By Angela Ma, Dezan Shira & Associates
BEIJING – Wholly Foreign Owned Enterprises (WFOEs) are able to repatriate funds out of China in a variety of forms, for which tax implications vary according to the form of repatriation used and the Double Taxation Agreement (DTA) in place between China and the recipient country. The four most commonly used channels for profit repatriation are dividends, loans, service fees, and royalties. While WFOEs can repatriate funds to an overseas shareholding company in any of these forms, it is important to note that funds may be repatriated using dividends or loans only if the recipient entity is a shareholding company of the WFOE.
In the United States, for example, a WFOE repatriating profits to a U.S. shareholding company using dividends would be subject to a 10 percent Withholding Tax (WHT) based on the DTA in place between China and the U.S.; the WHT paid in China could potentially be claimed as a foreign tax credit in the U.S. to reduce the shareholding company’s income tax burden. It should be noted that not all profits can be repatriated – a number of conditions must be met before any dividends may be distributed. A portion of the profit (at least 10 percent for WFOEs) must be placed in the WFOE’s reserve fund account until reserve holdings reach 50 percent of the WFOE’s registered capital.
The WFOE may also remit undistributed profits to a U.S. shareholding company by extending a loan to the overseas shareholder. The WFOE’s interest income would be subject to a 25 percent Corporate Income Tax (CIT) and a 5 percent Business Tax, although the CIT paid in China may later be used to offset the U.S. income tax liability incurred according to the terms of the China-US DTA. Regardless, Circular 59 requires that overseas lending be limited to the overseas parent company’s share of profits in the China WFOE, which is the sum of the WFOE’s dividends payable and undistributed profits attributable to the overseas parent company’s shareholding percentage in the China WFOE.
The WFOE may also repatriate funds in the form of a service fee by signing a services agreement with an overseas company. The service fee would be subject to a 6 percent Value-added Tax (VAT) and related surcharges, and possibly also CIT (3.75 to 12.5 percent), depending on the existence of a “permanent establishment (PE).” If made in connection with the use of intellectual property (e.g., patents, copyrights, trademarks, and proprietary technology), the payment would likely be regarded as a royalty/licensing fee, and thus subject to a 10 percent WHT and 6 percent VAT with related surcharges.
In order to assess which option would maximize repatriated profit and minimize taxes, it is necessary to consider which tax liabilities are likely to be incurred in both China and the recipient country. Taking stock of tax liabilities in only one of the two countries, or the nominal tax rates of only one form of repatriation, may mislead one into believing that whichever form offers the lowest nominal rates will be the most tax efficient, which may not necessarily be the case.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam in addition to alliances in Indonesia, Malaysia, Philippines and Thailand as well as liaison offices in Italy and the United States.
For further details or to contact the firm, please email firstname.lastname@example.org, visit www.dezshira.com, or download the company brochure.
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