Repatriating Profits from China

For multinational corporations operating in China, repatriating cash from their subsidiaries has always been an important but challenging issue.

Contributing Advisor

Hannah Feng

Partner

China maintains a strict system of foreign exchange controls, meaning funds flowing into and out of China are tightly regulated. Laws and regulations – such as the Company Law, relevant tax regulations, as well as China’s transfer pricing rules – impose additional barriers to profit repatriation. In this environment, businesspeople need to understand and incorporate a profit repatriation strategy from the very beginning to ensure access to the profits earned.

There are several ways to repatriate profits from China:

• The most common is for the company's China-based entity to pay dividends directly to its foreign parent company. However, this is subject to certain prerequisites; or
• As an alternative, many multinational corporations use intercompany payments, such as service fees or royalties, to remit cash from China; or
• Other Chinese subsidiaries remit undistributed profits by extending a loan to a foreign-related company with which it has an equity relationship; or
• Companies may also use cash pooling arrangements, which allow them to centralise and utilise their balances more efficiently.

Below, we introduce and analyze the pros and cons of each method to provide the investor with some initial references for their planning.

Remitting profits as dividends

Remitting profits as dividends is the most direct and common way to distribute profits. However, this is subject to certain prerequisites.

The paperwork at least required for preparing for dividend distribution is as follows: business license, a recent audit report of paid-in capital, an external auditor's report, a certificate of tax filing, a tax payable receipt, and a relevant board resolution on profit distribution. The entire procedure may take two to four weeks, though it can take longer for complex cases.

In addition to filing the required paperwork, several legal requirements must be fulfilled:

• A FIE can only repatriate profit after its registered capital has been injected within the time limits as set out in the company’s Article of Association;
• An FIE can only repatriate profit once a year after the annual audit and tax compliance process. This is to ensure a 25 percent CIT had been paid up with regard to the profit to be distributed;
• No profits can be distributed before the losses accumulated in the previous years have been made up. The FIE can only distribute dividends out of its accumulated profits; the accumulated losses from the previous year must be more than offset by the profits;
• Not all profits can be repatriated after tax clearance. For example, companies have to place 10 percent of their annual after-tax profits into a mandatory surplus reserve fund until it reaches 50 percent of the company’s registered capital. Besides, the investors usually allocate a portion of after-tax profits to the staff welfare and incentives fund, though these are not mandatorily required; and
• The dividend is subject to an additional 10 percent withholding CIT when repatriating to foreign investors, with limited exceptions. If a double tax treaty (DTA) is available, and the parent company qualifies as the beneficial owner, a preferential withholding CIT rate of five percent or even lower may apply. And if non-resident enterprises decide to re-invest the dividends derived from FIEs into projects not prohibited by the country, the withholding CIT on this part of the dividends can enjoy deferral treatments by fulfilling certain conditions.

Under Announcement No. 2 of 2025, foreign investors reinvesting qualifying China-sourced profits domestically between 1 January 2025 and 31 December 2028 can claim a tax credit that offsets future enterprise income tax on distributions from the same Chinese enterprise — a meaningful upgrade on the previous deferral-only regime.

According to the PRC Company Law, PRC companies can only distribute after-tax profits after: (i) recovering losses incurred in previous years; and (ii) putting aside a legal reserve, which is 10 percent of its after-tax profit until such a reserve reaches 50 percent of the registered capital. The China subsidiary needs to first obtain a tax recordal for the distribution of dividends. After obtaining the tax recordal, the China subsidiary may then proceed with foreign exchange conversion and remittance subject to review by the processing bank.

A reasonable time period to complete all the steps for paying a dividend is approximately 2 months where there is no additional application for treaty relief.

The table below provides an example to demonstrate the tax implication and reserve requirements of repatriating profits by dividends.

*Suppose there are no accumulated losses and other pre-tax deductible items

Paying intercompany fees to foreign investors

Many multinational firms repatriate profit from China through intercompany payments when faced with the requirements of remitting dividends. Often, they attempt to achieve this by charging for supporting services (such as human resources, information technology, or financing) or intangible assets (such as trademarks, patents, or know-how) provided to Chinese affiliates.

In comparison with remitting dividends directly, profit repatriation through intercompany payments has some advantages for some investors.

• Due to fewer prerequisites, intercompany payments are often an easy way to repatriate profits. For example, the FIE can make intercompany payments without going through the annual audit and tax compliance process.;
• The company can make intercompany payments when needed, rather than once per year for dividend remittance; and
• Remitting money through intercompany payments is more tax-efficient as well. Although the intercompany transactions are subject to turnover taxes and possible withholding CIT, these intercompany payments can be deducted from the CIT taxable income by fulfilling certain requirements.

Despite these many advantages, profit repatriation through intercompany payments bears more risk for tax investigation. Tax authorities put special scrutiny on intercompany service fees and royalties paid by Chinese enterprises to overseas related parties because they regard the practice as a tool for avoiding tax and shifting profits.

Service fees

By providing certain business services (such as marketing, accounting, or technical support) to the FIE, the parent company can repatriate funds as a service fee. If the income is deemed China-sourced (which is typically the case), the FIE may have to withhold CIT (usually 5-10%),  VAT (usually 6%) and surtaxes on behalf of the parent company to comply with regulations.

Royalties

The parent company can charge royalties to its FIE. Royalties are fees for using intellectual property (IP) such as trademarks, patents, technology, and copyright. Taxes on royalty payments are subject to withholding tax on corporate income (usually between 5-10%), VAT (usually 6%), and other surtaxes. To qualify for a DTA benefit, the company needs to submit an application to the tax authorities, together with a Statement of Beneficial Ownership.

Reimbursements

Investor reimbursements for Chinese subsidiary costs allow for legitimate fund transfers. Careful documentation is vital to prove expense validity and subsidiary benefit, ensuring compliance with Chinese regulations.

Cash pooling and intercompany loans

The cash pooling system allows companies to centralise and utilise their balances more efficiently. Since China's restrictions on cross-border financing have been gradually eased, various cash pooling arrangements are now available, though some restrictions may continue to apply.

Intercompany loans

Outbound intercompany loans from a Chinese subsidiary to its overseas shareholder offer a mechanism for fund transfer. This involves the subsidiary extending a loan to its parent company or shareholder abroad. Like other methods, this requires strict adherence to arm's length principles, including market-rate interest rates and clearly defined repayment schedules. Chinese regulatory bodies scrutinize such transactions to prevent disguised profit distributions.

All foreign debt must be registered with the State Administration of Foreign Exchange (SAFE), and interest payments are subject to withholding taxes. Unlike registered capital contributions, loans can be repaid easily as a means to transfer excess cash out of China.

Generally, there are regulatory restrictions imposed by China foreign exchange administration and the People's Bank of China on intra-group cross-border lending.

Cross-border cash pooling

Cross-border cash pooling in China was separated into two types by currency — RMB and foreign currency — until the government launched a new integrated program in 2019, implemented in 2021. Since 2014, China has permitted multinational companies to operate cross-border RMB and foreign currency cash pooling, subject to certain conditions. In March 2019, SAFE published an amended Circular to integrate foreign debt quota, outbound loan quota, and cross-border payments, with main improvements including support for both currencies, streamlined account structure and procedural requirements, and consolidated quotas.

Anti-avoidance

The anti-avoidance rule empowers Chinese tax authorities to make reasonable adjustments where an enterprise implements an arrangement without reasonable business purposes to reduce its taxable income or profit.

According to the CIT Implementation Guidelines, “an arrangement without reasonable business purpose” refers to an arrangement that has the main purpose of obtaining tax benefits such as the reduction, elimination, or deferral of tax payments.

The Implementation Measures for Special Tax Adjustments (for Trial Implementation) (Guo Shui Fa [2009] No.2) provided a stronger regulatory basis for disregarding a special purpose vehicle (SPV) that lacked economic substance.

The areas specified for anti-avoidance investigation include:

• Abusing tax treaties;
• Avoiding tax via tax havens;
• Abusing corporate organizational structures; and
• Other arrangements without reasonable business purposes.

Instead of having a single defining factor, the STA Announcement [2015] listed a number of elements that may contribute to the transaction having a reasonable commercial purpose. These factors are:

• Whether the main value of equity in the foreign entity is made up of taxable assets in China;
• Whether the assets of the foreign entity are mainly comprised of investments in China or whether its income is mainly sourced from China;
• Whether the corporate structure has economic substance, from the point of the functions the foreign company is performing and the risk it is bearing - this is commonly assessed by looking at the related companies’ equity structure, assets, staff arrangements, income, and other operational information;
• The length of time the foreign company’s business model, shareholders, and organizational structure have been in existence - tax authorities will look for “traces of a plan” to avoid tax by indirect transfer, such as an intermediary company being set up shortly before the indirect transfer, which would be a clear red flag that the investor is trying to evade tax by using foreign corporate structures;
• Whether foreign tax is being paid on the transaction - the tax authority will assess whether the transaction is resulting in cross-border tax advantages by looking at both the party transferring and the party receiving the shares. If the tax burden is less than what would have been paid in China, this will get flagged by tax authorities;
• Whether the transaction could have been substituted by a direct transfer - the tax authorities will consider a variety of matters to determine whether not transferring assets directly serves a reasonable business purpose, such as market access, the need for a review of the transaction, compliance requirements for the transaction, and the goal of the transaction;
• Whether China has a DTA with the states in question or other tax-reducing arrangements relevant to the case; and
• Other matters deemed relevant.

China’s position on intercompany payments

Under China’s transfer pricing rules, intercompany payments are only deductible when they comply with the arm’s length principle.

For intra-group services, China requires arm’s length transactions to be beneficial in nature, which is relevant to the authentication of the service provided. That is to say, China’s tax authority wants to ensure the intercompany services are purchased based on real needs, than for the purpose of reducing tax burden or shifting profits. For example, intercompany management fees in relation to finance, tax, human resources, and legal support are scrutinized by China’s tax authority, as those services may fall into the scope of “shareholder activities”—a typical category of “non-beneficial” services, whose definition is much broader in China than international tax practices.

For intra-group royalties, China’s tax authorities hold the idea that profit derived from transferring or licensing intangible assets should be distributed based on the enterprises’ contributions to the value of the intangibles. That is to say, certain overseas related parties might not be qualified to receive royalties at all or can only receive royalties to a limited amount.

Under this condition, companies repatriating profits through intercompany payments have to maintain transaction documents as detailed as possible for demonstrating the authentic and beneficial nature of the intra-group transactions, in the case they are challenged by the tax authorities. This substantially increases the compliance burden to the enterprises.