China: Change in taxation of equity investments

Deemed-income IIT filing rescinded

Using a deemed-income approach in individual income tax (IIT) filings is no longer allowed for investment-holding sole proprietorship and partnership owners, effective from 1 January 2022, per Announcement 41 issued by the Chinese tax authority. Instead, a booked-income approach must be used and their equity holding status must be reported by a specific deadline.

The deemed-income approach had been used by the said individuals to file IIT based on a flat IIT rate and a deemed income, without making reference to their accounting record. The practice faced intense criticism following the outbreak of some serious tax avoidance cases lately.

Anti-tax abuse

For some years, holding investments via sole proprietorship or partnership has been so popular that their portfolio scale has grown substantially beyond expectation.

Compared to limited liability companies, sole proprietorship and partnership entities are taken as a convenient equity-holding vehicle to register or de-register, and flexible to re-allocate the controlling right among the owners. Especially for their unique tax filing method, they are often used by high-net-worth individuals to hold equity investments, sometimes in combination with a trust vehicle.

Tax equality

However, the new policy has now set out that their tax base (or taxable income) for IIT filings has to be based on the actual profit, using the standard IIT rate scheme.

It is understood that Announcement 41 aims at removing tax abuses or inconsistency in the income-deeming practice, and at resolving the issue that natural person investors were paying less tax than corporate investors.

Implications

The following table illustrates how IIT burden could vary under two different IIT filing approaches when a natural person is selling a five-million-worth equity as an example. Between the deemed-income and the booked-income approach, the IIT burden can vary from CNY 109,500 to 634,500.

Announcement 41 represents another measure to safeguard a fair taxation environment and to put sole proprietorship and partnership operations under the same tax governance regime. Investors holding investment via a sole proprietorship or partnership entities are advised to re-evaluate the rationality and compliance requirements.

If you wish to discuss this topic, please contact: WTS China Co. Ltd., Shanghai

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