The pass-through tax treatment for partnership enterprises has finally been officially confirmed by the PRC tax authority, via the Circular on the Issues Concerning the Income Tax of the Partners in Partnership Enterprises, Caishui [2008] No. 159, which took effect retroactively as of January 1, 2008. It represents an important first step in the development of Chinese partnership tax law.
Stephen Nelson, Partner, and Alice Zhang, Taxation
The Circular introduces the principle of “allocate first, then tax”. As such, the partnership enterprise itself will not be subject to income tax, instead, each partner will be liable for income tax on his share of income allocated from the partnership enterprise. Specifically, individual partners shall pay individual income tax and ‘legal person’ partners will pay enterprise income tax. However, interestingly, the Circular also provides that where the partners are legal persons, the losses of the partnership enterprise may not be used by the ‘legal person’ partner to offset its income. This is of course inconsistent with the principal of pass-through treatment. It remains to be seen whether this position will be modified over time.
Many other questions remain on partnership taxation, particularly when partners are legal persons rather than individuals. These questions will be resolved only when separate regulations are issued to govern partnership taxation. Our tax team will keep a close eye on the subject and let you know as soon as there are new developments.