In China, businesses generally adopt a corporate form due to their operational and legal advantages. Common structures include:

• Limited Liability Company (LLC): Shareholders’ liability is limited to their capital contributions. This is the most popular form due to its flexibility and liability protection.
• Joint Stock Company (JSC): This structure is suitable for larger enterprises requiring access to capital markets. Shareholders’ liability is limited to their shareholdings.

These entities are taxed as separate legal entities under the Corporate Income Tax (CIT) system.

However, in China, not all enterprises generally adopt the company form. There are also other forms like sole proprietorships and partnerships.

• Sole Proprietorships: These are set up by one natural person. The owner has unlimited liability for the business’s debts and it is managed flexibly by the owner or appointed persons.
• Partnerships: These comprise general partnerships and limited partnerships. Partners in general partnerships have unlimited joint and several liability, while in limited ones, limited partners’ liability is limited to their contributions.

These entities are not taxed as separate legal entities under the Corporate Income Tax (CIT) system. Instead, the owner of a sole proprietorship pays individual income tax on business income, and partners in a partnership are taxed according to their nature: individual partners pay individual income tax, while entity partners are subject to corporate income tax.

In China, transparent entities are not taxed at the entity level; income is passed through to partners or investors, who are taxed individually. Common types include general partnerships (GPs), limited partnerships (LPs).

• GPs are commonly used by law firms, accounting firms, and consulting businesses, where all partners actively participate in management and bear unlimited liability for the partnership’s obligations.
• LPs are favoured in private equity and venture capital, consist of general partners who manage the entity and bear unlimited liability, while limited partners provide capital but have limited liability.

Advantages of Transparent Entities

• Tax Efficiency: They avoid corporate-level taxation and prevent double taxation on investment income.
• Flexible Profit Distribution: Investors and fund managers can tailor profit allocation strategies.
• Limited Liability for Investors: LPs provide liability protection for investors, restricting risk exposure to their capital contributions.
• Management and Liability Flexibility: The GP-LP model allows professionals (such as fund managers) to perform as a GP to assume unlimited liability, while passive investors only bear liability up to their capital contribution and have no management obligations.

It should be noted that trusts in China are not defined as transparent entities.

An incorporated business is considered a Chinese resident enterprise if:

• it is lawfully incorporated in China, meaning it is established in accordance with Chinese laws and administrative regulations and has completed the corporate registration process with the Chinese government; and
• its “place of effective management” is located in China, referring to where substantial and overall business operations, management, and decision-making occur.

For transparent entities (eg, partnerships), Chinese tax authorities generally determine tax residence based on where the partners or actual management reside. If the entity’s effective management is in China, it may be deemed a Chinese tax resident.

However, residency determinations for incorporated businesses and transparent entities are also subject to double taxation treaties (DTTs).

China’s DTTs generally follow the OECD Model Tax Convention or the UN Model, providing tie-breaker rules to resolve dual tax residency conflicts. When both China and another country treat a company as a tax resident, the place of effective management (PoEM) typically determines the final residence status. For instance, under the China-Singapore DTT, if a company is considered a resident in both jurisdictions, its PoEM decides its residence. Certain treaties, such as the China-Hong Kong DTT, may provide a more detailed definition of PoEM, sometimes requiring the company’s board of directors or top-level management to have a permanent establishment in the jurisdiction.

Incorporated Businesses

Chinese incorporated businesses are generally subject to multiple taxes administered at both national and local levels. The primary categories include corporate income tax, value-added tax, and various local surcharges. Other taxes may apply depending on the company’s business activities, industry, and location.

Corporate income tax (CIT)

• The standard rate is 25% for most enterprises.
• Preferential rates, such as 15%, are available for specific enterprises, including high and new technology enterprises (HNTEs) and businesses engaged in encouraged industries in certain regions, such as Hainan.
• Eligible small low-profit enterprises can benefit from an effective tax rate as low as 5%.

Value-added tax (VAT)

• General VAT rates usually range from 6% to 13%, with 13% being the most common.
• Certain goods or services fall under a lower 9% rate or a 6% category.
• Small-scale taxpayers may pay a simplified rate of 3%.

Consumption tax

• This tax targets specific goods like tobacco, alcohol, and luxury items.
• They may be subject to an ad valorem rate (ranging from approximately 5% to 56%) or a specific rate based on the quantity of goods (charging a fixed amount per unit), and in some cases, a combination of both methods.

Local surcharges and other taxes

• Urban Maintenance and Construction Tax: This is calculated as a percentage (1%–7%) of the VAT or consumption tax payable.
• Stamp Duty: This is levied on certain contracts or documents, with rates typically between 0.03% and 0.1%.
• Property Tax and Land Use Tax: This is applied to real estate and land, with specific rates varying by locality.

Tax Rates for Businesses Owned by Individuals or Through Transparent Entities

In China, businesses owned by individuals directly or through transparent entities (such as sole proprietorships, general partnerships, or limited partnerships) are generally subject to individual income tax (IIT) rather than corporate income tax (CIT). IIT applies on a progressive scale, typically ranging from 5% to 35%, depending on the amount of taxable income. Some local incentives and special policies may further reduce the effective tax burden.

Because income flows through to individual owners, no separate CIT is imposed on these structures. Investors or partners report their share of the operating profits as personal income, and any tax due is determined by their applicable IIT brackets. This pass-through system helps avoid a double layer of taxation but can result in higher tax liability if the individual’s total income places them in a higher tax bracket.

Similarly, businesses owned directly by individuals or through transparent entities must also pay transaction-based taxes such as VAT and consumption tax, just like incorporated businesses. However, the applicable tax rates may differ depending on specific circumstances.

Taxable profits in China are calculated based on accounting profits, with adjustments for tax purposes, including:

• Non-deductible Expenses: Certain expenses, such as fines, penalties, and excess entertainment costs, are not tax-deductible.
• Exempt or Preferential Income: Certain income, like qualified dividends from resident enterprises, may be exempt or eligible for preferential treatment. Profits are taxed on an accrual basis, meaning income is recognised when earned, and expenses when incurred.
• Specific Deductions/Allowances: Some expenditures (for instance, eligible research and development expenses) can be deducted at a higher percentage than recorded in the accounting books.

China primarily adopts an accrual-based system for tax purposes. Income is recognised when earned, and expenses when incurred, rather than upon actual cash receipt or payment.

Although the accrual method is standard, certain industries or transactions may be subject to special rules or industry-specific guidance from the tax authorities.

China does not operate a formal patent box regime; however, it provides a super deduction for R&D expenses, allowing eligible costs to be deducted at 200%.

Other special incentives for technology are outlined below.

HNTE Status

Qualifying HNTEs enjoy a reduced CIT rate of 15%, compared to the standard 25%.

Software Industry Incentives

• CIT: Encouraged software enterprises may be eligible for a “two-year exemption and three-year half reduction” policy, beginning from their first profitable year under the standard 25% statutory rate. Particularly crucial enterprises may qualify for a five-year exemption followed by a 10% tax rate.
• VAT: Businesses selling self-developed software products can receive a VAT refund for the portion where the actual VAT burden exceeds 3% after paying the standard 13% VAT.

Additional Local Support

Certain regions in China provide extra incentives, such as tax rebates, subsidies, and grants, to attract technology-focused businesses.

Free Trade Zones (FTZs)

China’s FTZs, such as the Shanghai Free Trade Zone and the Hainan Free Trade Port, offer tax and customs incentives designed to boost international trade and investment.

Benefits often include reduced import duties on certain goods, and, in some cases, a lower CIT rate of 15% for companies in encouraged industries.

Western Region Development Programme

Companies operating in designated western provinces may qualify for a reduced CIT rate of 15% if they engage in encouraged industries (eg, infrastructure, advanced manufacturing).

Eligible Small Low-Profit Enterprises

From 1 January 2023 to 31 December 2027, small and low-profit enterprises with annual taxable income of up to RMB3 million may include only 25% of that portion in their taxable income. CIT is then calculated at 20% on the reduced amount, resulting in an effective tax burden of 5%.

Enterprises Engaged in Pollution Prevention and Control

From 1 January 2019 to 31 December 2027, qualified enterprises focused on pollution prevention and control are eligible for a reduced CIT rate of 15%.

The incentives described above represent only some of the core special incentives available in China. The government periodically releases targeted policies for sectors such as biotechnology, semiconductors, and high-end manufacturing. These policies may provide tax credits, grants, or accelerated depreciation for qualified equipment purchases, all aiming to stimulate development and enhance China’s global competitiveness in key industries.

Enterprises can carry forward losses for up to five years to offset future profits. High-tech enterprises may carry forward losses for up to ten years. There is no provision for loss carryback in China. Business income and capital gains are generally consolidated into overall profits or losses. Income losses can be offset against capital gains and vice versa.

Thin Capitalisation Rules

• China enforces thin capitalisation rules, which limit the deduction of interest expenses on loans from related parties.
• Generally, the debt-to-equity ratio should not exceed 2:1 for most enterprises and 5:1 for financial institutions.
• If the ratio exceeds these thresholds, the excess interest may not be deductible for CIT purposes unless the enterprise can prove that the financing was conducted on an arm’s length basis.

Related-Party Loan Interest Deduction

• Interest on loans from related parties must comply with transfer pricing rules to ensure that interest rates and terms reflect fair market conditions.
• The tax authorities may adjust interest deductions if they consider the interest rate excessive or not at arm’s length.

Anti-Tax Avoidance Provisions

If an enterprise structures debt arrangements in a way that aims to erode the tax base artificially (eg, excessive intra-group interest payments), the tax authorities have the right to re-characterise the transaction and limit deductions under general anti-avoidance rules (GAAR).

Consolidated tax filings are generally not permitted in China, and each company must file taxes separately. Losses cannot be transferred between entities. However, businesses can optimise tax efficiency within a group through strategic structuring, transfer pricing compliance, and M&A arrangements while ensuring regulatory compliance.

Although parent companies and their subsidiaries cannot file consolidated tax returns, headquarters and branches can do so because branches are not separate legal entities from their headquarters.

In China, corporate capital gains are taxed as ordinary income, typically at 25% CIT, with no separate capital gains tax regime. However, dividends from resident companies are exempt, and tax deferrals may apply to qualified restructurings; however, for publicly issued and traded shares, dividend and profit distributions are exempt from tax only if the shares have been continuously held for more than 12 months.

Capital gains from selling shares are not exempt and remain taxable. Foreign investors selling Chinese shares may face a 10% withholding tax, subject to treaty relief.

The main taxes are outlined below.

VAT

• General VAT rates usually range from 6% to 13%, with 13% being the most common.
• Certain goods or services fall under a lower 9% rate or a 6% category.
• Small-scale taxpayers may pay a simplified rate of 3%.

Consumption Tax

• This tax targets specific goods like tobacco, alcohol, and luxury items.
• They may be subject to an ad valorem rate (ranging from approximately 5% to 56%) or a specific rate based on the quantity of goods (charging a fixed amount per unit), and in some cases, a combination of both methods.

Local Surcharges and Other Taxes

• Urban maintenance and construction tax is calculated as a percentage (1%–7%) of the VAT or consumption tax payable.

Stamp Duty

This is levied on certain contracts or documents, with rates typically between 0.03% and 0.1%.

Land Appreciation Tax (LAT)

This tax is imposed on gains from real estate transactions, such as the sale of land use rights or buildings. Progressive tax rates range from 30% to 60% based on the appreciation value.

Deed Tax

This tax applies to the transfer of land use rights and real estate transactions. Rates generally range from 3% to 5% of the transaction value.

Notable taxes applicable to incorporated businesses may include:

• environmental protection tax, which is levied on pollutants discharged into the environment;
• real estate-related taxes, such as land use tax and real estate tax, depending on property ownership and usage; and
• resource tax (businesses engaged in exploiting taxable natural resources like minerals are liable for resource tax; the tax is based on the quantity or value of the resources exploited, and rates differ according to different resource categories).

According to data released by the Chinese government, business entities in China are primarily sole proprietorships (individual industrial and commercial households) rather than corporate entities. This structure offers simpler registration procedures and lower operational costs. In most cases, non-corporate businesses are not required to maintain full accounting records, making them a more cost-effective option for small entrepreneurs.

In China, IIT rates range from 3% to 45%, with certain types of income, such as capital gains and dividends, taxed at a fixed 20% rate. CIT is commonly levied at 25%, and profits distributed from companies to individuals are generally subject to a 20% tax. As a result, CIT rates are not necessarily lower than individual income tax rates, and the overall tax burden depends on income structure and tax planning strategies.

In China, there are no specific anti-accumulation tax rules that explicitly prevent closely held corporations from retaining earnings for investment purposes.

Dividends from closely held corporations are taxed at a fixed 20% IIT, withheld at the corporate level.

Capital gains from selling shares in private corporations are taxed at 20% IIT, with the seller responsible for reporting.

Tax on Dividends

For secondary market shares (publicly traded shares bought on stock exchanges)

Dividends are subject to IIT based on the holding period:

• held for ≤1 month: 20% tax;
• held for >1 month but ≤1 year: 10% tax; and
• held for >1 year: exempt from IIT.

The listed company withholds and remits the tax before distributing the dividends.

For restricted shares (lock-up shares in a listed company)

Before the lock-up period ends

Dividends are taxed at an effective rate of 10%, as only 50% of the dividend amount is included in taxable income and taxed at 20% IIT.

After the lock-up period ends

Dividends are taxed the same as non-restricted shares, based on the standard holding period-based tax rates (0%, 10%, or 20%) as above. The holding period starts from the date of the share unlock (not the original acquisition date).

Tax on the Gains of the Sale of Shares

For secondary market shares (shares bought on the stock exchange)

Capital gains from selling A-shares (Mainland-listed stocks) are exempt from IIT, but a 0.1% securities transaction tax (STT) applies to the selling side.

Capital gains from selling restricted shares after unlocking are subject to a 20% IIT, the same as other private equity transactions.

In the absence of income tax treaties, China imposes a 10% withholding tax on interest, dividends, and royalties, with limited domestic relief options. If a tax treaty is in place, the withholding tax rate may be reduced.

The local tax authority closely monitors cross-border payments, especially for related-party transactions and royalty arrangements, and employs stringent enforcement measures to ensure compliance. The government’s strict monitoring is driven not only by tax enforcement considerations but also by China’s foreign exchange control measures, aiming to prevent companies from exploiting payments of interest, dividends, and royalties as loopholes to circumvent foreign exchange regulations and transfer funds overseas.

Hong Kong is the most commonly used jurisdiction (not a country) due to its favourable double tax treaties with China.

Under the China-Hong Kong Double Tax Agreement, withholding tax rates on dividends and interest may be reduced to 5%, subject to specific conditions. Hong Kong’s relatively simple tax system and strong financial infrastructure make it a preferred platform for investments into Chinese corporations.

In addition to Hong Kong, the Chinese government has signed DTTs with over 100 countries and regions, many of which include tax incentives related to investment.

Chinese local tax authorities often examine cross-border arrangements that appear to exploit treaty benefits without meeting the required conditions. In particular, they focus on whether the entity in the treaty country qualifies as the “beneficial owner” of the income.

Relevant Treaty Provisions and Interpretations

Certain double tax treaties include the concept of “beneficial ownership” as a criterion for enjoying preferential withholding tax rates on dividends, interest, or royalties. If a non-resident entity cannot demonstrate that it is the true beneficial owner of the income, local tax authorities may deny treaty benefits.

General Anti-Avoidance Rules (GAAR)

In addition to treaty-specific provisions, China’s Corporate Income Tax Law and its implementing regulations contain GAAR provisions. If an arrangement is primarily tax-driven and lacks a valid commercial purpose, tax authorities have the right to adjust the transaction. Non-treaty country residents using treaty country entities purely for tax benefits may have their structures recharacterised, resulting in the denial of treaty benefits and the application of standard withholding tax rates.

Inbound investors face challenges ensuring cross-border related-party transactions meet the arm’s length principle. Key issues include financing arrangements, intellectual property payments, management fees, intercompany pricing, and documentation compliance.

Related-Party Financing

• The main concern is whether cross-border loans and interest rates are at arm’s length.
• Non-compliance can lead to denied deductions and higher taxable income.

Intellectual Property Royalties

• The main concern relates to royalty rates and their alignment with market value.
• If deemed excessive, tax authorities may make adjustments and question the substance of the arrangement.

Service and Management Fees

• The main concern is whether services were provided and properly documented.
• Improperly supported fees can be disallowed or adjusted.

Profit Shifting and Intercompany Pricing

• The main concern is preventing profit shifting through related-party transactions.
• Disputes can result in additional taxes, penalties, and interest.

Documentation Compliance

• The main concern is meeting China’s strict transfer pricing documentation standards.
• Poor compliance can trigger audits, increase costs, and lead to adjustments.

Local tax authorities in China may challenge related-party limited risk distribution arrangements if they believe these arrangements do not comply with the arm’s length principle.

While China’s transfer pricing regulations are generally based on OECD guidelines, key differences exist in enforcement practices, the emphasis on local economic substance, and the treatment of location-specific advantages. These distinctions can result in outcomes that vary from OECD standards, especially in how profits are allocated to Chinese entities and the documentation burden placed on taxpayers.

In recent years, local tax authorities in China have stepped up their efforts on transfer pricing enforcement. They closely monitor transactions between related parties, especially those involving significant amounts or complex structures. They are willing to make new inquiries and to re-examine earlier tax years if fresh information or documentation suggests that past transfer pricing arrangements might not have been at arm’s length.

Meanwhile, the Chinese tax authorities have been actively participating in MAP negotiations to resolve related disputes and to enhance China’s reputation as a reliable investment destination. MAPs are becoming more common in China. The rise in cross-border transactions, coupled with more frequent audits and tighter transfer pricing scrutiny, has led to a growing number of disputes that taxpayers prefer to resolve through MAP. This trend is further reinforced by China’s commitment to implementing OECD recommendations, including enhanced dispute resolution mechanisms under the Base Erosion and Profit Shifting (BEPS) framework. As a result, MAPs are likely to play an increasingly important role in addressing complex transfer pricing issues and mitigating double taxation in China.

Compensating adjustments can be made when a transfer pricing dispute is resolved.

The local branches of non-local corporations are taxed differently to local subsidiaries of non-local corporations. The primary differences arise from their legal structure. A local branch is an extension of the foreign corporation and does not have a separate legal identity, while a local subsidiary is an independent legal entity.

Capital gains tax is generally imposed on non-residents who sell Chinese stock. Indirect transfers through foreign holding companies can also be taxed under China’s indirect transfer rules, and treaties may provide relief, but only if certain criteria – including economic substance and anti-abuse standards – are satisfied.

Chinese tax laws include provisions that could trigger tax charges in the event of a change of control, particularly under the rules governing indirect transfers of Chinese taxable assets.

In general, China does not rely on fixed formulas to determine the income of foreign-owned local affiliates that sell goods or provide services. Instead, the tax authorities primarily follow thearm’s length principle as outlined in transfer pricing regulations.

In China, the deductibility of payments made by local affiliates to non-local affiliates for management and administrative expenses is subject to strict transfer pricing and documentation requirements. The key standard applied is the arm’s length principle.

Key Conditions for Deductibility

Economic substance and necessity

• The local affiliate must demonstrate that the management or administrative services were actually provided and that they directly benefitted the local affiliate’s business.
• Payments for services that do not provide a measurable benefit or that duplicate the local affiliate’s existing capabilities are generally not deductible.

Reasonableness of charges

• The amount charged for the services must be reasonable, reflecting what independent parties would have agreed upon in a comparable transaction.
• Excessive charges or fees unrelated to actual services rendered may be disallowed.

Adequate documentation

• The local affiliate must maintain comprehensive documentation, including service agreements, invoices, and proof of services performed.

• Authorities may require a detailed breakdown of the nature of the services, the basis for the charges, and evidence that the costs were incurred at arm’s length.

China imposes constraints on related-party borrowing by foreign-owned local affiliates, primarily through thin capitalisation rules and transfer pricing regulations. For more details, see 2.5 Imposed Limits on Deduction of Interest.

At the same time, when the foreign-owned local affiliates pay to non-local affiliates, they must also comply with China’s foreign exchange controls.

Foreign income earned by local corporations is generally not exempt from corporate tax. Instead, it is included in the global taxable income of the corporation and subject to the same tax rates as local income. However, double taxation may be alleviated through foreign tax credits and applicable tax treaties.

If certain foreign income is exempt from Chinese CIT, any local expenses that directly relate to earning that exempt income become non-deductible under Chinese tax rules. This ensures that businesses do not receive both an income tax exemption and a deduction for expenses incurred in earning that exempt income.

Dividends received by a Chinese resident corporation from foreign subsidiaries are generally subject to CIT. These dividends are considered part of the company’s global taxable income and taxed at the standard rate of 25% (unless the company is a government-designated low-tax-rate entity, such as a high-tech enterprise, which qualifies for a 15% tax rate).

Special rules apply, as described below.

Tax Credits for Foreign Taxes Paid

To avoid double taxation, China allows a foreign tax credit for taxes already paid on the profits from which the dividends are distributed. The foreign tax credit is limited to the Chinese CIT payable on that same income. If the foreign withholding tax rate is higher than the Chinese CIT rate, the excess cannot be refunded or carried forward.

Tax Treaties

If a relevant tax treaty applies, it may lower the foreign withholding tax rate on the dividends, thereby reducing the foreign tax credit calculation. 

Local Policy Incentives

Hainan Free Trade Port, for example, offers tax exemptions on foreign-sourced income for qualified enterprises. According to relevant regulations, from 1 January 2020 to 31 December 2024, tourism, modern services, and high-tech enterprises that are established and substantially operating in Hainan Free Trade Port can be exempt from corporate income tax on newly acquired foreign direct investment income. This means that, during the specified period, qualified Hainan enterprises can enjoy tax exemptions on dividends received from overseas subsidiaries that correspond to newly added foreign direct investments. Whether this benefit will be extended beyond 31 December 2024 has not yet been officially confirmed by the government.

Intangibles developed by Chinese local corporations are generally taxed when used by non-local subsidiaries, and must adhere to the arm’s length principle.

CFC rules come into effect when a Chinese resident enterprise or individual (referred to as Chinese resident shareholders) has control over a foreign enterprise established in a low-tax jurisdiction and that enterprise does not distribute profits or significantly reduces profit distributions without valid business reasons.

A foreign enterprise can be classified as a controlled foreign corporation (CFC) if:

• the Chinese resident shareholder holds over 50% of the total voting shares, either directly or indirectly, or has substantive control over the enterprise’s operations, finances, or procurement and sales;
• the foreign enterprise’s actual tax burden is less than 50% of China’s statutory corporate income tax rate;
• the foreign enterprise does not distribute profits or reduces distributions without a legitimate business rationale.

If these conditions are met, the tax authorities can attribute the undistributed profits of the non-local subsidiary to the local parent corporation as if they had been distributed. However, if the adjustment has been made, no additional tax will be levied when these profits are eventually distributed.

CFC rules do not apply in the following situations:

• The foreign enterprise is located in a jurisdiction recognised by the State Taxation Administration (STA) as a non-low-tax country. For example, the STA lists 12 such countries, including the United States, the United Kingdom, France, Germany, Japan, Italy, Canada, Australia, India, South Africa, New Zealand, and Norway.
• The foreign enterprise earns most of its income from active business activities rather than passive or investment income.
• The foreign enterprise has annual profits under RMB5 million, which are considered insignificant for CFC purposes.

Treatment of Non-Local Branches

• Non-local branches are not separate legal entities.

• Unlike subsidiaries, the income of a foreign branch is immediately included in the local corporation’s worldwide income and taxed as part of the parent company’s overall taxable base. This means branches do not fall under CFC rules, as their income is already accounted for in the local corporation’s tax filings.

China’s tax regulations require non-local affiliates to have sufficient substance to qualify for treaty benefits and maintain favourable transfer pricing outcomes. Without demonstrable substance, affiliates risk losing treaty benefits, facing tax recharacterisations, or triggering CFC rules.

Economic Substance and Tax Treaties

To benefit from reduced withholding tax rates on dividends, interest, or royalties under double tax treaties, a non-local affiliate must often demonstrate substantial business activities in the treaty country.

Controlled Foreign Corporation (CFC) Rules

CFC regulations also emphasise economic substance. A foreign affiliate in a low-tax jurisdiction may be subject to Chinese tax if it lacks substantive operations and primarily holds passive income.

Transfer Pricing and Related-Party Transactions

Transfer pricing rules in China require that intercompany transactions reflect market conditions and align with the actual functions, risks, and assets of the entities involved.

Non-local affiliates must demonstrate that their substance – such as their role in value creation, decision-making, and operational activities – justifies the transfer pricing arrangements.

Tax authorities may challenge structures that appear to lack substance, and reallocate profits to reflect the actual economic activities.

Local corporations are taxed at the standard CIT rate (25%) on the gain from selling shares in non-local affiliates, with the gain calculated based on the difference between the sale proceeds and the tax basis. Foreign tax credits and treaty benefits may reduce the overall tax burden, but proper documentation and compliance with transfer pricing rules are essential.

China has established a comprehensive framework to combat tax avoidance, ensuring compliance with tax laws. These rules are designed to prevent businesses and individuals from exploiting loopholes to reduce their tax liabilities. Below is a breakdown of the key anti-avoidance measures in China.

General Anti-Avoidance Rule (GAAR)

The GAAR is a broad provision that allows tax authorities to challenge transactions or arrangements that lack commercial substance and are primarily aimed at reducing taxes. Key points include:

• Purpose: To prevent artificial or abusive tax arrangements.
• Application: Tax authorities can adjust taxable income if they determine a transaction was structured mainly for tax avoidance.
• Implications: Businesses must ensure their transactions have genuine economic purposes and are properly documented.

Transfer Pricing Rules

China has strict transfer pricing regulations to prevent profit shifting through related-party transactions. Key aspects include:

• Arm’s Length Principle: Transactions between related parties must be conducted as if they were between independent entities.
• Documentation Requirements: Companies must maintain detailed records to demonstrate compliance.
• Enforcement: Tax authorities actively monitor cross-border transactions and may adjust profits if they suspect non-compliance.

Controlled Foreign Company (CFC) Rules

The CFC rules target profits retained in low-tax jurisdictions by Chinese residents. For more details, see the discussion in 6.5 Taxation of Income of Non-local Subsidiaries Under Controlled Foreign Corporation-Type Rules.

Thin Capitalisation Rules

These rules limit excessive interest deductions on loans from related parties. For more details, see the discussion in 2.5 Imposed Limits on Deduction of Interest.

Beneficial Ownership Rules

China has rules to deny treaty benefits if the recipient of income is not the “beneficial owner”.

Special Tax Adjustments

Tax authorities have the power to make adjustments in cases of non-compliance. Key points include:

• The scope covers transfer pricing, thin capitalisation, and other anti-avoidance measures.
• Non-compliance can result in additional taxes, interest, and penalties.
• Authorities are increasingly vigilant in auditing cross-border transactions.

Practical Tips for Compliance

The Chinese government has established a comprehensive anti-avoidance rule system. In addition to the core rules mentioned above, the Chinese government has introduced other anti-avoidance regulations. Meanwhile, China has been actively aligning its tax policies with international standards. To navigate China’s anti-avoidance rules effectively, corporations who should:

• ensure transactions have genuine commercial substance;
• maintain thorough documentation to support compliance;
• seek professional advice for complex cross-border arrangements; and
• stay updated on evolving regulations and enforcement trends.

China does not have a standardised, routine audit cycle like some other jurisdictions. Instead, audits are conducted on a case-by-case basis, often triggered by specific circumstances.

China has made significant progress in implementing BEPS recommendations, particularly in areas such as transfer pricing, treaty abuse, and harmful tax practices. These changes have enhanced the transparency and fairness of China’s tax system while increasing the compliance burden for businesses. Companies operating in China must stay informed about these developments and ensure they meet the new requirements to avoid penalties and disputes.

The Chinese government views BEPS as a critical initiative to ensure fair taxation, combat tax avoidance, and align its tax system with international standards. China’s attitude can be summarised as follows:

• Supportive and Collaborative: China has actively engaged in BEPS discussions and implemented many of its recommendations.
• Focused on Sovereignty: While supporting global co-operation, China is keen to protect its tax base and ensure that multinational enterprises pay their fair share of taxes.
• Balancing Act: China aims to balance the need for robust tax rules with maintaining an attractive environment for foreign investment.

Given the US government’s wavering stance on the two-pillar principle, its implementation in China and globally may be correspondingly affected.

If both Pillars One and Two are given effect in China, it will have the most significant impact on the digital economy, multinational enterprises, and regions with large consumer markets. 

Pillar One Reallocation of Taxing Rights

• The objective is to reallocate taxing rights to market jurisdictions, ensuring that multinational enterprises pay taxes where they generate revenue, regardless of physical presence.
• Companies like Alibaba, Tencent, and foreign tech giants operating in China will need to adapt to new taxing rules.
• Provinces and cities with significant consumer markets may see increased tax revenues.
• Businesses will face additional reporting and compliance requirements.

Pillar Two Global Minimum Tax

• The objective is to establish a global minimum corporate tax rate of 15% to prevent profit shifting to low-tax jurisdictions.
• Chinese multinationals with subsidiaries in low-tax countries may need to restructure their operations.
• The global minimum tax could increase tax revenues from multinational enterprises operating in China.

International tax issues do not have a high public profile in China, but they have gained increasing attention in recent years. This environment enables the government to implement BEPS measures decisively, with relatively little public debate.

China, like other jurisdictions, seeks to maintain a competitive tax policy to attract foreign investment and support domestic economic growth.

Competitive Tax Policy

• Special Economic Zones (SEZs) and free trade ports (eg, Hainan) offer reduced CIT rates of 15%.
• The standard corporate tax rate is maintained at 25%, which is well above the 15% floor set by Pillar Two, but China offers credits and exemptions for qualifying activities, such as those undertaken by high-tech enterprises, which are taxed at 15%.
• For more incentives, see the discussion in 2 Key General Features of the Tax Regime.

Increasing Pressure to Implement BEPS

China is also facing increasing pressure to implement BEPS measures to ensure tax fairness and prevent base erosion. The government is expected to balance these two objectives by leveraging the tax incentives permitted under the BEPS framework, selectively extending or designing its own preferential tax policies, while simultaneously strengthening the regulation of eligibility criteria to prevent the misuse of tax benefits.

Since 2008, China has abolished the general corporate income tax exemption for foreign enterprises and fully unified the tax treatment of domestic and foreign enterprises by 2013. Currently, there are no significant features of China’s competitive tax system that are more vulnerable than other areas of its tax regime. China is also not bound by EU-style “state aid” or other similar rules.

The BEPS Action 2 Report specifically targets hybrid mismatch arrangements to eliminate tax benefits derived from these structures. These instruments can be used by multinational enterprises (MNEs) to exploit mismatches between tax systems, often resulting in double non-taxation, excessive deductions, or tax deferral.

While China does not yet have dedicated hybrid mismatch rules under BEPS Action 2, existing GAAR, thin capitalisation, transfer pricing, and withholding tax rules already limit the impact of hybrid instruments. Looking ahead, China is likely to tighten anti-hybrid provisions, ensuring that hybrid instruments do not result in tax avoidance.

While China does not operate a territorial tax regime, it already has interest deductibility restrictions through thin capitalisation, anti-avoidance, and transfer pricing rules. If China further aligns with BEPS Action 4, companies investing in and from China may face stricter limits on interest deductions, making it crucial to optimise financing structures and ensure compliance with evolving regulations.

China generally agrees with the principles behind controlled foreign corporation (CFC) rules, as they help prevent profit shifting to low-tax jurisdictions and ensure that Chinese MNEs pay a fair share of taxes. China’s existing CFC framework aligns with the global BEPS Action 3 recommendations.

Impact on Inbound Investors (Foreign Investors in China)

Double Taxation Convention (DTC) Limitation on Benefits (LOB) provisions and anti-avoidance rules are likely to impact both inbound and outbound investors in China. As China strengthens its tax enforcement under BEPS and OECD frameworks, businesses must ensure they meet substance and anti-abuse requirements to continue benefiting from tax treaties.

Increased scrutiny on treaty benefits (LOB Rules)

Many of China’s tax treaties include LOB provisions, which restrict preferential withholding tax rates on dividends, interest, and royalties unless the recipient meets certain criteria. If a foreign company does not have substantial business operations in the treaty jurisdiction and is merely a conduit (eg, a shell company in Hong Kong or Singapore), China’s tax authorities may deny treaty benefits.

Anti-avoidance and beneficial ownership rules

China’s beneficial ownership rules require proof that an entity claiming treaty benefits (eg, lower withholding tax rates) is the true owner of the income. If a foreign investor routes funds through an intermediary without substantial business functions, Chinese tax authorities may deny treaty benefits and impose the standard tax rate.

Impact on Outbound Investors (Chinese Companies Expanding Abroad)

Challenges in using offshore structures for tax planning

Foreign tax authorities are, at the same time, increasingly applying LOB rules and anti-abuse provisions to deny treaty benefits if the Chinese entity lacks sufficient substance in the intermediary country.

Chinese outbound investors must ensure their offshore entities have real business functions beyond just holding investments. Transactions may face higher withholding tax rates in foreign jurisdictions if the LOB test is not met.

Transfer pricing and substance requirements

BEPS-driven rules mean that offshore structures used for profit shifting or tax deferral could be scrutinised by tax authorities in foreign jurisdictions. Chinese companies with foreign subsidiaries must enhance transfer pricing documentation to justify cross-border payments.

China was already strengthening its transfer pricing enforcement. The BEPS initiative has significantly influenced China’s transfer pricing regime, but the changes have been more of an evolution rather than a radical transformation, and do not fundamentally alter China’s transfer pricing system.

IP taxation is particularly complex and a major source of disputes, as China seeks to ensure that profits from IP-related activities performed in China remain within its tax jurisdiction. Companies must carefully document IP ownership, licensing, and profit allocation to avoid transfer pricing disputes and tax adjustments.

Moving forward, BEPS will likely further reshape IP taxation in China, reinforcing the country’s focus on substance-based profit allocation and market-driven tax rights.

Provisions for transparency and country-by-country reporting play a crucial role in combating profit shifting, tax avoidance, and base erosion by MNEs.

China has already implemented VAT and withholding tax rules for foreign digital businesses and is actively discussing new taxation frameworks aligned with BEPS Pillar One and possible DST mechanisms.

China has not yet introduced a specific digital services tax (DST) like some countries. However, it has taken a cautious but supportive approach toward OECD-led reforms, particularly under BEPS Pillar One. Rather than introducing a unilateral DST, China relies on VAT and withholding tax rules while awaiting a global digital tax framework.

Several proposals related to digital taxation issues have already been introduced in China. The core discussions and recommendations focus on:

• Potential Implementation of BEPS Pillar One in China: China is exploring how to integrate BEPS Pillar One into its domestic tax framework.
• Stricter Permanent Establishment (PE) Rules for Digital Businesses: Currently, China taxes foreign businesses only if they have a PE in the country. There are discussions about updating PE rules to cover digital platforms that operate in China without a physical presence.
• A “Significant Economic Presence” threshold may be introduced, allowing China to tax companies based on user engagement, data collection, or transaction volume.
• Increased Enforcement of VAT on Cross-Border Digital Transactions: China already requires foreign digital service providers to pay VAT if they sell services to Chinese consumers. Future reforms may include more rigorous enforcement and compliance checks to prevent tax leakage.
• Potential for a Sector-Specific Digital Tax: Some policymakers have proposed targeted taxation on specific digital economy sectors, such as foreign social media platforms, e-commerce marketplaces, and data-driven businesses. However, no official proposal has been introduced yet.

China has implemented both withholding tax and direct assessment rules to ensure fair taxation of offshore IP income. The tax treatment depends on:

• whether the IP owner is in a treaty country or a tax haven;
• whether the entity qualifies as a “beneficial owner” under treaty rules; and
• whether the transaction is structured in a way that artificially avoids taxation.

Foreign companies licensing or selling IP in China should carefully structure their royalty arrangements and IP ownership structures to comply with China’s evolving tax enforcement rules while optimising tax efficiency.