When establishing an entity in China, the end goal is to achieve success and generate profits. The main objective of this article is to explore how companies can repatriate profits from China while optimising profit and reducing tax liability.
As China’s market and Renminbi (RMB) are gradually opening up, the Chinese government has implemented various measures to guarantee financial stability while providing efficient financial support.
Even though the frameworks have developed more explicit standards and simplified procedures, foreign investors are still required to navigate a series of compliance hurdles imposed by intricate legal and regulatory frameworks. As such, it is essential to develop an effective strategy for reducing unnecessary risks and expenses.
There are multiple options companies have to get profit out of China. The main method used by companies in China is the issuing of dividends. Alternative options are the use of service fees, payment of royalties, inter-company loans, and cash pooling.
Profits earned by subsidiaries in China (referred to in this article as Foreign-Invested Enterprises or FIE) can be repatriated to their parent companies through issuing dividends. To begin the remitting of profits towards the parent company, subsidiaries must comply with prerequisites and file the required paperwork. The paperwork at least required with preparing for dividend distribution is:
- Business License
- A recent audit report of paid-in capital
- External auditor’s report
- Certificate of tax filing
- Tax payable receipt
- Relevant board resolution on profit distribution
The entire procedure may take two to four weeks, though it can take longer for complex cases.
Next to filing the required paperwork, several legal requirements must be fulfilled before a dividend distribution is approved. These are the following:
- Payment of annual Corporate Income Tax (CIT) and withholding tax.
The CIT usually amounts to a total of 25%. In some cases, the FIE may apply a reduced rate of withholding tax depending on the Double Tax Avoidance Agreement (DTA) between China and its home country.
- Covering of accrued losses from the previous year
- 10% of the after-tax income must be set aside in a profit reserve fund (until the reserve fund is equal to 50% of the FIE’s registered capital).
- An external audit by a Chinese accounting firm
After filing the required documents, making the required tax payments and profit reservations and receiving approval from the State Administration of Foreign Exchange (SAFE), the company can distribute dividends via overseas transactions at its Chinese bank.
There are also several alternative options for cash repatriation out of China. Next, this article will examine paying service fees, royalties and cash pooling. These methods can avoid CIT (usually 25%) and dividend withholding tax; however, they are subject to other taxes and conditions.
By providing certain business services (e.g. marketing, accounting, 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. Moreover, the agreement that is the basis for the transactions must be carefully structured to specify the type of service and the source of income.
The parent company can charge royalties to its FIE. Royalties are fees for using intellectual property (IP) such as trademark, 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.
The Cash Pooling system allows companies to centralise and utilise their balance more efficiently. Since China’s restrictions on cross-border financing have been gradually eased and various cash pooling arrangements are now available, however, some restrictions may continue to apply. In cash pooling, there are two main options to consider:
When the parent company provides inbound loans to the FIE, it receives interest from the FIE. These interest payments are tax-deductible (for CIT purposes) if the interest rate is set in line with current market norms and follows the arm’s length principle. The strict foreign debt quota, a restriction on the debt FIE is allowed to carry connected to the total investment and the registered capital, are calculated based on the FIE’s net asset value and the level of potential risk. All foreign debt must be registered with the 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.
Cross-border cash pooling
To complement the restriction on the inter-company loan system, the Chinese government created additional regulations for various forms of cash pooling aimed at increasing liquidity in cross-border financing. 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, the SAFE published an amended Circular to integrate foreign debt quota, outbound loan quota, and cross-border payments. The main improvements:
- Support for both currencies
- Streamlined account structure and procedural requirements,
- Consolidated quotas.
To be eligible for this system, companies must first clear their previous borrowing and lending and complete filing with the local SAFE authorities. This amended Circular leaves room for debatable questions on whether the new measure is stricter than the previous one.
For companies repatriating their profits out of China, dividend distribution is the most straightforward strategy; however, it entails some legal conditions and preparation. Alternatively, inter-company payments are relatively simpler, however, they are based on merit and involve supervision from the tax authorities. China has tried to ease liquidity management by extending and consolidating the cross-border cash pooling system. However, the current requirements do not make cash pooling an easy alternative in practice (yet).
As a result, FIEs are advised to thoroughly examine their repatriation plan before they commence with any procedure. A flexible approach is highly recommended based on the company’s financial circumstances, investment strategy, and objectives.
At Acclime China, our goal is to support our clients to become successful in China. We understand that profit repatriation is a crucial step in the process of success. Our team is specialised in helping you decide the best approach for you, based on your specific financials. For insights and support, feel free to reach out to us.