On 9 February 2022, the Ministry of Finance (MOF) and State Taxation Administration (STA) jointly issued bulletin [2022] No. 6, which allows relevant enterprises and individuals in the venture capital business to benefit from the preferential tax policies under Cai Shui [2018] notice No. 55.
Notice No. 55 provides that enterprises and individuals in the venture capital business that invest in technology enterprises at the seed or early stage (technology startups) should be entitled to a deduction equal to 70% of the investment amount when calculating their taxable income in the year, when their investment is held for at least two years.
Among other conditions to be considered a qualified technology startup under notice No. 55, the company should not have more than 200 employees, and total asset and annual revenue more than RMB30 million (USD4.7 million). This requirement is modified by bulletin No. 6 by increasing the number of employees to 300, and the total asset and annual revenue to RMB50 million, for the period from 1 January 2022 to 31 December 2023.
Preferential tax policies under notice No. 55 provide that 70% of the investment amount made by the enterprise and individual investors can be offset against their taxable income. The mechanism of the deduction depends on the form of the venture capital enterprise, e.g. corporate, limited liability partnership, or individual.
(1) Venture capital enterprise taking corporate form. Where the investment is held for at least two years, 70% of the investment amount can be offset against the taxable income of the venture capital enterprise. The balance can be carried forward to subsequent tax years.
(2) Venture capital enterprise taking limited liability partnership form. Where the investment is held for at least two years, legal persons and/or individual partners in the partnership may offset their portion of investment amount against their allocation of the taxable income from the partnership. The balance can be carried forward to subsequent tax years.
(3) Individual investors. Where the investment is held for at least two years, the individual investors may offset 70% of the investment amount against their capital gain from the disposal of their investment in the technology startups. The balance can be carried forward and used against capital gain from the disposal of their investment in the same technology startup in the future. Where an individual investor has invested in multiple tech startups, and one has liquidated, and the individual investor has not fully deducted its 70% of the investment amount in that startup, the balance may be used against capital gain from disposal of other tech startups within 36 months of the liquidation.
INDIVIDUAL PARTNERS
For individual partners in the venture capital enterprise taking a limited liability partnership form, special rules are provided under Cai Shui [2019] notice No. 8, which allows the partnership to choose between one of two accounting methods for their individual partners to determine their individual income tax (IIT) liability: (1) accounting based on a single investment fund; or (2) accounting based on the partnership’s annual income. Once the partnership chooses the accounting method, it cannot change this for three years.
(1) Accounting based on a single fund investment. The individual partners will be subject to IIT at a 20% rate on their share transfer, dividend and interest income. While the individual partners can benefit from a lower IIT rate, it should be noted that any balance of the deduction under notice No. 55 (i.e. 70% of the investment amount) should not be carried forward if it is not fully offset by the share transfer income in the current year.
(2) Accounting based on the partnership’s annual income. The individual partners will be subject to the progressive IIT rate, ranging from 5% to 35%, on all income from the partnership as that income will be treated as operating income. However, the individual partner can deduct costs, fees and losses when calculating their taxable income from the partnership. Meanwhile, the balance of the deduction under notice No. 55 can be carried forward to subsequent years.
Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by e-mailing Howard Wu (Shanghai) at howard.wu@bakermckenzie.com
