On March 23, 2009, China’s Ministry of Finance and State Administration of Taxation jointly issued a Notice on the Policy of Enterprise Income Tax for China Clean Development Mechanism Fund ("CCDMF") and China Clean Development Mechanism ("CCDM") Projects (hereinafter referred as to the “Notice”) to introduce new tax incentives for CCDM projects and the CCDMF. The Notice has retroactive effect from January 1, 2007.

Background

The United Nations Framework Convention on Climate Change and the Kyoto Protocol established the Clean Development Mechanism ("CDM"), a market-based approach that encourages industrialized countries to reduce greenhouse emissions by investing in clean energy projects in developing countries. In 2005, China promulgated "Measures for the Operation and Management of China Clean Development Mechanism Projects" to establish a national legal framework for the approval and implementation of CDM projects. The Notice clarifies a series of tax incentives for the CCDMF and enterprises participating in CCDM projects.

Key Points of the Notice

The Notice provides that the following types of income earned by the CCDMF will be exempt from the enterprise income tax ("EIT"): (i) the proceeds from sales of certified emission reductions (“CERs”) that are contributed to the government, (ii) donations from international financial organizations, (iii) interest income from fund deposits and treasury bonds, and (iv) donations from domestic or international institutions, organizations, and individuals.

Additionally, enterprises implementing CCDM projects are authorized to deduct the contributions of CER sales proceeds made to the government. The deductions are equal to 65% of the sales price of CERs from projects involving hydrofluorocarbon (“HFC”) and perfluorocarbon (“PFC”) and 30% from projects involving nitrous oxide (“N2O”). Further, a deduction equal to 2% of the sales price of CERs from new and renewable energy projects and tree planting is available.

Enterprises implementing HFC, PFC and N2O projects will enjoy a three-year EIT exemption, followed by a three year 50% EIT reduction, beginning in the tax year when the enterprise first earned income from CER sales. Importantly, the Notice underscores that the income available for the tax incentives will be the net amount, taking into account deductions for both the contributions to the government and the relevant costs incurred by carrying out the CCDM projects. Additionally, a separate accounting of income from CCDM projects and other businesses must be maintained.

Conclusion

The Notice encourages foreign investment in CCDM projects by providing significant tax exemptions and preferences. Foreign enterprises will find more investment opportunities under the CDM, and China could emerge as a leader in the trade of global carbon credits.

Authored By:

William Zheng

86.21.2321.6000

WZheng@sheppardmullin.com