The long arm of the Chinese tax man: taxation of non-resident enterprises
Posted by Matthew on April 27, 2010 under Corporate Tax Planning | 
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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.
