Posted by Matthew on April 27, 2010 under Corporate Tax Planning | 
Changes begin – first reported decision
As we mentioned in the March edition of Hwuason Insights, significant changes have been implemented in the manner in which representative offices (ROs) are taxed in China (see Circular 18). The first quarter (the reportable tax period for ROs) ended on 31 March 2010 and accordingly we are now beginning to see the interpretation of the new rules by the local tax authorities.
In early April the Shajing Local Taxation Office in Shenzhen province re-assessed 15 ROs and increased the payable tax by almost RMB700,000. As part of the new tax environment for ROs, the Shajing Local Tax Office examined these ROs and discovered that the ROs had only paid their income tax to the state tax bureau but had not met their taxation obligations with the local tax bureau. The chief representatives of the RO were required, as part of these investigations to have discussions with the local tax officials in relation to the nature of their business.
The tax officials also examined and compared the materials provided by the ROs. As part of this process, the ROs indicated that there were some ambiguous aspects to the new policies. As transitional concessional arrangement, the local tax officials provide some guidance of the new policy to the ROs. However, it cannot be expected that the officials will take such a conciliatory approach in the future. These turn of events reflect the general cynicism of tax officials towards ROs in China. It can be expected that a continued tough line will be adopted by tax authorities in China in relation to the tax practices of such structures.
Actual income confusion
There has been some confusion recently relating to the SAT’s treatment of ROs (in Circular 18) and the treatment of them by the State Administration for Industry and Commerce (SAIC in that the SAIC rules provide that ROs could not undertake direct business in China, yet the Circular 18 indicates ROs may be taxable on actual income. A question has arisen, from some, as to how an RO can have actual income if it is not able to undertake direct business. What this question misunderstands is that representative office are assessed and required to pay enterprise income tax on its attributable income. The term “attributable income” has a very specific meaning in international tax – it is commonly used in terms of taxing companies in respect of “permanent establishments” they have in a foreign country. Income could be attributable to a source (such as an RO) without that source actually directly earning the income. In other words, the parent company of an RO will often earn income that could be attributable to the RO without the RO engaging in direct business. This is actually the classic model of an RO. In such circumstances, Circular 18 is saying that China will tax the RO on that income and in order for the foreign investor to avoid either of the two deemed methods, accurate accounting records need to be maintained to reflect what income is attributable to the RO.
Regardless, it should be noted that the SAT has no legal authority to indicate what business activities are lawful for an RO to operate. At the same time, the SAT will treat legal and illegal income equally – it will tax them. A drug dealer cannot resist tax on the basis that his/her income derives from the proceeds of a criminal act. Such an argument that the “inconsistency” between Circular 18 and the SAIC Notice requires clarification is therefore misguided.
Posted by Shi Zhiqun on under Anti-Avoidance, Corporate Tax Planning |
In 2009 the State Administration of Taxation (SAT) undertook significant steps in relation to clamping down on anti-avoidance practices. Yet, recent indications suggest that the SAT considers that there is a significant way to go. Officials have been repeatedly indicating that in 2010, China will step up efforts to counter tax evasion, with a particular focus on transfer pricing in the pharmaceutical and automotive industries, the use of intangible assets and share transfers, and cross-border related business transactions.
The SAT spent considerable recourses in 2009 developing a sound system for its anti-avoidance investigation practices and it is expected that in 3020 this will continue to be fine-tuned. An official from the SAT’s International Tax Department recently commented that up until “present investigations focused more on anti-avoidance in respect of the purchase and sale of tangible assets, cost sharing by controlled foreign companies and thin capitalization”. However, from this year, the SAT will look beyond these more simplistic anti-avoidance practices and will examine the issues on a more complex level, including exploring rational pricing of intangible assets and equity. In addition, outbound investment will receive special attention, particularly the transfer pricing practices employed by Chinese companies investing abroad and controlled foreign company management.
The SATs efforts to combat anti-avoidance in 2009 garnered significant results – the work of the national anti-avoidance team resulted in adjustments to taxable income totally 16.09 billion yuan and 2.09 billion yuan in back taxes.
Promisingly, the SAT official also indicated that the SAT will seek to encourage bilateral Advance Pricing Agreements (APAs). Bilateral APAs allow multinational companies to achieve greater certainty in terms of their transfer pricing practices. There has been some doubt in the past about the difficulties in obtaining bilateral APAs and accordingly it is encouraging to see commitment to them by the SAT. Since 2005 China has entered into 12 bilateral APAs and it is expected that this number will rise as multinationals become more familiar with China’s approach and the attitude of tax officials to them.
Posted by Matthew on under Corporate Tax Planning |
In mid-February the Chinese tax authorities issued Guoshuifa [2010] 19 (“Circular 19″). Circular 19 outlines the State Administration of Taxation’s new administrative approach to collecting tax from non-resident enterprises. Prior to discussing the changes introduced in Circular 19, it is apt to briefly outline the general rules for the taxation of non-resident enterprises.
Taxation of Non-resident Enterprises
The taxation of non-resident enterprises depends upon whether they have a “permanent establishment” in China. Non-resident enterprises that do not have a permanent establishment will be liable to tax at 10% on income sourced or “derived” from China. Non-resident enterprises that do have a permanent establishment in China will be subject to tax at 25% on income (derived outside or inside of China) that is attributable to the permanent establishment.
Circular 19
Circular 19 applies to non-resident enterprises whether or not they have a permanent establishment in China. Article 3 of Circular 19 simply requires non-resident enterprises to maintain accurate accounts and to pay enterprise income tax in accordance with the income in those accounts.
Article 4 then provides that where accurate accounts have not been maintained, the authorities may deem the enterprise to have a specified profit level. There are three methods for deeming the requisite profits. The deemed profit rates under Article 4 will generally be more relevant in the case of a permanent establishment and is similar to the treatment of representative offices under Circular 18.
Article 5 then provides a deemed profit rate in respect of particular transactions. These profit rates are as follows:
- Engineering contracts, design, and labor consulting contracts – 15%-30%;
- Management services – 30%-50%; and
- Other labor services, or other operations – no less than 15%.
The tax authorities may impose a higher rate where they consider the actual profit to be higher. It is not clear whether Article 5 applies when a non-resident enterprise can, through accurate accounting records establish that their profit rate on a particular transaction is lower than the prescribed levels. On a fair reading of the Circular, it seems that the better argument would be that these rates apply regardless.
Accordingly, from this there are two important things note:
- Any company that does not presently operate a business in China but does enter into business arrangements with Chinese resident companies should review such arrangements to ensure that their actual profit is at least of that prescribed rates.
- Not all such arrangements will result in the income being regarded as income sourced from China. However, it is imperative for non-resident companies to consider whether Chinese tax will apply in the circumstances and whether any alterations to an arrangement can be made to ensure that it does not.
Circular 19 does discuss a few other issues, including indicating a minimum 10% profit rate for the sale of machinery or merchandise by a non-resident enterprise to a resident enterprise, but the above are the main salient points for companies contracting with Chinese companies, or who have a permanent establishment, to consider.
Posted by admin on April 19, 2010 under Corporate Tax Planning, Hwuason News |
Hwuason Seminar Series
The End for Representative Offices?
On 20 February 2010 the State Administration of Taxation issued Circular 18/2010 outlining a new tax treatment for representative offices (ROs) of foreign enterprises in China.
Circular 18/2010 replaces several older circulars relating to the taxation of ROs and introduces significant changes. The new circular represents a fundamental shift in tax liability for ROs in China and all foreign companies with ROs should determine how it affects them. Hwuason’s tax lawyers will outline the changes and illustrate how they will impact upon the bottom line
Issues covered will include:
1. Previous tax treatment of ROs;
2. An outline of Circular 18 and its practical implications; and
3. Moving from a RO to a corporate structure.
For those unable to attend the seminar but who would like more information in relation to this latest development, please do not hesitate to contact us.
Details:
Date: Wednesday, 21 April 2010
Time: 2pm to 3pm
Location: Hwuason Boardroom, Suite 1505, Tower B, Jianwai SOHO, No 39, East 3rd Ring Road,
Chaoyang District, Beijing
Language: English
Hwuason is the first law firm in China specialized in taxation law. Hwuason has extensive experience in tax planning, corporate finance, foreign investment, M&A and tax related litigation.
Click here to register for the seminar.
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Tel: 8610-58697282 E-mail: china@chinataxlawyers.com |
Posted by Matthew on April 16, 2010 under Corporate Tax Planning |
One of the common questions that we are asked at Hwuason is in relation to the tax treatment of H-Shares – shares in Chinese companies that are listed on the Hong Kong stock exchange.
Dividends
According to Articles 3 and 6 of the Enterprise Income Tax Law, non-resident enterprises are required tax in relation to the dividends from shares in a resident enterprise. The relevant tax rate on such income is 10%. Despite this, up until November 2008, the general practice was that dividends from H-shares were exempt from tax. In November 2008, the State Administration for Taxation issued Guoshuifa [2008] No. 897 which indicated that tax was payable on such dividends and that the resident Chinese enterprise was a withholding agent for its non-resident shareholders.
Capital Gains
It has not been clearly stated whether non-resident enterprise are taxable on capital gains from H-shares. The current practice, based on previous regulations, is that the income from the transfer of H-shares is exempt from tax. However, there is some genuine concern that such a practice will be changed in the near future. Given that dividends are now taxed, I think it would be doubtful that an exemption for capital gains will be continued in the future.
In terms of removing the risk of changes to the tax treatment off capital gains, it may be advisable for investors to take advantage of favourable DTAs that prevent China from taxing holdings below 25%. The merits of such an option would be subject to the particular circumstances, and the powers that China’s tax officials have in accordance with the General Anti-Avoidance Rule always needs to be kept in mind.
