated enterprises. The names of the debtor and creditor, the amount, the interest rate, the period and the method of repayment of capital with interest shall be translated into Chinese in the official text, in addition, there shall be attached explanations in Chinese of the loan interest.

B. If the loan contract is between associated enterprises, if the responsible taxation authorities think it necessary, in addition to the official text of the loan contract and the explanations as mentioned in the previous section, there shall be documentary evidence provided by financial institutions or by international accounting companies to show that the loan belongs to normal loans and that the interest rate is reasonable.

C. The responsible taxation authorities shall inform the enterprise of the results of the examination and verification within two months from the date when the enterprise presents the contract text and documentary evidence.

(GUO SHUI FA [191] 1991.11.27)

3.4.11 Categorization of management expenses given to the head office

A. The reasonable fees paid by the enterprise to the head office for management in relation to the production and operations of the enterprise, shall not be categorized as expenses until the responsible taxation authorities check and approve them based on relevant documentary evidence and the verification report of the certified accountants provided by the enterprise, according to Article 20 of the Detailed Rules. Such management expenses shall not be categorized into expenses on calculation of Enterprise Income Tax, if the enterprise cannot present relevant documentary evidence according to the regulations or if the documents provided cannot prove that the management expenses are reasonable.

B. If the foreign oil company has chosen to pay management expenses to the head office according to the amount written in the oil contract, it may do so according to Article 22 of the Detailed Rules which shall come into force on January 1, 1992.

(GUO SHUI FA [191] 1991.11.27)

3.4.12 Determined profit margin

If the enterprise engaged in contracting engineering operations for exploration and development of oil resources or in supplying labour service, fails to present complete, accurate vouchers for costs and expenses, and cannot calculate the taxable income correctly, then as required by Article 16 of the Detailed Rules, the taxable income of the enterprise shall be calculated according to the profit, with the profit margin determined as 10%, appraised on the basis of total business income.

(GUO SHUI FA [191] 1991.11.27)

3.4.13 Tax payments for labor services provided in China by an associated enterprise

For labour services (including technical services ) provided in China by the associated enterprises of foreign oil companies engaged in cooperative exploitation of oil in China, the labor service charges shall be collected and paid as if they are independent enterprises, and on the income from labor services, income tax shall be calculated and paid according to the Tax Law and the Detailed Rules. The taxable income shall be calculated according to the profit obtained with 10% as the profit margin, if the enterprise fails to present complete, accurate vouchers for costs and expenses, and cannot calculate the taxable income correctly.

(GUO SHUI FA [191] 1991.11.27)

3.4.14 Capital repairs fund

According to the Tax Law, China Offshore Petroleum Corporation is not permitted to draw capital repairs fund, the expense on repairs actually occurring in the year in China Offshore Petroleum Corporation may be categorized as expenses upon examination and approval by the taxation authorities. The remainder of the capital repairs fund drawn in previous years shall be written off from the expenses on repairs in the following years. Expenses on repairs for the year shall not be paid until the remainder is used up.

(GUO SHUI YOU FA [009] 1994.4.23)

3.4.15 Allocation of income from personal expenses

China Offshore Petroleum Corporation may draw a share of revenue from personal expenses according to the relevant regulations by the Ministry of Finance. If the total sum of bonuses, floating wages and wage rises. etc., which shall be categorized in and drawn from the share of revenue from personal expenses, actually occurring in the enterprise is more than the total sum of the share of revenue drawn from the personal expenses, the excess part may be categorized in the expenses for the period, and vice versa, the insufficient part may be written off from the expenses of the year.

(GUO SHUI YOU FA [009] 1994.4.23)