June 2009

Once FIEs have been successfully established in China whether in the form of a Representative Office or Limited Company, they tend to believe the biggest hurdle has been dealt with. However it is as equally important as during the establishment process to pay close attention to the PRC's ever changing laws and regulations when it comes to operating and maintaining the entity - especially in regards to the tax system.

Representative Offices (RO)

A RO, although indirectly operational, is liable for filing and paying Business Tax, Enterprise Income Tax, and Individual Income Tax for the employees as well as Stamp Tax. This may sound strange to many FIEs, especially as a RO is a non-profit-making center, however the Chinese government does require that tax be paid as they consider that by having such an office in China, profit is at least being made in the parent company.

It is therefore recommended to keep a series of bookkeeping accounts based on all the expenses of the RO and all original receipts should be kept in the office for a minimum of five years according to the PRC Law. On a monthly and/or quarterly basis, the RO will then pay approximately 10% tax on its total expenses for that period.

If the parent company is a manufacturing entity, the RO can apply for tax exemption status, meaning they would no longer be liable to file and pay Business Tax and Foreign Enterprise Income Tax.

Additionally Annual Audits and Annual Inspections are necessary for ROs and must be completed before May each year.

Limited Companies in China

A Limited Company is liable for filing and paying the below mentioned taxes as well as Individual Income Tax for the employees and potentially a series of other taxes depending on the activities of the entity. It is therefore required that the company has an approved accounting software system to conduct monthly bookkeeping, and to create all government required financial statements and tax declarations.

Profits Tax
The profits tax rate of 25 percent has been implemented for both foreign and domestic companies in 2008 and is paid on a quarterly basis.

Business Tax
Business Tax is imposed in relation to transactions on services provided by enterprises. An example would be after-sales services, quality control services, installation of equipment, etc. Business tax is levied on gross turnover at rates between 3 percent and 20 percent. The most common rates are either 3 percent or 5 percent and it is paid on a monthly basis.

Value Added Tax (VAT)
The Chinese government rules that all enterprises and individuals that are engaged in the sale of goods, provision of processing, repairs and replacement services, and import of goods within China have to pay Value Added Tax (VAT). In China, companies are divided into two categories depending on their registered capital and revenue earned.

1. General Tax Payer Status
The benefit of having the General Tax Payer Status is that it gives the company the right to issue VAT receipts to its clients in China. The General Tax Payer Status is usually important for FIEs that trade in industrial related products and not so much when trading in consumable products to individual customers. In January 2009 the requirements for the application for a General Tax Payer Status changed, in that now the company has to have a registered capital of at least RMB 1 million and an annual sales turnover of RMB 800,000 (previously this was RMB 1.8 million). The general VAT rate for General Taxpayers is 17 percent. The General Tax Payer will usually purchase goods during the course of doing business. The VAT paid is known as Input VAT. The Input VAT can be deducted from the Output VAT which has to be paid when selling products. The VAT Payable is calculated on a monthly basis using software provided by the tax bureau.

General Tax Payer Status - Export of Goods
When a trading / distribution / manufacturing company exports goods from China to overseas, it can apply for a refund of the initial 17 percent VAT. The amount of the refund depends on the goods that are being exported. Export companies must follow a formal approval process to apply for a VAT refund. They have to submit a series of documentation (most importantly the customs document and foreign exchange certificate) to their responsible tax authorities for the approval. As a result, if a company cannot complete the VAT filing for export sales within 90 days after exportation these sales must be deemed as local sales and are taxed with 17 percent VAT.

General Tax Payer Status - Import of Goods
When goods are being imported by a General Tax Payer, customs duty and VAT of 17 percent have to be paid on the imported goods. Should the goods go into a Bonded Logistics Park or Free Trade Zone (in case of a WFOE for example), these payments only occur once the goods are being imported into "domestic China". For further domestic sales in China, 17 percent VAT will be added onto the invoice.

2. Small Scale Tax Payer Status
Small Scale Tax Payers are companies where the annual taxable sales value falls below RMB 800,000 and the registered capital is below RMB 1 million. The current VAT rate for Small Scale Tax Payers is 3 percent which has been reduced from 4 percent since 2009. Small Scale Tax Payers cannot deduct Input VAT.

Small Scale Tax Payer Status - Export of Goods
When goods are being exported from China there is no VAT implication for Small Scale Tax Payers. However, as mentioned above should the company fail to submit all documentation in time, the sales will be considered as a domestic sale. In this case, the company would be liable to pay 3 percent VAT.

Small Scale Tax Payer Status - Import of Goods
When goods are being imported by a Small Scale Tax Payer, customs duty and VAT of 17 percent have to be paid on the imported goods. Should the goods be delivered into a Bonded Logistics Park or Free Trade Zone (in case of a WFOE for example), these payments only occur once the goods are being imported into "domestic China". For further domestic sales in China, 3 percent VAT will be added onto the invoice. This means that the initial 17 percent paid on the import cannot be offset and has to be considered as a cost.

Customs Duties
Customs duties are imposed on goods imported into or exported out of the PRC at various rates. For certain categories of goods, a zero rate may apply. Meanwhile, VAT and, if applicable, consumption tax is also imposed on the importation of goods.

Consumption Tax
Consumption Tax is levied on manufacturers and importers of specified categories of consumer goods, including tobacco, alcoholic beverages, ethyl alcohol, cosmetics, skin and hair care products, jewelry, fireworks, gasoline and diesel, automobile tires, motorcycles and small automobiles. The rates range from 3% to 50%. Consumption tax is imposed in addition to applicable customs duties and VAT.

Stamp Tax
All enterprises and individuals who execute or receive "specified documentation" are subject to stamp tax. Rates vary between 0.005% on loan contracts to 0.1% for property leasing and property insurance contracts. A flat amount of RMB 5 applies to certification evidencing business licenses and patent, trademark or similar rights.

Annual Audits and Annual Inspections are necessary for Limited Companies and must be submitted before May each year. The annual audits must be conducted by a local Certified Public Accounting firm.

Consideration for Ease of Tax Operation

Obtain Advice
The biggest mistake a FIE can make when handling taxes in China is trying to do it by itself. For tax matters it usually does pay to seek professional advice in advance. In China, the tax and regulatory environment changes very rapidly. Virtually every week you see new circulars, regulations and laws coming out. On top of all this, because of China's vastness, there are regional variations, so the interpretations of tax laws and regulations tend to vary from location to location by the different tax bureaus. In addition, the practices of the tax authorities may differ, which adds to the complexity of the system. It is therefore important to seek professional advice and be kept updated on all the recent developments and changes.

Be organized
It is highly recommended for all FIEs to have two sets of books. It is a requirement of PRC Law to have the accounting in Chinese; however it is strongly advised to have simultaneously the information in English. An English version helps the headquarters to be able to understand and to be organized in terms of the content and the filing system.

Aware of tax bureaucracy and enforcement
The Chinese tax authorities have a wide network of tax bureaus throughout China. We have seen a growing trend towards enforcement in recent years, including targeted or random audits. In recent circulars there has been an enhanced emphasis on tax compliance. The enforcement is relatively fair, but the circulars do highlight the concept of "key" tax payers, "key" industries and "key" companies, however this does not mean that smaller companies will not be investigated.

Discretion given by the tax bureau
Because of the regional variations, in practice many tax laws and regulations are subject to the interpretation of the responsible tax bureau. To that extent the local tax officers do have a certain degree of discretion. How much discretion is exercised in non-compliance cases generally depends on the specific circumstances involved, including the nature of the omission, the taxpayer's level of cooperation, whether or not there is reasonably sufficient internal control in identifying issues, and whether or not the taxpayer is willing to come forward and voluntarily disclose these issues rather than sit and wait for the authorities to audit them. All of this will play in the final outcome. In some cases the tax authorities may decide to waive some of those penalties, but generally speaking there will be interest charges and some degree of punitive measures.

Conduct internal audits
Although companies in China are not required by law to perform internal audits, more and more FIEs are becoming aware of the importance of it as an effective tool to ensure the companies are operating in an effective and efficient way, the financial reports submitted to the government authorities and public are reflecting the true position and performance of the companies and most importantly that the companies are in compliance with the relevant laws and regulations.

Outsourcing Administration Functions
Many companies look to outsource their administrative functions, such as accounting, tax filing, payroll and other corporate governance functions to external consultants. This benefits the investor in two ways:

1. Professional advisors often provide a "new set of eyes" or they can predict what problems may arise and they offer a greater level of understanding of the corporate environment; bringing experience and best practice across all business functions - from finance, accounting, legal and IT
2. They can act as independent "Administrative Managers" making sure that the Limited Company / Rep Office is in compliance in all aspects of operations. This can be an asset for investors who want to only focus on the company's day-to-day activities and alleviate any financial and business risks.

Conclusion

Developing a China tax strategy is the key to any companies' success in China. This does not only include seeking advice on and being in compliance with China's tax law, but for internal companies to arrange beneficial profit allocation strategies among its entities.

For some international businesses, structuring investments into China via Hong Kong can make a lot of sense. Concerns over direct exposure to China liabilities, ease of a future sale of a China investment, and certain tax planning and profit distribution capabilities as mentioned above can make the insertion of a holding company as part of the China strategy an interesting option. It is recommended to seek professional advice concerning the best available options and strategies associated with the China approach.

If you require assistance with the above subject, please contact us at This e-mail address is being protected from spambots. You need JavaScript enabled to view it with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.