In contrast to the previous regime, under the EITL no distinction is made between a domestic or foreign invested enterprise. Under Article 2, liability for taxation now turns upon whether an enterprise is a “resident enterprise” or a “non-resident enterprise”.

Resident Enterprise

A “place of effective management” test is used to determine whether an enterprise is resident or non-resident. Resident enterprises are those enterprises which are established inside China or whose ‘actual office of management is inside China.’ An establishment will be considered the “actual office of management” if it exercises substantive and overall management and control over the production and business operations, personnel, financial functions and properties, etc of an enterprise. Under Article 2, Resident enterprises are taxed on their worldwide income, generally at a rate of 25 per cent.

Non-resident Enterprise

Under Article 2 of the EITL a non-resident enterprise refers to an enterprise established under the law of a foreign country whose place of effective management is not within China but which has “offices or establishments inside China”, or has income sourced in China. Article 5 of the EIT Regulations state that “offices or establishments inside China” refers to offices and establishments that “conduct production activities and business operations” in China, including:

1. Management institutions, operational institutions, and offices;
2. Factories, farms and place for exploitation of natural resources;
3. Establishments for the provision of labour services;
4. Establishments for engineering operations with respect to construction, installation, assembling, repairing, and surveying, etc; and
5. Other institutions and establishments where production activities and operations are carried out.

Under Article 5, an office or establishment shall also be created within China where a non-resident enterprise engages an agent to ‘carry out production activities or business operations within the territory of China, including the entrustment of any entity or individual to sign contacts on its behalf to handle the warehousing or delivery of goods, etc.’

Under Article 3 of the EITL, a non-resident enterprise is liable to taxation in China on any income which is effectively sourced from China. In the case of a non-resident enterprise that has offices or an establishment within China this includes both income derived from inside China and income derived outside of China ‘but which has a real connection with’ its offices or establishments inside China. The concept of a “real connection” with offices or establishments inside in China is purportedly clarified in Article 8 of the EIT Regulations to mean where the office or establishment within the territory of China ‘acquires equity or credit, or owns, manages or controls its property.’ Under Article 4 of the EITL, the tax rate for non-resident enterprises that do have an office or establishment in China, with respect to income connected to that office or establishment, is 25 per cent.

Under Article 3 of the EITL, non-resident enterprises that do not have an office or establishment inside China, or a non- resident enterprise whose incomes have no actual connection to its office or establishment inside China, are subject to taxation on any income derived from China (“withholding tax”). Dividends, royalties, interest and rental income are the main types of China source income that most likely would not have a connection with an office or establishment, and accordingly would be subject to withholding tax. Under Article 4, the withholding tax rate is 20 per cent. However, in accordance with Article 27(5) of the EITL, the EIT Regulations reduce the withholding tax rate to 10 per cent.

The formula for calculating the tax payable by an enterprise is as follows:

Tax amount = taxable income X applicable rate – amount of tax reduction and exemption – tax credit