Original article by Rachel Wang
Executive summary
- China has issued a new policy introducing enhanced tax incentives for overseas investors who reinvest their profits in the country, providing an additional tax credit for future withholding taxes on top of the existing tax deferral policy. The policy aims to encourage overseas investors to reinvest their dividends in China, optimize foreign investment structure and promote long-term investment. The new policy is to apply retrospectively to direct investments that occurred after January 1, 2025.
- Under the previous tax deferral policy, investors were relieved of their immediate tax payment obligation on profits distribution, with the tax due being payable upon disposal of the investment, provided the reinvestment conditions were met. The new policy now additionally grants a tax credit equal to 10% of the amount of the reinvested amount (or the lower applicable tax rate stipulated in the relevant Double Taxation Agreement, e.g., 5 percent under the China-Germany DTA) for qualified reinvestments during the period from January 1, 2025 to December 31, 2028. This credit can be used to offset withholding tax payable by the overseas investors on dividends, interest, royalties, and other income derived from the profit-distributing companies.
- This policy underscores the Chinese government’s support for overseas investors to sustain their investments in China. We suggest overseas investors evaluate the plan of strategic investments in China to utilize the tax incentives properly, to properly utilize these tax incentives and optimize the group tax outcomes.
Detailed Content of the new policy
Overview of the tax incentives
On June 27, 2025, the PRC Ministry of Finance (MOF), State Taxation Administration (STA), and Ministry of Commerce (MOFCOM) jointly issued the Announcement on the Policy of Tax Credits for Direct Investment by Overseas investors with Distributed Profits (Announcement [2025] No. 2, hereinafter referred to as the “Announcement No. 2” or the “New Policy”). Subsequently, the STA further issued an announcement (STA Announcement [2025] No.18) to clarify the implementation details, and at the same time, issued an official interpretation of the new policy, to help overseas investors better grasp the details of the policy.
According to the new policy, overseas investors who use the profits distributed by a resident enterprise in China for domestic direct investment during the period from January 1, 2025 to December 31, 2028 and meet the specific conditions, will be granted a tax credit equal to 10% of the amount of the reinvested amount (or the lower applicable tax rate stipulated in the relevant Double Taxation Agreement, e.g., 5 percent under the China-Germany DTA). This credit can be used to offset withholding tax payable by the overseas investors on dividends, interest, royalties, and other income derived from the profit-distributing companies.
Before the issuance of the new policy, Caishui [2018] Circular No. 102 (hereinafter referred to as “Circular No.102”) had been implemented for several years, which provides the incentive of tax deferral for overseas investors reinvesting in the territory with profits distributed by China domestic companies. Under Circular No.102, the 10% withholding tax (or a lower tax rate under DTA) can be temporarily exempted on qualified reinvestments of profits, with the tax deferred until the investment is disposed of.
The new policy provides additional tax incentives on top of Circular No.102. Investors meeting the conditions could simultaneously enjoy the two preferential policies for qualified domestic reinvestment, significantly reducing the tax burden associated with these cross-border transactions.
Conditions for enjoying the tax incentives
i. Base of tax credit
The profits distributed to overseas investors shall be equity investment income such as dividends and bonuses resulting from the actual distribution of retained earnings by resident enterprises in China to investors.
Other capital gains, such as income derived from a share transfer, are not eligible for the tax credit.
ii. Ways of reinvestment
The qualified reinvestment of profits includes the following situations:
- Increasing the paid-in capital or capital reserves of a domestic resident enterprise through new contributions or capital conversion;
- Investing in the establishment of a new domestic resident enterprise within China; or
- Acquiring equity in a domestic resident enterprise within China from an unrelated party.
However, increases in capital arising from the conversion of capital reserves, or purchases of shares in listed companies (except where such purchases qualify as strategic investments) are not eligible.
iii. Industry
During the period of reinvestment in China by the overseas investor, the industry in which the invested companies must operate within a nationally encouraged industries, as listed in the Catalog of Encouraged Industries for Foreign Investment.
iv. Holding period
The overseas investor must maintain the reinvestment in China for a minimum consecutive period of five years (60 months).
v. Fund transfer
For profits paid in cash, the funds shall be transferred directly from the profit-distributing enterprise’s account to the account of the invested enterprise or equity transferor, without being circulated through any other domestic or foreign accounts prior to such direct reinvestment;
For profits paid in kind or through non-cash means such as securities, ownership of the relevant assets shall be transferred directly from the profit-distributing enterprise to the account of the invested enterprise or equity transferor, without being held or temporarily held by any other enterprises or individuals prior to the direct reinvestment.
It is important to note that in comparison to the conditions of Circular No. 102, the conditions listed in Announcement No.2 are either the same or more stringent than those in Circular No. 102. This implies that a foreign investment meeting the requirements for the reinvestment tax credit under Announcement No. 2 would also satisfy the requirements for the tax deferral under Circular No. 102.
Treatment on future disposal of the investment
Where the overseas investor disposes part or all of the reinvestment through share transfer, repurchase or liquidation, it will be required to repay related taxes. Specifically:
- If the investment period is over 60 months
The investor shall, within seven days of the recovery, declare and pay the deferred withholding tax on the profits attributable to the portion of the disposed investment. Any unused balance of the reinvestment tax credit may be carried forward. - If the investment period is less than 60 months
The portion of profits distributed by the domestic resident enterprise corresponding to the recovered investment will be deemed not to have met the tax preferential conditions set forth in Announcement No.2. In such cases, in addition to paying the deferred taxes as described in the preceding paragraph, the eligible tax credit amount for the overseas investor shall be proportionally reduced.
If the amount of tax credit already used exceeds the adjusted eligible amount, the overseas investor shall repay the excess portion within seven days of recovering the investment. Late payment penalties will be imposed on the excess amount.
Given the potentially high annualized interest rate on late payment penalties, investors should carefully decide whether to opt for the reinvestment tax credit policy, especially take into account the estimated holding period of investments.
Numerical illustration
The official interpretation issued by STA provides several examples in calculation of the tax credit. We illustrate below a selected scenario to provide a sense of how the mechanism works.
Assumption: Investor A (an overseas company) receives profit distribution of 1,000 from its Chinese subsidiary B and reinvest the fund to another Chinese company C. Assume the transaction qualifies all the conditions under Announcement No.2 and assume 10% tax rate on dividend is applicable.
The following table shows the tax implication under the preferential treatment of Announcement No.2 and Circular No.102, for each transaction.
| If no tax incentives | Under Circular No.102 and Announcement No.2 | ||
|---|---|---|---|
| a) | Receive profit distribution from Company B and reinvest into Company C | Withholding tax payable = 1,000 × 10% = 100 | Tax payable is deferred until disposal of the investment. Tax credit amount = 1000 × 10% = 100 |
| b) | Receive royalty payment from Company B in the amount of 600. Assume an applicable tax rate of 10%. | Withholding tax payable = 600 × 10% = 60 | The tax credit amount can be used to offset the tax payable. No tax due. The remaining balance of tax credit = 100 – 60 = 40 |
| c) | After 2 years, dispose 100 of investment. (Gain on the investment is not considered) | / | The tax credit amount shall be decreased in proportion to the disposed investment that holding for less than 5 years. The adjusted tax credit balance = 40 – 100 × 10% = 30 The deferred tax amount corresponding to the disposed investment shall be paid. Withholding tax payable = 100 × 10% = 10 However, by utilizing the tax credit to offset this liability, no actual tax payment is required, and the remaining balance of tax credit = 30 – 10 = 20 |
| d) | After 5 years, dispose the remaining 900 of investment. (Gain on the investment is not considered) | / | The deferred tax amount corresponding to the disposed investment shall be paid. Withholding tax payable = 900 × 10% = 90. The remaining tax credit balance can be utilized to offset this tax payable. The final tax payable = 90 – 20 = 70. |
| e) | Total tax payment | 160 | 70 (of the total tax credit of 100, 90 was utilized, 10 was not utilized due to the portion of investment disposed of before the five-year holding period) |
Procedures
To qualify for the tax incentives, the invested company must report the relevant information to its local commerce authority, on behalf of the investor, through MOFCOM’s unified online service system platform. The information will be reviewed and verified by provincial-level commerce authority, in conjunction with the finance, tax, and other relevant authorities. After verification, the commerce authority will issue a Profit Reinvestment Information Form with a unique national code to the invested company, which shall be shared with the investor and the profit distribution company which must be shared with the investor and the profit-distributing company as supporting documentation for claiming the subsequent tax credit.
Given the procedural complexity and the need for collaboration among all parties involved, we suggest companies engage professional advisors to ensure smooth and compliant processing.
How can we help you?
Dr. Gerald Neumann
Partner
