Hainan Free Trade Port’s New Preferential Tax Policies: How do They Apply (updated)

UPDATE (September 28, 2022): The People’s Government of Hainan Province released on September 18, 2022 the Interim Measures for the List-based Management of High-end and Urgently Needed Talents Eligible for the Preferential Individual Income Tax Policy in the Hainan Free Trade Port, to be effective on January 1, 2023. The Measure made further clarifications on the conditions to be met for access to the IIT incentives in Hainan. 

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• Foreign investors should note Hainan Free Trade Port’s incentives to attract firms include a lowered corporate income tax rate for enterprises, tax exemption for overseas income, one-off pre-tax deduction and accelerated depreciation and amortization for newly purchased assets, as well as individual income tax relaxations.
• These preferential policies are applicable from January 1, 2020 to December 31, 2024. They were confirmed in two circulars released by the finance and tax authorities.
• These follow China’s previous announcement of the Overall Plan for the Construction of Hainan Free Trade Port aiming to transform Hainan into a high-level free trade port.

On June 30, 2020, the Ministry of Finance (MOF) and the State Taxation Administration (STA) released the Circular about Preferential Corporate Income Tax Policy for Hainan FTP (Cai Shui [2020] No.31) and the Circular about Individual Income Tax Policy for High-End and Urgently Needed Talents at Hainan FTP (Cai Shui [2020] No.32). The two circulars contain preferential policies and incentive schemes that are applicable from January 1, 2020 to December 31, 2024. According to the Cai Shui [2020] No.31, enterprises registered in the Hainan Free Trade Port (FTP) will get a chance to enjoy the following three major corporate income tax (CIT) relaxations:

• Enterprises in encouraged industries and engaging in substantive operations are entitled to CIT at a reduced tax rate of 15 percent;
• Income from new overseas direct investment derived by enterprises in the tourism, modern service, and high-tech industry may be exempted from CIT; and
• Eligible capital expenditures can be allowed one-off pre-tax deductions or accelerated depreciation and amortization.

According to the Cai Shui [2020] No.32, the individual income tax (IIT) rate is capped at 15 percent for ‘high-end’ and ‘urgently needed’ talents working at the Hainan FTZ. This article aims to offer a detailed interpretation of these two preferential tax policies.

Application of preferential corporate tax policies

Lowered corporate income tax rate of 15 percent

Currently, the statutory CIT rate in China is 25 percent. However, enterprises may enjoy a favorable CIT rate of 15 percent in Hainan, if they meet the following three criteria:

• The enterprise is registered in the Hainan FTP;
• The enterprise has substantive operations in the Hainan FTP; and
• The primary business of the enterprise is on the list of encouraged industries in the Hainan FTP.

By substantive operation, authorities refer to the actual management of the enterprise, such as the board of directors and board of shareholders, who should be based in Hainan FTP and must implement substantive management and control over the enterprise’s manufacturing and business operations, staff, accounts, and properties from Hainan.

In addition, the main business of the eligible enterprise must be in the encouraged industries of Hainan. The income from the main business of the enterprise must also constitute 60 percent or more of its total income. To determine if your business falls under the encouraged industries in Hainan FTP, investors can refer to the Guiding Catalogue for Industrial Structure Adjustment (2019 Edition), the Catalogue of Encouraged Industries for Foreign Investment (2019 Edition), and the catalogue of encouraged industries newly added in Hainan FTP. Foreign-invested enterprises should mainly refer to the encouraged catalogue for foreign investment. In case any of these respective catalogues are revised, the revised versions shall prevail with immediate effect. To be noted, the 15 percent CIT rate is applicable only to the income of head offices and/or branches set up in Hainan FTP. Any income from head offices and/or branches outside of Hainan FTP is not eligible for this preferential tax rate

Tax exemption on overseas income

The statutory CIT rate on income from overseas direct investment of resident enterprises in China is currently 25 percent. But in Hainan, the CIT is exempt on such overseas income, if the following criteria are met:

• The income is derived by companies in the tourism, modern service, and high-tech sectors included in the encouraged industries in Hainan FTP; and
• The income is from newly increased overseas direct investment.

At the same time, such overseas income must satisfy the following conditions:

• The overseas income is the operational revenue of newly established overseas branches, or dividend income corresponding to the new direct investment obtained from the overseas subsidiaries with a 20 percent plus (inclusive) equity held by the parent company; and
• The statutory CIT rate of the invested country or region is not less than 5 percent.

That is to say, income from equity transfer cannot enjoy the tax exemption nor can overseas income from tax havens like the Cayman Islands.

One-off pre-tax deduction or accelerated depreciation and amortization for newly purchased assets

For an enterprise established in Hainan FTP, its newly purchased fixed assets or intangible assets with a unit value of no more than RMB 5 million (US$775,000) are allowed to be included in the current costs and expenses and to be fully deducted on a one-time basis before calculating the taxable income, and there is no need to annually calculate depreciation and amortization. If the unit value of the new assets exceeds RMB 5 million (US$775,000), the depreciation or amortization period can be shortened, or the accelerated depreciation or amortization method can be adopted.

The newly purchased fixed assets and intangible assets include those assets that are self-constructed and self-developed but exclude houses and buildings. The one-off pre-tax deductions or accelerated depreciation and amortization for new assets are expected to reduce the current tax burden of enterprises, increase their cash flow, and encourage them to upgrade their equipment and technology in time.

Application of preferential individual income tax policies 

Currently, individual income tax in China is levied at a progressive rate, ranging from three percent to 45 percent with seven tax brackets. Operation income tax is also levied at a progressive rate, ranging from 5 percent to 35 percent with five tax brackets. However, according to Cai Shui [2020] No.32, for high-end talents and talents in short supply working at Hainan FTP, the portion of their actual IIT burden exceeding 15 percent will be exempted. The following types of income sourced from Hainan FTP will be eligible:

• Comprehensive income, such as wages and salaries, remuneration for labor services, author’s remuneration, and income from royalties;
• Operation income; and
• Talent subsidy income recognized by Hainan Province.

This implies that income from investment, such as dividends and bonuses, and income from property transfer, such as equity and real estate transfer, are not to be included. Taxpayers completing the formalities for annual final settlement of IIT in Hainan Province may enjoy the aforesaid preferential policies. That is to say, eligible Hainan talents still need to pay IIT according to China’s general IIT rate in the current year first. When the final settlement is made the next year, the Hainan tax bureau will refund the portion of the IIT that exceeds 15 percent of the actual taxable income. A list of professions that qualify as high-end talent and talent in short supply who can enjoy the aforesaid preferential policies and specific administrative measures was introduced in August 2020 and recently amended in September 2022. According to the new administrative measures to be effective from January 1, 2023, to qualify for the IIT incentives in Hainan, the applicants generally need to meet the following conditions:

• Condition I: Residing in the Hainan FTP for a total of 183 days within a tax year; and
• Condition II: Being talents as recognized by the talent management departments of various levels in Hainan or receiving income of over 300,000 yuan in the Hainan FTP within a tax year.

For special personnel in aviation, shipping, offshore oil and gas exploration, and other industries who have resided in Hainan FTP for less than 183 days in a tax year due to their occupation characteristics, can enjoy the preferential IIT policies by satisfying some extra conditions in addition to condition II, after applying to the tax authorities within the stipulated period and passing the review. The extra conditions include:

• Having contributed to the basic pension insurance for employees in the Hainan FTP for more than six months (including the month of December of the current year) consecutively within a tax year (except for a person who is exempted from social insurance contribution based on the social security agreement signed between the home country and China); and
• Having entered into a labor contract (or documents of the same kind) with a term of one year or longer with an enterprise or organization registered and operating substantively in the Hainan FTP.

The preferential tax system of Hainan FTP is expected to attract many enterprises or the relocation of businesses in encouraged industries. You are welcome to contact our professionals for clarifications on how Hainan’s preferential policies may apply to your business and derive practical solutions. Please email us at China@dezshira.com.

(This article was first published on July 7, 2020 and last updated on September 28, 2022)

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