Chris Devonshire-Ellis: RO Chief Representatives May Consider Power of Attorney in Tax Questioning

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Op-Ed Commentary: Chris Devonshire-Ellis and Richard Hoffmann

Mar. 9 – With foreign company representative offices coming under intense scrutiny at the present time due to the changes in tax treatments levied from January 1, 2010, pressure is now on the chief representatives of China-based ROs to fully comply with tax audits and questions raised over their activities for the audit period 2009.

The State Administration of Tax issued Guoshuifa [2010] No. 18, issued on February 20, 2010, explicitly stipulates that ROs will need to pay corporate income tax on their taxable income, as well as sales tax and VAT. ROs will need to use the cost plus method or actual revenue method to determine their deemed profit margins, and under the new regulations, that deemed profit margin is to be no less than 15 percent, an increase from the previous deemed profit margin of 10 percent.

Hand in hand with this has come a marked increase in the numbers of China RO accounts, which have to be presented for audit at this moment, that are being subjected to additional specific questioning by the local tax bureau. We have come across cases whereby chief representatives are being asked to personally visit the tax bureau to explain certain anomalies in the accounts. As the legally responsible person, chief representatives in China are the focal point of contact with the Chinese authorities and must attend such meetings upon demand.

The tax authorities are under increasing pressure to stop the usage of China-based ROs as quasi business and trade offices, and using offshore, Hong Kong or similar companies to invoice for China-based work actually carried out by the representative office. It was never the intention for RO to be used in this manner, and the resulting tax loss to China of what is termed “China derived income” is both seen as illegal and unfair to properly registered, and capitalized entities such as China’s own domestic companies, as well as foreign-invested commercial enterprises or wholly foreign-owned enterprises.

The use of RO as a vehicle to trade and conduct work while billing offshore is strictly forbidden, and if RO have been used for such purposes the implications are twofold. Firstly, the tax bureau will want to make an assessment of the extent of any illegal trading, and calculate any taxable income that has been funneled through a holding company. Any taxable income found that has not been declared can be subject to late payment penalties of up to five times the amount due. This could be significant.

There are additional concerns for the chief representative. Tax evasion in such a manner is a criminal offense in China. Under such circumstances, if aware of problems, it may be prudent for the chief representative to sign off a power of attorney to a China-based lawyer to represent them if called to such meetings. Demands for interviews with the tax authorities should also take place with a credible tax inspector. Such a person is qualified to discuss with the tax bureau in China details of tax liability and to try and determine acceptable arrangements in the face of any wrongdoings. Most reputable accounting firms employ such personnel.

In our experience, provided a tax amount due can be agreed upon and any unpaid balance met immediately, the tax bureau tend not to take further action either in late payment penalties or criminal action. However, chief representatives of RO in such non-compliant circumstances may wish to consider engaging China-based legal representation to discuss their cases under such circumstances via power of attorney. The provision of qualified tax inspectors to also be present may also be part of this arrangement.

Dezan Shira & Associates has qualified China accountants and legal professionals and can assist China-based representative offices and their incumbent chief representatives get into China tax compliance. The firm has nine China offices. Please contact Richard Hoffmann at legal@dezshira.com if in need of such assistance.

Chris Devonshire-Ellis is the principal and founding partner of Dezan Shira & Associates, establishing the firm’s China practice in 1992. The firm now has 10 offices in China. For advice over China strategy, trade, investment, legal and tax matters please contact the firm at info@dezshira.com. The firm’s brochure may be downloaded here. Chris also contributes to India Briefing , Vietnam Briefing , Asia Briefing and 2point6billion

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