The Ministry of Finance and the State Administration of Taxation recently issued a circular in which they agreed to provide deductions to venture capital enterprises and individual angel investors on income tax. The circular primarily stipulates the scope of deduction and the applicable conditions and explanations for some of those conditions as highlighted below.
I. Scope of deduction
For a venture capital investment enterprise or an individual angel investor who has directly invested in a start-up technology enterprise (the “Investment Target”) through purchase of equity for two years (24 months), 70% of the investment amount may be deducted from the payable income tax for the year in which its investment reaches two years. However, the taxable items that may be deducted are slightly different for different types of investors.
For a corporate venture capital investment enterprise, the deduction may be made to the taxable income of the company. For a partnership venture capital enterprise, it is the income distributed to the partners from the investment object; in case of legal person partners, the income refers to various types of income; and in case of individual partners, the income shall refer to the operating income.
For an individual angel investor, the deduction may be made to the income from the transfer of the shares of the Investment Target. For example, if an angel investor has multiple Investment Targets, and there is one Investment Target in which the full 70% of the investment amount deduction is not used up at the time of liquidation, the remaining amount may be used in the investments in other enterprises within 36 months after the above Investment Target is canceled and liquidated.
Other than the above-mentioned 36-month limit, in all other circumstances, deductible amounts which have not been used up in the current year may be carried over to the following year.
II. Applicable conditions
(1) The “start-up technology enterprise” set forth in the circular shall satisfy the following conditions at the same time:
1. It is a resident enterprise incorporated in the territories of China (not including Hong Kong, Macao and the Taiwan area) and is subject to audit collection of taxes.
2. At the time the investment is accepted, the enterprise has no more than 200 employees with no less than 30% of employees holding at least a college degree, and its total assets and annual sales revenue do not exceed RMB30 million.
3. It has been incorporated for less than 5 years (60 months) at the time the investment is accepted.
4. It has not been listed in any domestic or overseas stock exchange at the time of investment and within two years after the investment is accepted.
5. The ratio of the total research and development expense to the total costs and expenses in the year when the investment is accepted and in the following tax year is not lower than 20%.
(2) The “venture capital enterprise” set forth in the circular shall meet the following conditions at the same time:
1. It is a resident enterprise or partnership venture capital enterprise incorporated in the territories of China (not including Hong Kong, Macao and the Taiwan area), is subject to audit collection of taxes, and is not a promotor of invested start-up technology enterprises.
2. It is compliant with the special requirements for venture capital funds under the Interim Measures for the Administration of Venture Capital Enterprises or the Interim Measures for the Supervision and Administration of Private Investment Funds, and it has completed recordation and has been operating its business pursuant to the above requirements.
3. The combined shareholding of a venture capital enterprise and its affiliates in an invested start-up technology enterprise is lower than 50% within two years after the investment.
(3) The “individual angel investor” set forth in the circular shall meet the following conditions at the same time:
1. The individual is not a promoter, employee or their relative (including spouse, parent, child, grandparent on the father’s or mother’s side, grandchild on the daughter’s or son’s side, or sibling) and have no labor dispatch relations with the invested start-up technology enterprise.
2. The combined shareholding the individual and his/her relatives own in the start-up technology enterprise is lower than 50%.
(4) “Investment” as mentioned in the circular shall meet the following conditions:
This is limited to equity investment obtained by paying cash directly to the start-up technology enterprise and does not include inventory equity received from other shareholders.
III. Interpretation of specific conditions
(1) The number of employees mentioned in the circular includes employees who have established labor relations with the enterprise as well as dispatched personnel accepted by the enterprise; the sales revenue set forth in the circular includes revenue from the main business and from other businesses; the costs and expenses include the costs of the main business, the costs of other businesses, the sales expenses, management expenses and financial expenses.
(2) The investment amount mentioned in the circular is determined according to the amount actually paid by the venture capital enterprise or the individual angel investor to the start-up technology enterprise. The investment amount of the partners of a partnership venture capital enterprise in a start-up technology enterprise shall be determined according to the amount actually paid by the partnership, calculated by the percentage of each partner’s contribution pursuant to the partnership agreement underlying the venture capital partnership. The income received by the partners shall be calculated in accordance with the Circular of the Ministry of Finance and the State Administration of Taxation on Issues Concerning the Income Taxes on Partnership Partners (Cai Shui  No. 159).
(3) When a start-up technology enterprise becomes listed on the Shanghai Stock Exchange or the Shenzhen Stock Exchange two years after the enterprise has accepted the investment of the individual angel investor, should the angel investor decide to transfer the shares of that enterprise, the transfer shall be handled pursuant to relevant current requirements for restricted shares. The deduction of the investment amount not yet deducted shall be calculated at the time of tax settlement.
The personal income tax policy for individual angel investors pursuant to the circular went into effect on July 1, 2018, while the effective date of the other policies is January 1, 2018. If the investment took place within 2 years before the effective date and would become invested for 2 years after the effective date, it is eligible for the tax policy as long as the investment meets the other conditions stipulated in the circular. The Circular of the Ministry of Finance and the State Administration of Taxation on the Pilot Tax Policies for Venture Capital Enterprises and Individual Angel Investors (Cai Shui  No. 38) was abolished on July 1, 2018. The deduction of an investment amount in compliance with the pilot policy conditions may continue in accordance with the provisions of the circular.