China's Venture Capital Funds Escape Higher Taxes

China's State Council has put forward a compromise on controversial plans that would have effectively raised taxes on the income of partners in venture capital firms, after resistance from the industry and local governments and as policymakers focus on boosting innovation and entrepreneurship to support economic growth.

“Venture capital funds have grown quite considerably in scale, and now play a big role in catalyzing investment,” Premier Li Keqiang said, according to an English-language statement on the government's website after a meeting of the State Council on Wednesday. “It is critical to send positive signals to the market when implementing these tax policies to help venture capital funds grow. This will foster an enabling environment for businesses to develop. Every bit of effort counts.”

A total of 6,442 venture capital funds with combined assets of 880 billion yuan ($128 billion) were registered with the Asset Management Association of China (AMAC) as of November, accounting for 39% of the private fund industry's assets of 2.26 trillion yuan.

From Jan. 1, 2019, limited partners in venture capital firms that are legally registered will be allowed to pay income tax at a flat rate of 20% on income they earn from their funds through dividends and capital gains, if the company chooses to have its taxes calculated as one investment fund, the State Council has decided. Alternatively, partners can pay a progressive tax rate starting at 5% and rising to 35% on income over a specific amount, if the firm chooses to have its taxes calculated based on annual income. The policy will be implemented for five years.

The progressive tax proposal, which stipulated that any income over 100,000 yuan would incur the highest rate of 35%, was put forward in August by the State Administration of Taxation (SAT) as part of an overhaul of the taxation system. The bureau also said that the 20% flat rate tax offered to firms as incentives by many local authorities was against the law.

A source in the SAT told Caixin at the time that the tax breaks led to inconsistency in implementing tax laws and also led to an unfair tax burden, as the 20% rate was lower than the rates paid by ordinary individual taxpayers. Another source in the administration said that those who use capital rather than their own labor to get rich should pay more tax.

But the administration's proposal triggered strong opposition from the venture capital industry out of concern it would significantly add to the tax burden of companies and partners. It also aroused concern from local governments who used the tax breaks to lure investment capital into their jurisdictions in order to follow government policies to promote innovation and entrepreneurship. Beijing, Shanghai and Chongqing are among the cities offering the flat rate tax.

The State Council stepped in to mediate and on Sept. 6 Premier Li stated that local preferential tax policies for venture capital firms could be maintained and that there should be no increase in their overall tax burden. He also called for more incentives to support the development of venture capital funds.

“The personal income tax incentives for venture capital firms are important for developing and nurturing the capital market,” Premier Li said, according to the government statement. “Such incentives need to be further improved and better implemented to ensure that the tax burdens of individual partners of venture capital firms will be reduced rather than increased.”

Contact reporter Leng Cheng (chengleng@caixin.com)