Case Study: Tax Withholding for Non-Resident Foreign Enterprises in China

As part of our mission to provide business intelligence on the legal, tax and operational issues of doing business in China, China Briefing presents here the first in a series of case studies, based on the practical experience of Dezan Shira & Associates professionals.

Scenario

A non-resident foreign company without an office in China provides design services for a Chinese resident enterprise and dispatches employees to China for the handover of design work. According to Chinese law, enterprise income tax (EIT) shall be levied on income earned from commercial operations conducted within Chinese territory, by both resident and non-resident taxpayers. Therefore, the company is required to pay both EIT and value-added tax (VAT) for non-resident enterprises on the service income derived from China.

Companies unfamiliar with China’s tax declaration procedures face the risk of incurring considerable penalties. For example, failure to provide proof of the division of a project inside and outside China (such as workload, work hours, cost and expenses) can result in excessive taxation, whereby the local tax authorities deem all income to have been derived from China. To remedy this, we outline the procedure for tax declaration below.

Tax Declaration Procedure

Step 1. The company should electronically file VAT, VAT surcharges, stamp-tax and enterprise income tax (EIT) with the local tax bureau.

According to China’s Corporate Income Tax Law, the applicable EIT rate for this type of non-resident enterprise (without an office in China or deriving income unrelated to such an office) shall be 20 percent. Notably, the applicable EIT rate can be as high as 25 percent for other types of non-resident enterprises (e.g., those deriving income from an office established within China). The general formula for calculating EIT is as shown below (assuming that the relevant contract includes tax):

EIT payable = Contract price × applicable profit rate stipulated by the tax authority × applicable EIT rate (i.e., 20 or 25 percent)

The profit rate ranges from 15 percent to 50 percent, depending on the type of services provided. Specifically, the profit rate shall be:

• 15 percent to 30 percent for services such as design and consulting;
• 30 percent to 50 percent for management services; and
• Over 15 percent for other services.

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In this case, assuming a contract price of RMB 1 million, the profit rate is 25 percent (given that design services fall within the 15 percent to 30 percent range) and the EIT rate is 20 percent. Therefore, the EIT payable should be:

EIT payable = RMB 1 million × 25%× 20% = RMB50,000

Generally, the VAT rate for such projects shall be six percent. The relevant calculation method is as shown below:

VAT payable = Sales volume × applicable VAT rate

Step 2. The company should apply to the local tax bureau for approval of foreign currency online payments .

Step 3. The company should submit the relevant documents to the local tax bureau to obtain a tax certificate and collect the approval certificate from Step 2. This requires the following:

• Contracts signed between the two parties for the provision of services
• Invoices
• Tax payment invoices
• Other relevant materials

 Step 4. The company should make a bank transfer of the taxes owing.

Conclusion

Owing to the complexity of tax declaration procedures in China and the regulations governing non-resident foreign enterprises, taxpayers are encouraged to seek out the assistance of a professional services firm such as Dezan Shira & Associates, whose expertise can often succeed in negotiating a lower VAT rate with the relevant tax authorities.

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