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TAX & FINANCE: Exploring opportunities under the innovative tax system of Hainan Free Trade Port
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Exploring opportunities under
the innovative tax system of Hainan Free Trade Port

Author: Sophia Li, PWC

BT 202008 TAX 04On 1 June 2020, the CPC Central Committee and the State Council released the (the “Plan”). The Plan provides 39 specific policies from 11 aspects including free and convenient flow of trade, investment, and cross-border capital, etc. It also sets forth two stages of development goals by the year 2025 and 2035 respectively, with an aim to build Hainan into a high-level free trade port with international influence. Among them, the tax system includes five goals, namely: zero tariff, low tax rates, streamlined tax structure, strengthened law enforcement, and implementation in stages. Tax policies formulated under these five goals will run through the two milestones of 2025 and 2035, with each having its own focus.

In this article, we analyse the highlights in the tax system of the Plan and share with you our observations.



Zero tariff


BT 202008 TAX 02The Plan aims to build Hainan FTP into a “zero tariff” special customs supervision area, with international competitiveness and influence. Zero tariff will effectively reduce trading costs, while at the same time the difficulty of controlling trading risks will increase relatively. Therefore, the Plan proposes a system design with “opening the front line, controlling the second line, and freedom in the island”. For further illustration please see the diagram in the next page.

According to the Plan, at the front line, customs will focus on "non-tariff" supervision involving port public health and safety, national border bio-safety, food safety, and product quality and safety control. It is expected that the corresponding declaration procedures will be simplified to allow free, safe and convenient flow of overseas goods entering Hainan FTP.

After entering the island, the "zero-tariff" goods will be exempted from routine customs supervision, which is different from the traditional customs supervision measures for bonded goods under processing trade. Enterprises can save procedural and administrative costs, which fully embodies the system design concept of promoting free, orderly, safe and convenient cross-border flow of various production elements.

It is worth noticing that, for goods that are produced by enterprises engaging in the encouraged industries and which do not contain imported materials, or where there are imported materials the added value of the processing in Hainan FTP is more than 30% (inclusive) of the value of the goods, import duties would be exempted when they enter the mainland through the second line (import VAT and Consumption Tax would be collected in accordance with the regulations). In other words, the imported materials meeting the above conditions can achieve a "zero-tariff" effect when imported from overseas to the mainland, which should be welcomed by enterprises in the encouraged industries.

As introduced above, the launch of independent customs operations throughout Hainan Island with “zero-tariff” is unprecedented in Mainland, which will greatly promote the convenience and free flow of international trade.






Low tax rates


BT 202008 TAX 06The Plan proposes preferential Corporate Income Tax (CIT) rates for enterprises with operational substance and preferential Individual Income Tax (IIT) rates for qualified individuals in Hainan FTP, respectively as follows:

The CIT incentives have the following highlighted features:

•Enterprises in the encouraged industries are entitled to a reduced CIT rate of 15%, and by 2035, enterprises in all industries except for negative-listed industries will be entitled to the reduced CIT rate. It is expected that the list of encouraged industries in Hainan FTP may follow the current encouraged industry catalogues, such as the and the , as well as taking into account of the features and positioning of Hainan Province, focusing on the development of tourism, modern services, and high-tech industries.

•The Plan proposes that enterprises in tourism, modern service and high-tech industries are exempted from CIT on income generated by new overseas direct investment before 2025. According to the prevailing CIT regulations, China tax resident enterprises (TRE) are taxed on their worldwide income, and foreign tax credit is available on profits repatriation from overseas investments. The Plan grants exemption to CIT on income generated by new overseas direct investment before 2025, which is a breakthrough to the current CIT regulations, and would encourage enterprises engaging in tourism, modern service and high-tech industries to go abroad.

As for IIT incentives, the Plan directly reduces the tax rates for qualified individuals for the first time from two aspects:

•By 2025, qualified talents working in Hainan FTP are exempted from IIT on the portion of IIT which exceeds an effective tax rate of 15%. The IIT incentive in Hainan FTP should be better than the IIT rebate policy introduced for the Guangdong-Hong Kong-Macau Greater Bay Area (the GBA) in 2019:

1.The IIT rebate policy in the GBA is only available to overseas qualified talents, while the 15% IIT rate in Hainan FTP seems to be available to all high-end talents and talents in short supply working in Hainan FTP, without restricting it for foreign qualified talents;

2.The IIT rebate policy in the GBA achieves 15% tax rate through tax rebates, while the 15% tax rate in Hainan FTP seems to be achieved by a direct exemption of IIT on the portion of IIT which exceeds an effective tax of 15%. It is expected that the tax incentives of Hainan FTP will greatly improve the effectiveness of enjoying the tax benefits by qualified talents.

By 2035, Individuals who have resided in Hainan FTP for 183 days or more during a tax year will be taxed at progressive IIT rates of 3%, 10% and 15% on their comprehensive income and business income derived from Hainan FTP. Under the current IIT regime, progressive rates of 3% to 45% and 5% to 35% are applicable to comprehensive income and business income, respectively. The 3 marginal tax brackets proposed by the Plan would be a major breakthrough in the current IIT regime and require a comprehensive revision to current tax rate tables. In practice, it is yet to be further clarified how to determine the number of days residing in the Hainan FTP and how to determine the source of the income.










Streamlined tax structure


BT 202008 TAX 08The Plan proposes to explore ways to streamline the tax structure that is in line with China’s tax reform. Reform in the categories of taxes should be conducted to reduce the proportion of indirect taxes and make the structure of tax categories simpler and more scientific, optimise the tax system elements, reduce overall tax burden, with clear attribution of tax revenues and more balanced fiscal position.


Strengthened law enforcement


BT 202008 TAX 05The Plan proposes reduced CIT rate of 15%, IIT rate of 15%, and 3 marginal tax brackets of progressive IIT rates of 3%, 10% and 15% to encourage enterprises to make real investments and operate in Hainan FTP, so as to increase local employment, attract talents, and make substantial contributions to the local economy. In order to prevent enterprises/individuals from abusing the tax incentives through setting up shell companies or false employment arrangements, the Plan sets forth several prerequisite, such as enterprises to “register and conduct substantial economic activities in Hainan FTP”, individuals to "work in Hainan Free Trade Port", or “reside 183 days or more in Hainan FTP within a tax year", etc. The Plan also requires local tax authority to assess the eligibility based on the places where substantial activities and value-creation activities take place, and publish early warnings; develop methods to determine substantial place of business and place of residence to combat tax evasions. Hainan will also enhance the international exchange of tax-related information to minimise Hainan being seen as a "tax heaven".


Other tax-related regulations


BT 202008 TAX 07In order to promote the shipping and air transportation industry in Hainan, the Plan proposes the following tax policies:

•Under the premises of effective supervision and risk control, domestically built ships registered at “Yangpu-Port-of-China” and engaged in international shipping are deemed as export and entitled to export tax refund.

•Domestic ships engaging in “domestic and foreign trade goods on board” (内外贸同船运输)which transit at Yangpu Port are allowed to refuel with bonded oil required for the voyage; export tax refunds are available if the ships refuel with locally produced fuel oil for the voyage.

•For container cargoes departing from China that meet relevant conditions and transit at Yangpu Port, a tax refund policy for port of departure will apply on a trial basis.

•Allow both inbound and outbound flights to refuel with bonded aviation oil.

In addition, the Plan stipulates the import and sale of foreign exhibits at national-level exhibitions of China International Consumer Goods Expo will be exempted from tax.







The takeaway


Many of the tax policies included in the Plan are innovative and unprecedented, especially the zero tariff, the low tax rates of CIT and IIT, the exemption of CIT on income from new overseas investment in certain industries, the streamline of indirect taxes into Sales Tax in the retailing stage, the allocation of Sales Tax and taxes other than income taxes as local tax revenue, etc. To implement these policies requires monumental reforms of the current tax and fiscal system, which shows the Chinese government’s determination in developing Hainan FTP.

The Plan serves as a high-level guideline which provides a general direction for future development of tax policies, while uncertainties regarding the detailed implementation remain to be further clarified. Enterprises interested in investing or relocating to Hainan should analyse the business opportunities in the Plan, pay attention to any follow-up tax policies, adjust the business model, group structure and employment arrangements, etc. according to their own situation, in order to better enjoy the benefits. At the same time, we hope that the MOF and STA should consult with businesses and tax experts for specific implementation details before releasing detailed implementation regulations, so that taxpayers can effectively enjoy these incentives and benefits.



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