China's headline corporate income tax is 25% — the standard rate, alongside the other bands covered in China corporate income tax rates. A small company can end up paying an effective 5% — and the mechanism is not a lower rate at all. It is a reduced income figure taxed at a rate that is itself below the standard one.
Article 28 of the Enterprise Income Tax Law sets a 20% rate for qualifying small low-profit enterprises. MOF and STA Announcement No. 12 of 2023 then does the rest: the taxable income is calculated at 25% of the actual figure, and 20% is applied to that. Twenty percent of a quarter is five percent.
The relief runs to 31 December 2027. It is generous, widely used, and surrounded by two misunderstandings that cost real money — one about the rate, one about the boundary.
The three tests
Qualification is not a matter of size in the ordinary sense. All three conditions must be met simultaneously, and the enterprise must also be engaged in an industry that is neither restricted nor prohibited:
| Test | Threshold | How measured |
|---|---|---|
| Annual taxable income | Not more than 3,000,000 yuan | Taxable income, not revenue |
| Number of employees | Not more than 300 | Annual quarterly average, including dispatched labour |
| Total assets | Not more than 50,000,000 yuan | Annual quarterly average |
Two details in that table do most of the work. The income test uses taxable income — after deductions, not turnover. A company with 40 million in revenue and no profit passes. A company with 8 million in revenue and 3.2 million of taxable income fails.
And headcount includes dispatched workers supplied by a labour agency, not just direct employees. A manufacturer running 260 own staff plus 60 agency workers is at 320 and outside the regime.
How the 5% is built
The arithmetic is worth spelling out because the two-step structure explains why the benefit is so large:
| Step | Calculation | Result on 2,000,000 taxable income |
|---|---|---|
| Taxable income | — | 2,000,000 |
| Income included at 25% | 2,000,000 × 25% | 500,000 |
| Tax at 20% | 500,000 × 20% | 100,000 |
| Effective rate | 100,000 ÷ 2,000,000 | 5% |
Compare 25% on the same income: 500,000. The saving is 400,000 yuan — four times the tax actually paid.
What changed in 2023
Before 2023 the regime was tiered, and a lot of material still reflects the old tiers. Income up to 1 million was effectively taxed at 2.5%, and the portion between 1 and 3 million at 5%.
Announcement No. 12 of 2023 replaced that with a single 5% across the whole 3 million. The lower band got more expensive, the structure got simpler, and the ceiling stayed where it was.
This matters in practice because a finance team working from a 2021 or 2022 template will still be applying 2.5% to the first million and will under-provide for tax by half of that slice. On 1 million of taxable income the difference is 25,000 yuan.
The cliff at three million
This is the part that deserves the most attention, because the test is a threshold and not a taper. At 3,000,000 of taxable income the effective rate is 5%. At 3,000,001 it is 25% — the relief does not phase out, it stops.
| Taxable income | Tax | After-tax |
|---|---|---|
| 2,800,000 | 140,000 | 2,660,000 |
| 3,000,000 | 150,000 | 2,850,000 |
| 3,100,000 | 775,000 | 2,325,000 |
Earning 100,000 more produces 525,000 less after tax. The company is worse off than if it had stopped at three million.
The break-even point is 3,800,000: below that, after-tax profit is still under what 3,000,000 would have delivered. So the band between 3 and 3.8 million is a genuine dead zone — every additional yuan of taxable income reduces the owners' outcome until the company climbs out of it.
What this means operationally. A company approaching the threshold has legitimate options: bringing forward deductible expenditure, timing revenue recognition, or — more structurally — splitting genuinely separate business lines into separate entities. What it does not have is a licence to move profits around on paper. Splitting an entity that has no independent substance is the version of this that tax authorities examine and recharacterise, and the consequence is worse than the tax saved.
Measuring the headcount and asset tests
Both are calculated as a full-year quarterly average, not a year-end snapshot and not a monthly average:
Quarterly average = (opening value + closing value) ÷ 2. Annual average = the sum of the four quarterly averages ÷ 4.
A business that opens or closes during the year uses its actual operating period as the tax year for these purposes. The practical consequence is that a seasonal company cannot pass the headcount test by shedding staff in December — the fourth-quarter average captures half of that reduction, and the earlier quarters count in full.
Claiming it during prepayment
The relief is available in quarterly prepayment, not only at annual reconciliation. The figures are tested against the position at the end of the prepayment period rather than the full year.
The corollary bites: if you claimed at prepayment and fail the test at annual reconciliation, the difference is payable. Qualification is ultimately determined by the annual filing, and a company that grew through the year will find itself settling up.
The procedure is self-assessment: judge your own eligibility, claim it in the return, and keep the documentation — a statement that the industry is not restricted or prohibited, the headcount calculation, and the asset calculation. The method of assessment does not matter; both audit-based and deemed-assessment taxpayers can claim.
Stacking with other reliefs
The 5% regime is not the only relief aimed at small companies, and the interaction is not always additive.
- R&D super deduction — stacks. The additional deduction for qualifying research spending reduces taxable income before the 25% inclusion is applied. A company that would otherwise sit at 3.2 million can deduct its way back under the threshold, and the value of each yuan of R&D deduction is amplified by the low rate.
- High and new technology enterprise at 15% — does not stack. The two regimes are alternatives applied to the same income, so the company takes whichever produces the lower tax. For a profitable small company, 5% beats 15% comfortably; above 3 million of taxable income the 15% HNTE rate becomes the better of the two, which is precisely why the cliff is less brutal for HNTE-qualified businesses than for others.
- The "six taxes and two fees" halving — stacks. Announcement No. 12 of 2023, Article 2 halves resource tax, urban maintenance and construction tax, property tax, urban land use tax, stamp duty, farmland occupation tax and the two education surcharges. Article 4 confirms these can be claimed on top of other relief already enjoyed.
The practical point: at the boundary, the question is not "how do I stay under 3 million" but "which combination of reliefs produces the lowest total charge". Those are different calculations, and the second one sometimes points above the threshold.
A note for foreign-invested companies
The regime is defined by size and industry, not by nationality of ownership, so a wholly foreign-owned enterprise qualifies on the same terms as a domestic one. Two operational points follow.
Headcount includes foreign employees working under a Chinese employment contract, and includes staff supplied by agencies. Both are easy to under-count in a group where some people are on a regional payroll.
And the relief attaches to a legal entity. A branch of a foreign company is not a separate taxpayer for this purpose and cannot claim it — the tests are applied to the enterprise as a whole, which for a branch means the foreign company's global figures. For groups structuring a China entry, that is a reason to consider a subsidiary rather than a branch where the business is expected to stay small.
Where companies get it wrong
- Applying 2.5%. That tier ended on 31 December 2022.
- Using revenue instead of taxable income for the 3 million test.
- Leaving dispatched workers out of headcount. Announcement No. 12 counts them expressly.
- Using a year-end snapshot for headcount or assets instead of the quarterly average.
- Ignoring the industry condition. Size alone does not qualify; restricted and prohibited industries are excluded regardless.
- Assuming the relief tapers. It does not, and the 3 to 3.8 million band destroys value.
- Forgetting the settlement. Prepayment relief that fails at reconciliation becomes arrears.
Sources and current status
- Enterprise Income Tax Law of the PRC, Article 28 — 20% rate for qualifying small low-profit enterprises; as last amended 29 December 2018.
- MOF and STA Announcement No. 12 of 2023, Article 3 (25% inclusion, 20% rate, through 31 December 2027) and Article 5 (the three tests and their measurement).
Status note. The current relief has a stated end date of 31 December 2027. It has been extended repeatedly in the past, but planning beyond that date should not assume continuation. The tiered 2.5% structure that applied before 2023 should not be used for any period from 2023 onward.
This is a plain-English reference, not tax advice. Qualification depends on the full-year figures and on facts about the business that cannot be assessed from a summary. Confirm with a licensed practitioner before relying on the position for a specific year.