Corporate income tax treatment for Hybrid Investment

Published on 2022-03-28

Preface

Equity investment and loans are two different forms of investment investors may contribute to the invested enterprises with respect of repayment and calculation of return. Accordingly, tax treatment for both investors and investees for these two kinds of investment is different. For equity investment, the return is treated as dividends which can be exempted tax for resident enterprise. For invested enterprise, the dividend cannot be deducted before corporate income tax (“CIT”). While for loans, the return is interest. The investing enterprise shall levy CIT and invested enterprise can make deduction before CIT.

In this article, we would like to introduce tax regulation for investment which may have characteristics of both equity investment and loans.

What kind of hybrid investment can apply the tax regulation?

Only the hybrid investment which meets the following 5 conditions at the same time can apply the tax treatment for hybrid investment under tax regulation:

  • The invested enterprise shall pay interest on a regular basis at an interest rate agreed in the investment contract or agreement (or pay minimum guaranteed interest, fixed profit or fixed dividend on a regular basis, the same hereinafter)
  • Explicit investment period or specified investment term shall be stipulated, and invested enterprise shall buy back the investment or repay the principal upon the expiration of investment period or fulfilment of the specified investment term.
  • The investing enterprise has no ownership to the net assets of the invested enterprise.
  • The investing enterprises do not have the right to vote and stand for election.
  • The investing enterprise shall not involve in the daily production and operation activities of the invested enterprise.

Cross border hybrid investment under tax regulations refers to the above defined hybrid investment which is conducted by overseas investor in China.

Corporate Income Tax (“CIT”) tax treatment

The hybrid investment which meets the conditions can apply the below CIT tax treatment:

  1. Tax treatment for interest payment on a regular basis

For investor, the interest income from the investment shall be included in taxable income to levy CIT on the due date when invested enterprise shall make payment. For overseas investor, withholding tax shall be paid.

For the invested enterprise, interest expense can be recognized on the due date when payment shall be made, and only the portion of interest expense which is equal or lower than an amount calculated at interest rate of the financial institutions for the same duration and same category loans, is allowed to be deducted before CIT.

  1. Tax treatment for buy back investment

For buy back of investment, both the investor and investee shall treat the transaction as debt reorganization and recognize the gain or loss of debt reorganization with the difference between the cost of investment and the consideration paid for the buy back as gain and levy CIT. If the consideration is higher than the investment cost, investment enterprise shall recognize gain and pay CIT, and invested enterprise shall recognize loss which can be deducted before CIT. On the contrary, if the consideration is lower than investment cost, investment enterprise shall recognize a loss which can be deducted before CIT and the invested enterprise, a gain and shall levy CIT.

For overseas investor, for the gain from debt reorganization, still, withholding tax shall be paid.

Different Tax treatment for certain cross-border hybrid investment

The cross-border hybrid investment which meets the following two additional conditions at the same time shall be treated differently:

  1. The overseas investor and invested enterprise in China are related parties.
  2. The state or region in which the overseas investor is located identifies the investment income as equity investment income and does not levy CIT.

For the above cross border hybrid investment, interest shall be treated as dividend. For the overseas investor, still, withholding tax shall be levied. For the invested enterprise in China, the interest shall not be deducted before CIT.

Comments

  1. The hybrid investment that meets the conditions defined in the tax regulation shall apply the relevant tax treatment as debt investment. Therefore, in designing the transaction procedure and agreement term, tax requirement shall be checked carefully for the consideration of tax arrangement.
  2. For cross-border hybrid investment, even all 5 conditions have been satisfied, tax treatment as debt investment shall not be applied, if both parties are related parties and the investment income is regarded as equity investment income and no tax is levied by the country (region) in which the overseas investor is located. For this kind of cross-border hybrid investment, investment income is treated as dividend for tax treatment.

List of applicable tax regulations

  1. The announcement on certain issues relating to corporate income tax issued by State Tax Bureau (Announcement by State Tax Bureau（2011）34)国家税务总局关于企业所得税若干问题的公告(国家税务总局公告2011年第34号)
  2. The announcement on corporate income tax treatment for hybrid investment issued by State Tax Bureau (Announcement by State Tax Bureau (2013)No.41)国家税务总局关于企业混合性投资业务企业所得税处理问题的公告(国家税务总局公告2013年第41号)
  3. The announcement on implementation of certain policies for corporate income tax by State Tax Bureau (Announcement by State Tax Bureau (2021) No.17)国家税务总局关于企业所得税若干政策征管口径问题的公告(国家税务总局公告2021年第17号)

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