Partnership is one form of enterprises organizations. According to law of partnerships, the natural person, legal person entity or other form of organizations can be partner of the partnership. Partnership is not legal person status, and does not own civil rights and relevant obligations a legal person entity shall have. Accordingly, partnership is different from legal person entity in levying income tax. In this article, we will explain the tax treatment by analyzing tax regulations.
1. General tax requirement
According to tax regulation (Caishui（2008）159)，for partnership, each partner is tax payer. The natural person partner shall levy individual income tax (“IIT’) and legal person partner shall levy corporate income tax (“CIT”). With respect of operation income and other income, the tax levy principle shall be that the partnership firstly makes the distribution to partners which will then levy tax respectively.
According to tax regulation (Caishui（2000）91,Caishui(2008)65)), operating income and other income of partnerships shall be the income distributed by the partnership as well as the retained earnings of the partnership. This means that no matter whether the partnership distributes the profit to partners or not, as long as there are retained earnings, it is treated that profit has been distributed and income tax shall be levied, even if no cash is actually paid or distribution decision is yet to be made.
The tax regulation provides certain guidance on profit distribution:
1) Partnership can use the distribution rate stipulated in the partnership agreement
2) If distribution rate in 1）is not clear, partners can make decision on distribution rate by negotiation.
3) If negotiation is not workable, the occupationratio of actual capital injection can be applied.
4) If the capital injection ratio cannot beclarified, the income can be averagely distributed to the partners.
5) Profit of the partnership shall not all be distributed out.
2. Tax treatment by main income categories
1) Operating income and other income
According to tax regulation (Caishui(2008)65)), operation income of partnership shall be the balance of total revenue of the partnership after reducing expense and loss. Salary to investors shall not be deducted before income tax.
Natural person partner
Regarding the operation and other income, natural person partner shall pay IIT under itemof operation income at progressive rates ranging from 5% to 35%. According to IIT tax law, for operation income item, if no comprehensive income, fixed deduction of one tax year shall be 60 thousand. Other deduction items include specific deduction, specific additional deduction and other deductions allowed by tax.
Legal person partner
The income from the partnership shall be combined in the income of the legal person’s enterprise to calculate CIT, while the loss of the partnership cannot be used to net off the income of legal person’s enterprise.
2) Dividend and interest from the investment made by the partnership
Natural person partner
According to tax regulation (Guoshuihan（2001）84)，the dividend and interest from the investment of the partnership shall not be included in the operation income of the partnership enterprise can shall be separately treated as tax item of interest and dividend to levy IIT at tax rate of 20%.
For example, if total income of partnership for year 2019 is RMB 110 thousand, including interest and dividend from invested project at RMB 10 thousand, dividend and interest at RMB 10 thousand shall separately levy IIT at 20%, and operation income at RMB 100 thousand shall levy IIT at progressive rates ranging from 5% to 35%, after reducing expense and loss as allowed by tax.
Legal person partner
Dividend and interest shall be combined in profit of legal person’s entity for calculating CIT.
According to law of CIT of PRC, if conditions are satisfied, the interest and dividend between domestic resident enterprises shall be free of tax. However, since one condition is that the investment shall be that directly made by the resident enterprise, the interest and dividend obtained from investment made through partnership shall still levy CIT.
3) Income fromtransfer of equity shares
Natural person partner
Accordingto tax regulation (Caishui (2000)91), for partnership, the income from transfer of equity shares of investment shall be included in operating income and other income. As mentioned above, for natural person partner, operation income shall levy IIT at progressive rates ranging from 5% to 35%.
For partnerships which invest start-up enterprise, according to tax regulation (Caishui(2019)8), if conditions are satisfied, partnership can choose one from two methods to calculate the taxable profit for tax levy. The first method is to book and report the income of interest and dividend and transfer of equityshares from projects invested by each fund.
Underthis method, for natural person partner, the interest and dividend and incomefrom transfer of equity shares can be levied IIT at 20%. This method is only applicable to the natural person partner. Partnership shall file with tax authority the method selection and withhold IIT for partners. After selected, the method cannot be changed for 3 years.
Another method is to calculate total income of all funds of the year. Under this method, natural person partner’s income from the partnership shall levy tax as operating income at progressive rates ranging from 5% to 35%.
Legal person partner
The income shall still be combined in income of the legal person’s enterprise topay CIT.
3. Tax favor policy
According to tax regulation (Caishui (2018)55), where the limited partnership enterprise directly invests start up technology enterprise by equity investment and the investment period reaches 2 years, if the conditions for both the enterprise invested and the investors are satisfied, for the natural person partner, 70% of theinvestment made to start up scientific and technique enterprise can be deducted from the income distributed by the partnership in calculating IIT and the remaining balance after deduction can be carried forward to the following year for further deduction. This tax favor policy is also applicable to legal personentity.
Regarding the above, if you need further explanations on the tax regulation or tax treatment, please contact us.