On 20 February 2010, the State Administration of Taxation (SAT) issued Circular Guoshuifa [2010] No.18, entitled Provisional Measures for Tax Collection and Administration of Representative Offices of Foreign Enterprises (Circular 18), to clarify and update tax rules relating to the taxation of representative offices (ROs) in China.
Circular 18 provides the landscape of taxation rules for ROs covering Corporate Income Tax (CIT) calculation, Value Added Tax (VAT) and Business Tax (BT) treatment, tax registration and filings and procedures for tax treaty benefits claiming etc. This circular shall come into effect from 1 January 2010.
Highlights of Circular 18
- ROs must perform tax registration within 30 days after the relevant business registration or approval is obtained. Amendment or tax deregistration is required when the contents of the tax registration have been changed or the RO ceases operations. ROs are required to report CIT on their liquidation income before tax deregistration.
- The profit attributable to an RO should be subject to CIT. Where an RO conducts VAT and BT taxable activities, the RO shall be subject to VAT and BT that are calculated based on the relevant tax regulations. ROs must report CIT and BT every quarter and the VAT filing period should follow the relevant VAT regulations.
ROs should calculate their tax liabilities based on one of the following methods:
Actual profit method
ROs are required to maintain accounting books based on official and valid vouchers to ascertain the actual revenue and profit. The reported profit should be commensurate with the functions and risks undertaken by the RO.
- CIT = Actual taxable profit x CIT rate
- BT / VAT = Actual taxable income x applicable BT/VAT rate.
Deemed profit methods
The Chinese tax authorities shall adopt deemed profit methods to determine an RO’s taxable income if an RO cannot correctly compute its revenue and costs or is unable to use the actual profit method to ascertain the tax liabilities.
The deemed profit rate in the calculation should not be less than 15% according to the new requirement set forth in Circular 18.
- For ROs that can accurately compute the operating expenses but cannot accurately calculate the revenue or costs, expense-plus method should be used:
- Deemed revenue = expenses for the period / (1 – deemed profit rate – applicable BT rate)
- CIT = Deemed revenue x deemed profit rate x CIT rate
- BT/VAT = Deemed revenue x applicable BT/VAT rate
- For ROs that can accurately compute the revenue but cannot correctly calculate the costs and expenses, actual revenue and deemed profit method should be used:
- CIT = Actual revenue x deemed profit rate x CIT rate
- BT/VAT = Actual revenue x applicable BT/VAT rate
- For ROs that can accurately compute the operating expenses but cannot accurately calculate the revenue or costs, expense-plus method should be used:
- Circular 18 has invalidated the previous tax circulars governing various tax treatments for ROs, and the local tax authorities will no longer accept CIT exemption applications under the old rules. They are likely to stop previously approved exemptions as their registrations become due for renewal.
- ROs that believe they are eligible for an exemption from CIT pursuant to relevant tax treaties may apply to the tax authorities for the exemption in accordance with the Administration Measures on the Application for Preferential Treatment under a Tax Treaty by non-residents (Guoshuifa [2009] No.124). Such ROs are also required to file tax returns within the period mentioned above.
Acclime’s observation
China tax authorities have widely adopted deemed profit methods as a tax calculation basis for existing ROs. With the issuance of Circular 18, the existing ROs will be facing a heavier tax burden, with the deemed profit rate being raised from 10% to a minimum of 15%.
The following example illustrates how much the total CIT and BT will be increased for an RO, which is taxed based on the expense-plus method.
| Formula | Old rules | Circular 18 | |
|---|---|---|---|
| Total operating expenses | A | 100 | 100 |
| BT rate | B | 5% | 5% |
| Deemed profit rate | C | 10% | 15%* |
| CIT rate | D | 25% | 25% |
| Deemed revenue | E=A/(1-B-C) | 117.65 | 125 |
| BT payable | F=E*B | 5.88 | 6.25 |
| CIT payable | G=E*C*D | 2.94 | 4.69 |
| Total tax burden based on the expenses | H=(F+G) | 8.82 | 10.94 |
| % increase in total tax burden | (10.94-8.82)/8.82*100%=24% | ||
*The minimum deemed profit rate per Circular 18
Final thoughts
A company establishing a RO in China is relatively simple as there is no registered capital requirement, simplified application process and ongoing compliance requirements, and therefore costs are cheaper.
Consequently, it is common for foreign investors to initially register an RO and use this as a stepping-stone when starting to do business with China. According to our above illustration, the total tax burden will be increased by at least 24% following the issuance of Circular 18.
It should also be noted that, generally, a RO cannot be converted to a company and that deregistration can take between six and twelve months. It is, therefore, important that foreign enterprises take this taxation into consideration when reviewing their longer-term business plans relative to China.
A comparison of a Representative Office and a Foreign Invested Commercial Enterprise (FICE) is detailed in our Appendix for your reference.
For more information, please contact us at infochina@acclime.com.
Appendix
Comparison of RO and FICE
| RO | FICE | |
|---|---|---|
| Business perspective | Pros
Cons
| Pros
Cons
|
| Tax perspective | Generally, taxes are paid based on deemed revenue:
[Trading by the parent of the RO would be subject to VAT on import and export and possible import duties on import, which need to be taken into account when review overall business model and structure] | Taxes are paid based on actual revenue and profit:
|
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