China’s New Tax Break: Direct Investment with Distributed Profits (2025)
According to the Announcement on the Tax Credit Policy for the Direct Investment Made by Overseas Investors with Distributed Profits (hereinafter referred to as the “FATC Announcement”) which was released in early this year, later, the State Administration of Taxation has issued the Announcement on Matters Concerning the Tax Credit Policy for the Direct Investment Made by Overseas Investors with Distributed Profits (hereinafter referred to as the “Administrative Announcement“) on July 31, 2025.
Background
Currently, the global economic situation is complex, and attracting foreign investment is vital for our country’s economic growth. To encourage foreign investors to keep and increase their investments in China, the government has implemented a series of favorable tax policies.
- Key Takeaway
Foreign investors who use profits distributed by resident companies in China for direct investments within China during the four years from January 1, 2025, to December 31, 2028, and meet the relevant conditions, may offset 10% of the investment amount against the taxable amount of income the investor subsequently receives from the company.
As is well known, before the tax credit policy was introduced, to encourage foreign investors to reinvest their profits, mainland China began implementing a deferred taxation policy in 2017. This means that the income tax that should have been paid on these profits can be temporarily deferred.
Key Points and Observations
- Clarifying “Eligible Reinvestment”
Key Points: Both making up for unpaid registered capital and increasing capital reserves by using the distributed profits are considered eligible reinvestment activities.
Observation:
Article 1 addresses a gray area in practical implementation. The Administrative Announcement explicitly states that when overseas investors use the profits that they have received to make up for the registered capital they have subscribed to but have not yet paid in, or to increase the capital reserves of the company, both scenarios meet the requirements for “newly added or increased capital” and are eligible for tax credits. This provides investors with greater operational flexibility and avoids the risk of losing tax incentives due to differences in capital contribution methods.
- Optimized Holding Period Calculation
Key points: The investment holding period begins in the month when the funds are invested and ends in the month when the equity change (e.g., share transfer) is registered or the consideration is received in advance.
Observation:
Start Date (Article 2): The holding period is not calculated from the date of profit distribution or the date the business department issues a certificate but is explicitly defined as the month in which the funds listed in the “Profit Reinvestment Status Table” are received. This eliminates uncertainty regarding the timing and facilitates accurate calculation of the holding period by companies.
End Date (Article 3): The holding period ends on the earlier of the following two dates:
- the month in which the investee company completes the equity change or cancellation registration; or
- if, prior to this, the investor has already received assets from the investee company or payment consideration from the equity transferee, the month in which these assets or consideration are received.
This provision aims to prevent investors from substantively recovering their investments before formal procedures are completed, thereby ensuring that the policy benefits investors who genuinely engage in long-term investments.
- A New Binary Choice for Credit Calculation
Key points: Investors may choose between 10% of the reinvestment amount and the lower dividend tax rate applicable under the tax treaty to calculate the credit amount; however, this choice cannot be changed once made.
Observation:
(Article 4):
This represents a significant shift in policy, offering investors strategic options.
Option A: Calculate the tax credit based on 10% of the reinvestment amount. This is a simple and direct method.
Option B: If the withholding tax rate on dividends specified in the tax treaty between China and the investor’s home country is lower than 10% (e.g., many European countries have rates of 5% or 7%), the investor may choose to calculate the credit based on this lower treaty rate.
Key restriction: Once selected, if the investment is withdrawn early after being held for five years and additional taxes are owed, the previously selected ratio must be maintained, and the more favorable treaty rate cannot be chosen retroactively. This requires investors to conduct long-term tax planning from the outset and select the most advantageous option.
- Handling Multiple Profit Sources and Currency Conversion
Key Points: Profits distributed from different companies must be calculated separately; foreign currency reinvestments must be converted into RMB at the midpoint exchange rate on the payment date.
Observation:
Multi-source profits (Article 5): If an overseas investor receives profits from multiple Chinese subsidiaries and reinvests them, when claiming tax credits, the credits must be aggregated and calculated separately for each profit-generating company and cannot be mixed. This requires companies to maintain separate accounting records.
Foreign Currency Conversion (Article 6): For reinvestments made in foreign currency, the RMB exchange rate must be calculated based on the exchange rate published by the China Foreign Exchange Trading Center on the actual payment date. This locks in the exchange rate risk point, and companies cannot choose exchange rates from other time points.
- Simplified and Clear Compliance Process
Key points: Clarifies the procedures and documentation requirements for investors, profit-distributing companies, and tax authorities, and promotes the use of “reporting in lieu of filing.”
Observation:
When claiming the tax credit (Article 7): The core of the process is the profit-distributing company.
When recovering investments and paying additional taxes (Articles 8 and 9): If investments are recovered prematurely and additional taxes need to be paid, the overseas investor, as the reporting entity, must directly or through an agent submit the “Withholding Company Income Tax Report Form” and the “Information Report Form” to the competent tax authority of the profit-distributing company.
Subsequent Management (Articles 10 and 12): Tax authorities will establish management ledgers and conduct tracking management through data sharing. They have the authority to request investors, profit-distributing companies, and investee companies to provide any materials and information related to the enjoyment of tax incentives, thereby strengthening post-event supervision.
- Mandatory Order of Disposal
Key Point: When recovering investments, the portion that has already benefited from tax incentives is disposed of first by default.
Observation:
This rule is crucial and aims to prevent tax arbitrage. When an investor partially withdraws their investment, tax authorities assume that the portion that has already received tax credits is sold first, followed by the eligible but uncredited portion, and finally the ineligible portion. If multiple investments are made in the same company, the order of withdrawal is determined by the time sequence, with the first withdrawal being considered the first investment.
This rule ensures that the behavior of “first enjoying tax credits and then withdrawing early” will first be subject to tax recovery, and investors cannot artificially designate the disposal order to avoid taxes.
Conclusion
The Administrative Announcement 2025 encourages profit reinvestment while featuring refined preferential treatment, flexible policy application, and transparent tax supervision.
Before deciding on profit reinvestment, be sure to assess the investment structure and holding plan and carefully select the method for calculating tax credits.
If you need more information or advice, please contact us.
