Posted by Matthew on March 31, 2010 under Corporate Tax Planning, International tax | 
fter the last few weeks I have given some thought about Circular 18 and whether I think the changes are appropriate or not. I have now decided that I am not a fan of it. Why? Because it perpetuates the notion, which is incorrect as a matter of law, that representative offices (ROs) in China have a separate legal personality. Let me explain why it does this and the problems it causes.
As most people know, ROs are not meant to be, subject to limited exceptions in respect of banks and professional service firms, utilised to carry out direct business in China. Rather, China requires foreign companies to establish a local company (a WFOE or JV) or, as of 1 March 2010, a registered partnership in order to undertake direct business here. This is no different from most jurisdictions. Australia, for example, requires foreign companies to register under the Corporations Act if they wish to carry out business.Yet, over time many ROs flagrantly breached this restrictions. More accurately I should say that many foreign enterprise utilised ROs as vehicles to undertake direct business contrary to the restrictions. This was a function of the high set-up costs for WFOEs and JVs and the requirement that such entities have a limited amount of registered capital – as an aside, I have always thought that in most cases the fear of registered capital requirements was rather strange. Who would consider establishing a business without having the necessary capital to meet initial (say first 2 years) costs? In a classic RO, the RO should never be taxable because it is really the parent company that is earning the income. The parent company should be taxed in that income – where it relates to a permanent establishment (which a RO would nearly always be) this would be at 25% and otherwise it would be at 10% as withholding tax.
However, in response to the fact that ROs were, in truth, engaging in direct business and earning income, the Chinese tax authorities sought to impose tax on them. As ROs rarely kept good accounting records (in part because they wished to avoid the perception that they were engaging in direct business and hence would not report the earning of income), the tax authorities decided to deem a ROs income based on the amount of their expenses. Expenses relating to the classic use of an RO (liaison office, marketing, promotion of goods of parent co etc) were exempt from this deeming because the RO was never intended to be taxed on such income. A lot of this was moot because a large majority of ROs actually received exempt status on all income from local tax officials are part of the policy on encouraging foreign investment in that local area – as a further aside, I have always found China’s pre-2008 tax policy fascinating and have thought that it is a great example of what the OECD refers to as “harmful tax competition”.
Circular 18, by contrast, taxes ROs on any income that is attributable to the RO – this would include income from direct business and income of the foreign parent that is attributable to the activities of the RO. Circular 18 removes both the outright exemptions and the exemption on expenses relating to the foreign parent noted above. In effect, this means that an RO will be the relevant taxpayer for the income of a non-resident enterprise and the income attributable to the RO will be taxed at 25% in accordance with the Enterprise Income Tax Law (EITL). Article 3 of Circular 18 provides as follows:
Article 3: Representative office shall apply and pay the enterprise income tax on its incomes, and apply and pay business tax and value-added tax on its taxable incomes.
Where the RO has not kept accurate accounting records, the tax authorities will again deem a profit – 15% of expenses. My problem with this is following:
- Strictly speaking the relevant taxpayer in respect of the income of a non-resident enterprise should be the non-resident enterprise. Now, whilst in practice imposing tax on the RO as opposed to the non-resident enterprise should not result in any difference, it is an example of expedience over legal consistency. ROs are not enterprises so should not be taxed under the EITL.
- If the SAT wishes to utilise ROs as withholding agents for the income of the non-resident enterprise, which is understandable, then they should make this clear. This would be an approach that is legally consistent and achieves the objectives of effective tax collection. Unfortunately, Circular 18 precedes on the basis that the RO is the relevant taxpayer and is not merely a withholding agent.
Circular 18 represents a messy approach to a rather simple problem.
This is more than just a philosophical objection – a legitmate questions arises as how ROs will operate in the context of China’s double taxation agreements (DTA) and, in particular, whether they will be regarded as companies for those DTAs and, in fact, whether the DTAs should apply to ROs themselves (as opposed to the parent companies). Now, interestingly Circular 18 indicates that DTA relief will be available for ROs (see Article 10 of Circular 18). I am not confident that this is strictly correct. Let me explain why
As I usually do I will utilise the China-Australian DTA as an example (dont worry most DTAs are pretty much the same so the points I raise here will be of general application). Article of the DTA provides that the agreement:
shall apply to persons who are residents of one or both of the Contracting States.
Article 3 then provides the following definitions:
(d) the term “person” includes an individual, a company and any other body of persons;
(e) the term “company” means any body corporate or any entity which is treated as a company or body corporate for tax purposes;
Under this definition, the question of whether an RO is a company, and hence a person, for the purposes of the DTA is dependent on whether they are treated as a company for tax purposes. Under a strict reading of the EITL, ROs are not treated as companies for the purpose of Chine tax purposes – they do not fall within the definition of enterprise. However, Circular 18 seems to treat them as such in saying that the EITL applies to them . Can ROs then be regarded as resident companies for the purposes of China’s DTAs? Interesting dilemma and to be honest there is no easy answer. Does anyone else have any other ideas?
Despite the title of this post there is really only ugly here.
Posted by Jane Peng on March 23, 2010 under Corporate Tax Planning |
On 20 February 2010 the State Administration of Taxation issued a further clarification on certain aspects of the Enterprise Income Tax Law (EITL) in Guoshuihan [2010] 79 (Circular 79). Circular 79 answers some common problem areas of the operation of the EITL.
The clarifications in Circular 79 include the following:
- “Income” from equity transfers refers to the consideration from the transfer less the original cost incurred to obtain the equity. Further, undistributed profits cannot be deducted from the transfer price for tax purposes.
- An enterprise obtaining equity investment income (such as dividends, bonus shares etc) are deemed to have received the income on the date when board of directors or general meeting of shareholders make decision to distribute profits or issue the bonus shares .
- A enterprise begins to calculate its profit and losses in the year that the enterprise started commenced production and operation of its business. The cost and expense occurred during preparations before the enterprise engaged in production and operation, shall not be counted as a loss of current period.
- Costs and expenses relating to exempt income may be deducted when the enterprise calculates its taxable income, unless otherwise specified.
A translation of Circular 79 will be posted on the Hwuason website within the next 7 days.
Posted by Jane Peng on under China Tax, Corporate Tax Planning |
On 20 February 2010, State Administration of Taxation issued Guoshuifa [2010] 18 entitled “Notice of the State Administration of Taxation on Issuing ‘Tentative Measures Regarding Administration of Taxation on Representative Offices of Foreign Enterprises’ ” (Circular 18), updating China’s tax policies with respect to representative office (ROs). Circular 18 abolishes all previous circulars with respect to the taxation of ROs. Circular 18 applies retroactively as from 1 January 2010. The key points of Circular 18 are as follows:
1. The scope of taxpayer: All ROs in China shall apply and pay the enterprise income tax (EIT) on the profits attributable to the ROs , only except some ROs which shall apply for EIT exemption in according with relevant tax treaty.
2. The type of taxes: ROs in China shall submit EIT, as well as Business Tax (BT) and Valued Added Tax (VAT).
3. The method of tax filing:
(i) The methods of filing EIT of ROs in China are no longer determined based on the principal business of the head office, but on the profits actually attributable to RO itself.
(ii) ROs shall settle accounting books and record based on official and valid vouchers, calculate its taxable turnover and profits based on actual performed functions and business risks (the “actual method”), and submit EIT and BT within 15 days after the quarter ending, meanwhile, submit VAT based on deadline in Provisional Regulations of the PRC on VAT.
(iii) If the accounting records required by the laws are not intact, or the cost and income cannot be verified with reasonable certainly, the RO cannot use the actual method. In such case, the tax authority shall have the right to determine the amount of taxes payable through the following two methods (deemed profit methods):
(a) Expense method: calculating taxable incomes based on appropriation expense, it is applicable to an RO which can provide accurate details of business expenses but cannot accurately substantiate its turnover or cost.
(b) Income method: calculating taxable income based on the gross income of the RO. This is applicable to an RO which can provide accurate gross income information but cannot provide cost and expense details.
(iv) ROs shall calculate and submit VAT and BT in accordance with relevant laws and regulations
(v) Deemed profit rate: If the deemed profit method is used, the deemed profit rate shall not be less than 15%, an increase from the old 10%.
4. Tax exemption application:
(i) The methods of tax exemption application of ROs in China is no longer determined based on the principal business of the head office, but on the applicable tax treaty and Guoshuifa [2009] 124 entitled “Notice of the State Administration of Taxation on Issuing ‘Administrative Measues on the Application for Preferential Treatment under a Tax Treaty by Nonresident’”
(ii) Local tax authorities shall no longer accept application from ROs for tax exemption from EIT, and shall revisit the taxability of ROs whose tax exemption has been previously approved based on the old rules.
A translation of Circular 18 will be posted on the Hwuason website within the next 7 days.
Posted by Sunny on March 18, 2010 under China Tax, Tax Controversy |
On 10th February 2010 the State Administration of Taxation (SAT) issued new Tax Administrative Review Rules (SAT Order [2010] 22) (the “Rules”) providing a comprehensive guideline for tax disputes in China. There are 105 articles in the Rules, which is 53 more articles than was contained in the original. A fundamental component of the new Rules is the introduction of a reconciliation and compromise system. The Rules are operable from 1 April 2010.
Reconciliation and compromise
As introduced by the stakeholder, the added reconciliation and compromise system stipulates the applicable scope and fundamental principle of the reconciliation and compromise. It also designs details of procedures and requirements . The new rules allow the applicant and the respondent to reach a settlement agreement voluntarily and the administrative review shall terminate after permitted by institution of administrative review, however , the applicant shall not apply the administrative review again for the same fact and reason .The institution of administrative review shall conduct the conciliation in accordance with the principle of voluntary.
Other issues
Some of the other more important changes in the Rules include guidance on the admissibility of evidence, a shift from documentary hearings to full public oral hearings, stipulations on which level of local taxation bureaus have jurisdiction for administrative review and a direction that tax authorities of all levels must provide guidance and supervision in respect of tax administrative review.
A translation of the new Rules will be posted on the Hwuason website within the next 7 days.
Posted by admin on March 16, 2010 under Transactional Taxes |
For the past 12 months, the question of whether to introduce a property tax has been at the forefront of political discussion in China. China does already tax property (most usually when such property is realized) but the proposed “property tax” would be an annual tax on property.
The policy reasons behind the proposed the tax are to deter speculators from driving the price of property up and to provide a steady stream of revenue for local government. However, the prevailing perception is that given that the major property owners have significant political influence it is doubtful that the proposed tax will be ever made law. Taxes are never popular but this is one that has been the subject of more criticism than usual. It will be interesting to see what happens.
