As an important vehicle for collective investment, private equity funds (hereinafter referred to as "private equity funds", "RMB funds", or "funds") have a significant impact on the performance of the fund, and have a significant impact on the establishment, investment, and exit stages of the fund, as well as on fund investors, fund managers The fund itself and different entities of the invested enterprise have different applications and impacts. Therefore, an important driving force for the development of private equity funds is taxation. From the development of RMB funds over the past 30 years, it can be seen that the structure of RMB funds has undergone multiple rounds of iterative evolution. Although the fund structure has become more complex, the nature of the income received by various tax payers, especially fund managers, is relatively clearer, and the tax burden borne by each entity is more determined and easy to handle (as shown in the figure below). It can be said that tax considerations are the most important force driving the evolution of the fund structure.

Source: Zero2IPO Research Center

If we look overseas, we can see the same logic. For example, the development of alternative investment vehicles used in US dollar funds from a vertical to a parallel is mainly due to the fact that US dollar funds seek to assist their investors in avoiding tax burdens, Including the "unrelated business taxable income" (UBTI) borne by tax exempt entities due to investment funds or the actual connected income (ECI) payable by non U.S. investors.

In summary, an excellent fund lawyer should have a thorough understanding of the different investment entities of the fund and the taxes that should be borne at different stages of the fund's operation, with a view to establishing an excellent fund structure throughout the fund's life cycle and improving the fund's investment efficiency with minimal tax losses throughout the entire process. We summarize the life cycle of fund raising, investment, management, and retirement in accordance with the business priorities of different stages. This article attempts to summarize the different taxes that RMB funds should incur in the investment cycle for RMB investors, with a view to benefiting investment industry clients.

1、 Fund establishment

During the fund establishment phase, the main factors that initiators need to consider and may have an impact on the fund's tax burden are:

（1） Place of establishment

Location selection is the most important tax factor for fund establishment. Although from the perspective of development trends, local tax policies tend to be fair and transparent. However, local tax incentives, incentive policies for attracting investment, and the close relationship between the fund management team and local tax authorities are still considerations related to the location of the fund.

1. Tax incentives for direct investment

Currently, Hainan and Hengqin are the main examples of local tax incentives for direct investment nationwide.

As early as 2014, the Ministry of Finance and the State Administration of Taxation issued policies to reduce the corporate income tax rate by 15% for encouraged industrial enterprises in the former Hengqin New Area; In 2019, the Ministry of Finance and the State Administration of Taxation included the tourism industry in the Hengqin enterprise income tax preferential list. Since then, the original Hengqin New Area preferential industry catalog has included a total of 80 items in six major categories, including high-tech, medicine and health, science and education research and development, cultural creativity, business services, and tourism. The scope of industrial preferences is mainly reflected in the encouraged industries in the area, and the proportion of main business income indicators is required to be above 70%. For domestic and foreign high-end talents and scarce talents working in the cooperation zone, the portion of their personal income tax burden exceeding 15% will be exempted. On the other hand, the cooperation zone follows the mainland tax system and connects with the Macao tax system. For Macao residents working in the cooperation zone, the portion of their personal income tax burden exceeding the Macao tax burden will be exempted.

According to the provisions of the Notice on Preferential Policies for Enterprise Income Tax in Hainan Free Trade Port, enterprise income tax is levied at a reduced rate of 15% for encouraged industrial enterprises registered in Hainan Free Trade Port and operating substantively. For high-end talents and scarce talents working in Hainan Free Trade Port, if the actual tax burden of personal income tax exceeds 15%, they can be exempted from personal income tax.

2. Tax refund

In addition to tax incentives for direct investment, many places offer preferential policies for tax returns on investment funds. At this point, it is not only necessary to pay attention to the tax refund ratio promised by the local competent department, but also to the proportion retained in the local area. The actual proportion that the fund can receive is the multiplication of the two. At the same time, attention should also be paid to the scope of the return: whether it includes corporate income tax, personal income tax, and value-added tax, or only corporate income tax. However, it is possible that tax returns may be linked to the tax contribution of the investment fund, so the fund should also consider the feasibility of tax returns.

3. Incentive policies for investment promotion

In addition to the aforementioned preferential tax policies, the incentive policies for local governments to attract investment are also applicable to investment funds, which can also be considered for establishment.

The tax rebates and investment incentives that the fund may receive from the local government will be included in the "subsidy income". According to the Notice of the Ministry of Finance and the State Administration of Taxation on the Treatment of Enterprise Income Tax on Special Purpose Financial Funds (CS [2011] No. 70), those that meet specific conditions can be regarded as non taxable income and deducted from the total income when calculating taxable income. As for the tax returns granted by local governments, how to determine their nature and conditions, and whether they are taxable, we recommend that the fund sponsor confirm with the local competent department in advance whether they will be subject to secondary collection for this portion of income.

For the above preferential policies related to the fund establishment location, we recommend that the fund sponsor actively communicate with the competent authority before establishment, and confirm the relevant preferential policies in written form such as an investment memorandum. However, in many cases, the competent authority is not willing to provide corresponding written confirmation documents, and will explicitly rely on the minutes of government meetings in lawyer interviews. There are no clear provisions or agreements, which are oral commitments to registered fund management companies.

However, it should be noted that in May 2022, the General Office of the State Council issued the latest document, which will gradually abolish the policy of retaining or increasing the return of fiscal revenue for various regions, levy taxes and fees in accordance with the law and regulations, and strictly implement the policy of tax refund, tax reduction, and fee reduction, which requires follow-up attention from industry insiders.

（2） Form of establishment

1. Preferential tax policies for choosing to register as a venture capital fund

The "Several Opinions of the State Council on Promoting the Sustainable and Healthy Development of Venture Capital" (GF [2016] No. 53, "National Ten Articles of Venture Capital") proposed the requirement of "further improving the investment deduction preferential policies for venture capital enterprises". On May 14, 2018, the Ministry of Finance and the State Administration of Taxation issued the "Notice on Relevant Tax Policies for Venture Capital Enterprises and Angel Investment Individuals" (CS [2018] No. 55), It has replaced the "Pilot Tax Policy on Venture Capital Enterprises and Angel Investment Individuals" issued in April 2017 and has become a nationwide tax preferential policy, greatly reflecting the support of the national financial and tax levels for entrepreneurship and innovation.

The tax preference method in Document No. 55 is to deduct the "taxable income" during the process of collecting corporate income tax or personal income tax, which is to reduce the overall tax burden by reducing the tax base, and is basically unrelated to the applicable tax rate. In the implementation phase, local securities regulatory bureaus have issued the "Notice on No Objections to the Issuance of Tax Policies for Venture Capital Funds Subject to the Finance and Taxation Document No. 55" (local announcements are similar but slightly different, with some slight differences), which puts forward more detailed requirements for "venture capital funds" in accordance with some "quantitative standards" in the "Venture Capital Measures", Thus, the "venture capital enterprises" of the National Development and Reform Commission and the "venture capital funds" of the China Securities Regulatory Commission are basically consistent in their standards when applying the No. 55 document, avoiding regulatory differences. According to the application of the document No. 53, venture capital funds can deduct operating income based on 70% of their investment amount.
At the beginning of 2019, the "Notice of the Ministry of Finance, the State Administration of Taxation, the Development and Reform Commission, and the Securities Regulatory Commission on Issues Concerning the Income Tax Policy for Individual Partners of Venture Capital Enterprises" (CS [2019] No. 8) was issued, clarifying that venture capital enterprises can choose one of two methods: accounting by a single investment fund or accounting by the overall annual income of venture capital enterprises. If the fund chooses to register as a single accounted venture capital fund, a single project can be accounted for separately, and the income of individual partners derived from venture capital enterprises is subject to income tax at a rate of 20%. If the fund is registered for overall accounting, the loss can be carried forward for 5 years after offsetting the loss and profit. However, losses cannot be distributed to institutional investors in the current year to offset their income tax.

（3） Stamp duty

Regarding the question of whether a partner's capital contribution needs to be subject to stamp tax, the State Administration of Taxation made it clear through a question and answer that the amount of the partnership's capital contribution is not included in the "paid in capital" and "capital reserve", and no stamp tax is levied on the capital account book. Many local tax bureaus, such as Beijing Tax Bureau, Anhui Local Tax Bureau, and Jiangsu Local Tax Bureau, also repeat the statement of the State Administration of Taxation through question and answer forms. However, some local tax bureaus, such as Hubei Local Tax Bureau, Shenzhen Local Tax Bureau, Xiamen Local Tax Bureau, Wuhu Local Tax Bureau, and Guangzhou Local Tax Bureau, believe that partnerships are accounted for through the "paid in capital" and "capital reserve" accounts, You need to pay the stamp tax on the capital account book for the amount accounted for by the corresponding account.

We suggest that partnerships should establish separate accounts to account for partner contributions to prevent stamp tax disputes and tax risks.

2、 Fund investment

The tax burden at the investment stage of a fund mainly involves the outflow of monetary assets, as it generates income tax and value-added tax generated through the income generated during the holding period or capital gains generated through the transfer of fund shares.

（1） Fund level

We mainly analyze the tax burden of RMB funds through the different forms of company system, partnership system, and contractual system.

（2） Investor level

The fund contributor shall calculate value-added tax and income tax based on the income obtained from the fund, the capital gains obtained when transferring the fund shares, and the investment income obtained when reducing the fund shares. At the same time, fund contributors are still slightly different according to different organizational forms - companies, natural persons, or partnerships. We still list them in tabular form as follows:

It is worth mentioning that tax regulation for individual investors has been a focus of tax planning for many years due to different tax policies across the country. On December 30, 2021, the Ministry of Finance and the State Administration of Taxation issued the "Announcement on the Administration of the Collection of Individual Income Tax on Income from Equity Investment and Operation" (hereinafter referred to as "Announcement 41"), announcing the comprehensive end of the era of the collection of individual income tax by means of approved collection in the private equity industry, and the trend of unified collection of individual income tax. As the relevant taxes of individual investors are withheld and remitted by the fund, at this level, we still need to review the agreements reached with local governments and investment promotion departments at the time of fund establishment to ensure that relevant tax preferential policies are implemented at this level. For example, Beijing Fund Town once provided a preferential policy for fund executives (those at or above the director level) to return up to 30% of their total annual tax payment, and funds should pay attention to implementing this preferential policy when withholding and remitting funds.

3、 Fund withdrawal

Fund investment income is mainly generated during the exit stage through redemption of fund shares. The tax policy on redemption of fund units is relatively complex. As the author is not a specialized tax lawyer, I will attempt to make a preliminary summary of the tax policy at this stage:

epilogue

In practice, private equity investment has a diverse organizational structure, investment and exit methods, and different participants, making tax related matters more complex. This article only attempts to make a preliminary summary of the tax burden generated in the entire process chain of the fund, in order to help fund lawyers in fund document preparation and post investment management matters. However, specific tax matters need to be confirmed during the specific investment process of the specific fund. We look forward to further discussions with the industry on the topic of this article.