Tax optimization on foreign income

In this process, many Chinese enterprises are required to pay the corresponding taxes locally in accordance with local tax regulations. Moreover, the relevant income obtained from abroad must be declared for Corporation Income Tax (CIT) filing in China. In accordance with applicable bilateral tax treaties, enterprises should also apply for appropriate tax credits for taxes paid overseas.

It is important to note that the afore-mentioned tax credit applies only to tax payments of income tax nature that are required and have been actually paid in accordance with the tax laws and regulations of the foreign tax jurisdiction on income derived from outside China. However, foreign income tax under the following circumstance are NOT allowed for CIT credit in China:

A commonly-seen issue in practice is whether the foreign tax paid is indeed a tax that should have been levied under the foreign tax law and bilateral tax treaties. If not, the Chinese tax authorities have the right to deny the tax credit during the CIT annual filing process. Such situations often occur when Chinese enterprises provide services abroad without establishing a PE (permanent establishment) or fail to apply for preferential tax treaty rates when receiving dividends. Therefore, the first step for these enterprises in optimizing their tax burden related to foreign income is to determine whether the relevant activities have been taxed correctly abroad, and whether applicable tax benefits under local tax regulations or bilateral tax treaties have been applied for.

If the relevant business has been correctly taxed abroad, a corresponding tax credit can be claimed back in China. Different business models adopt different tax credit methods:

The principles of China’s tax credit system are as follows:

Overall Limitation method (综合抵免法): Profits and losses across different foreign countries can be offset against each other. This approach does not fully reflect the impact of tax rate differences across jurisdictions, potentially leading to disadvantages for taxpayers in certain cases.

Per Country Limitation method (分国抵免法): This method reflects the effects of differences in tax rates between countries or regions and can be more advantageous for taxpayers.

It is also important to note that the Chinese tax authorities require enterprises to provide official tax regulations issued foreign tax authorities, tax certificates, and other external supporting materials when applying for tax credits. For example, some developing countries offer special tax incentives to attract foreign investment. To ensure that these incentives are genuinely enjoyed by foreign investors and not negated by subsequent tax adjustments in their home countries (such as China), certain bilateral tax treaties include a special provision known as "credit for tax sparing". When claiming such a tax credit, enterprises must provide the relevant country’s tax regulations and original calculation basis for the spared income.

Optimizing the tax burden on foreign-sourced income is of great importance to Chinese companies. By applying tax credits and taking advantage of bilateral tax treaties, companies can significantly reduce their tax burden. A well-coordinated tax return in both countries is crucial. Professional advice can help develop and implement the best strategies.​​​​​​​​​