By Eunice Ku and Shirley Zhang
May 15 – For foreigners doing business in China, tax is always a key concern. As a foreign business or individual, income derived from China may be subject to taxes in both your home country and China, which could substantially increase your tax burden.
Under China’s Corporate Income Tax (CIT) Law, a non-resident enterprise (i.e., an enterprise organized outside of China and whose effective management is not within China) without an establishment or venue in China is subject to CIT at a withholding rate of 10 percent on their China-sourced income, which includes:
- Income from property transfers;
- Income from equity investment such as dividends and bonuses;
- Income derived from interests, rentals and royalties;
- Income derived from donations; and
- Any other income.
A non-resident enterprise with an establishment or venue in China is taxable on all of its China-sourced income, as well as non-China sourced income that has an actual connection to the Chinese establishment or site, at 25 percent CIT. “Actual connection” means that the establishment owns equity interests or debt claims giving rise to the income, or the establishment owns, manages and controls properties giving rise to the income.
RELATED: Tax Considerations for Legal Representative Offices in China
“Establishment or venue” is defined as those that are engaged in production and business operations in China, including:
- Management establishments, business operation establishments and branch offices;
- Factories, farms and venues that exploit natural resources;
- Venues that provide labor services;
- Venues that are engaged in engineering operations such as construction, installation, assembly, repair and prospecting; and
- Other establishments or venues that undertake production and business operations.
If the non-resident enterprise is a tax resident of a jurisdiction that has a double tax agreement (DTA) in place with China, it may be able to claim exemption from CIT if the establishment or venue does not constitute a permanent establishment (PE) pursuant to the PE article under the relevant DTA. DTAs aim to prevent income from being taxed by two or more states through providing tax credits (i.e., allowing the tax paid in one country to be offset against tax payable in the other country) and/or exemptions or reduced tax rates for specific income types such as interests, royalties and dividends. DTAs also provide certainty by defining the taxation right of each jurisdiction on various types of income arising from cross-border economic activities.
According to Article 7 of China’s tax treaties with various other countries,
“The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other Contracting State but only so much of them as is attributable to that permanent establishment.”
This means that, where a resident of a country which has a DTA with China carries on business in China through a PE, the profits derived by the PE will be subject to taxes in China. According to the various DTAs, foreign companies can be deemed to have a PE in China, if:
- It has an establishment or a place of business in China (Fixed place PE);
- It has a building site, a construction, assembly or installation project or related supervisory activities that last for a certain period of time (Construction PE);
- It appoints an agent in China to conclude contracts or accept orders in China (Agent PE); or
- It has employees working in China for a certain period of time (Service PE).
Fixed Place PE
DTAs define a PE as “a fixed place of business through which the business of an enterprise is wholly or partly carried on,” and can be a place of management, branch, office or factory.
The SAT released the “Interpretation Notes for the DTA between China and Singapore (Guoshuifa  No. 75) (‘Circular 75’)” in September 2010, which provides a detailed interpretation of the DTA between China and Singapore and is applicable to similar provisions in other DTAs concluded by China with other countries. According to Circular 75, a fixed place PE should possess the following characteristics:
- The business venue actually exists;
- The business venue is relatively fixed and stable; and
- All or part of the enterprise’s business is carried out through the business venue.
A PE can also take the form of a building site, a construction, assembly or installation project or supervisory activities in connection therewith that last for a period of more than six months (in most DTAs). According to Circular 75, the start and end dates of the six-month period is determined based on the date that the signed contract is implemented (including all preparation activities) until the completion of the work (including trial operations).
Where a person in China acting on behalf of a non-resident enterprise has the authority to conclude contracts in the name of the enterprise and does so habitually, a PE will also be constituted with respect to any activities that the person undertakes for the enterprise. However, the use of an independent agent (e.g., broker or general commission agent) to carry on business in China does not constitute a PE.
Circular 75 provides that the activities of an agent should meet the below two criteria in order to be considered an independent agent and thus not be deemed the PE of an enterprise:
1. The agent is independent from the enterprise both legally and economically. The following factors will be considered when determining independence:
- The degree of freedom of the agent’s commercial activity;
- Who bears the risks with respect to the agent’s business activities;
- The number of enterprises represented by the agent; and
- The extent to which the enterprise depends on the professional knowledge of the agent.
2. When the independent agent conducts activities on behalf of the enterprise, it should not engage in other activities that fall under the enterprise’s own economic activities. For example, if a sales agent sells goods on behalf of an enterprise under its own name, but at the same time acts as an agent who is authorized to sign contracts on behalf of the enterprise, the agent will be deemed as a non-independent agent and will constitute a PE of the enterprise.
A PE is also constituted where the provision of services, including consultancy services, by an enterprise through the dispatch of its employees or other personnel to China, continues within China for a period or periods aggregating to more than six months or 183 days within any twelve-month period, depending on the specific DTA (see “Six months vs. 183 days” section). The relevant provision in the China-U.S. tax treaty states that:
“The term ‘permanent establishment’ also includes […] the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where such activities continue (for the same or a connected project) within the country for a period or periods aggregating more than six months within any twelve month period.”
“Employees or other personnel” and “services”
According to Circular 75, the term “employees or other personnel engaged by the enterprise” is defined as employees of the enterprise and other individuals controlled by and receiving instructions from the enterprise. Meanwhile, “services” refer to professional activities such as engineering, technology, management, design, training and consulting services.
Circular 75 also lists the factors which should be considered when assessing when “connected projects” are constituted for the purpose of determining whether a Service PE has been established:
- Are the projects covered by a single master contract?;
- Where the projects are covered by different contracts, were these contracts concluded with the same/related person; and is the execution of one project a prerequisite to another?;
- Is the nature of work the same under different projects?; and
- Are the services under different projects performed by the same group of people?
Secondment arrangements as service PEs
Since mid-2009, local tax bureaus in China have tightened the tax administration of secondment arrangements in which the HQ sends staff to work in China. Overseas parent companies might be challenged that their actions constitute the provision of services to their China subsidiary and hence the creation of a Service PE in China. If a Service PE is constituted, the service fees will be subject to CIT based on a deemed profit ratio determined by the tax authority, as well as to business tax or value-added tax and other local surcharge taxes (see next article on “Tax Implications of a Service Permanent Establishment”).
According to Circular 75, where the parent company dispatches personnel to its Chinese subsidiary per the latter’s request, and such personnel is employed by the subsidiary with the subsidiary having the right to direct their work and bear the responsibilities for the relevant work and risks, the activities of such personnel do not constitute a PE of the parent company. Under this circumstance, the fees paid to such personnel by the subsidiaries, whether directly or via the parent company, will not be subject to CIT and other taxes. Rather, they are deemed as income distribution to the subsidiary’s internal staff. The payment can be listed as expenses by the subsidiary, and are subject to IIT in China.
Circular 75 provides the following factors to help assess whether the secondees assigned to the Chinese FIE are in fact working for the overseas parent company rather than the subsidiary:
- The overseas parent company has authority over the secondees’ work and bears the relevant responsibilities and risks;
- The number of secondees to the subsidiary company and the standard of such assignment are decided by the overseas parent company;
- The salaries and wages of the secondees are borne by the overseas parent company; or
- The overseas parent company obtains profits from the subsidiary company from the assignment of such employee.
If one of the above conditions is met, the tax authorities may determine that the seconded expatriate is working for the parent company. In this case, the PE clauses will apply in determining whether a Service PE is constituted.
Tax and Compliance Services from Dezan Shira & Associates
Tax focus: Foreign enterprises
In 2009, the SAT issued the “Notice Concerning the Inspection of CIT Collection on Foreign Entities’ Provision of Services to Domestic Companies through Secondment Arrangements [Jibianhan  No. 103],” requiring tax authorities in all provinces and cities to audit companies in manufacturing and service sectors in order to assess whether their arrangements of foreign staff sent to work in China are bona fide secondment arrangements or in fact provision of services in a disguised manner. In the latter case, the relevant local tax authorities are required to assess whether the arrangement constitutes a PE, in which case the foreign entities will be held liable for CIT and any late payments and penalties.
Legislative interpretations may differ throughout China thanks to the different practices of Chinese government officials. We have come across cases where:
- The registration of a PE was hampered by local tax officers;
- No taxes were charged when the customer was a state-owned enterprise; and
- Tax officers deemed that a PE had been constituted on additional “soft” factors.
Six months vs. 183 days
Currently, China has signed DTAs with 97 different countries plus Hong Kong and Macau. Previous DTAs generally adopted the six months rule, while more recent DTAs utilize the 183 days rule. Countries that adopt the 6 months rule include Switzerland, Norway, Italy, France, the U.S., Germany, New Zealand and the UK. Countries that adopt the 183 days rule include Singapore, Hong Kong, Macau, Belgium, and Finland.
How are six months counted?
The start of the calculation period is triggered the month the expatriate first arrives for the purpose of implementing the service, until the month that the expatriate leaves upon the completion of the service. The exact number of days is disregarded. Rather, the provision of services in China for a single day in a month is considered a provision of services for that entire month. However, if no expatriate is in China to perform the relevant services for 30 consecutive days, one month will be deducted. A PE is constituted if the expatriates are in China for more than six months according to this method of calculation in any 12-month period. This method of calculation as stipulated in Circular Guoshuihan  No. 403 was invalidated in January 2011. However, as of now, no new regulations have been set to replace it, and tax authorities continue to adopt this method of calculating the six-months period.
How are 183 days counted?
According to Circular 75:
- The 183 days is counted from the date on which the employee(s) of the non-resident enterprise first arrive(s) in China to provide the services, until the date on which the services are completed and delivered;
- Days spent in China by all employee(s) of the non-resident enterprise on the same project should be counted;
- If multiple employees work in China on the same day, that day should be counted as one day but not repeatedly. For example, where a Singaporean enterprise dispatches 10 personnel to work in China for 3 days for a certain project, the employees will be deemed to have worked in China for 3 days, not 30 days.
- Where a service project lasts for several years, but the 183-day threshold is met within only one 12-month period, a PE will still be constituted with regard to the entire project.
Depending on whether the six months rule or 183-days rule applies, the result of whether a PE is constituted varies, with the threshold for constituting a PE much lower under the six month rule (please see the accompanying table below).
Portions of this article came from the May 2013 issue of China Briefing Magazine titled, “Understanding Permanent Establishments in China.” This issue of China Briefing Magazine casts some light on permanent establishment status in China by discussing the circumstances triggering a PE in China, focusing on Service PEs. We also discuss the tax implications for a non-resident enterprise where its activities in China constitute a Service PE in the country, and address the taxation of representative offices.
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 as well as liaison offices in Italy and the United States.
For further details or to contact the firm, please email email@example.com, visit www.dezshira.com, or download the company brochure.
You can stay up to date with the latest business and investment trends across Asia by subscribing to Asia Briefing’s complimentary update service featuring news, commentary, guides, and multimedia resources.
The China Tax Guide: Tax, Accounting and Audit (Sixth Edition)
This edition of the China Tax Guide, updated for 2013, offers a comprehensive overview of the major taxes foreign investors are likely to encounter when establishing or operating a business in China, as well as other tax-relevant obligations. This concise, detailed, yet pragmatic guide is ideal for CFOs, compliance officers and heads of accounting who need to be able to navigate the complex tax and accounting landscape in China in order to effectively manage and strategically plan their China operations.