Tax Holes in China – From Trading To Manufacturing

One of the component parts that make up a business decision whether to either trade with, or establish operations in a country is the tax aspect. These are a moving target – not only can they vary from province to province, be subject to different interpretations by different tax bureau or customs officials, or be changed during the regular annual budget reviews that China has.  This is one reason why China tax consultants are never unemployed.

However, when it comes to China, there is a lot to absorb. Yet in both trading with China and developing a fully fledged business in China, tax is one of the areas that often gets ignored. This is problematic in a number of areas, from the punishments that can arise for not being tax compliant, to not realizing certain tax provisions can actually save you money. This lack of knowledge can be described as a “tax hole” through which many foreign investors can become stuck.  In this article I take the reader through a number of developing scenarios in which tax holes can appear – and what to do about them.

Trading With China

More foreign companies trade quite happily with their Chinese counterparts than actually establish full time operations there. Yet tax rears its head in these transactions too, and cannot really be avoided. However a dearth of information in English means it can be hard to find data on specific product duties – an import-export tax hole. Consequently one of the most common enquiries we receive at China Briefing is “How much are the import-export taxes and duties?” That is a question we get asked so often we wrote a specific article about the subject, which has now turned into a kind of Q&A session in its own right. Tell us the product, and ask us the rate, and we reply online. That thread now has hundreds of thousands of views and hundreds of replies, and can be found here.  

Aside from import export duties, there are other tax issues the China trader must consider. We dealt with many of the legal and tax questions in this issue of China Briefing:

Trading in China
In this issue of China Briefing, we focus on the minutiae of trading with China – regardless of whether your business has a presence in the country or not. Of special interest to the global small and medium-sized enterprises, this issue explains in detail the licensing framework concerning trading with the most populous nation on Earth – plus the inevitable tax, customs and administrative matters that go with this. We detail handling customs, and import-export duties.

The Half-Way House – Employing Staff in China but without a Legal Entity

As many trading companies develop, they often reach a “half-way” house whereby they have begun to employ foreigners or locals in China, but do so “on the quiet” by paying them directly to their bank accounts and not declaring that income to the tax authorities or going to the level of setting up a permanent presence. This is actually illegal, and is not encouraged, however our estimation is that about 20 percent of larger turnover traders with China do run their operations in this manner. The intent to set up may well be there, but the strategic decision to invest has not yet been triggered. We understand this, although we encourage such businesses to get into compliance as soon as possible. There are a number of issues that need to be recognized when operating in such a fashion however.

The gap between not having a permanent establishment in China and having one is actually defined not by your lawyers, but by your own government. Most governments around the world have entered into “Double Tax Treaties” with China, and these actually spell out in some detail what is considered to be a “Permanent Establishment” (PE) – even if you haven’t actually got your business license yet.  This means that if you are operating in this grey area – typically by employing staff but without having an office, or by engaging in contractual work in China – you can be deemed to actually be operating a PE in China. If so, this can be very bad news as the implications of doing so immediately trigger suspicions of deliberate tax avoidance. As your own government is signatory  to the DTA that define PE it can have very serious implications, even for executives that are not based in China.

Recognizing this, we published two issues of China Briefing that deal directly with this question and assist executives abroad in recognizing the trigger points of being seen to actually be operating a PE in China, even if you haven’t yet set up a physical office.  

Understanding Permanent Establishment In China
In recent years, China’s tax authorities have tightened the tax administration of expatriate secondment, whereby overseas parent companies may be challenged that their actions constitute provision of services to their China subsidiary and, hence, result in the creation of a Service PE in China. This issue of China Briefing Magazine casts light on this subject by discussing the circumstances that trigger the creation of a PE in China, and discuss the tax implications for a non-resident enterprise where its activities are deemed to constitute a Service PE in China.

Double Taxation Avoidance in China
In a related subject to the PE question, this issue of China Briefing deals with the Double Tax Agreements China has signed and with which countries. However, DTA can also be of benefit to Chinese foreign investors, as not only to they spell out bilateral tax treatment and definitions of companies and individuals working in either country, they contain clauses that can reduce trading and operational costs in China. This includes how long executives can remain on secondment in China, as well as how to minimize profits tax burdens if an operation has been established in China.

When a foreign entity is either thinking about, or has established a legal presence in China, a whole raft of taxes come into play. It is best to be fully aware of these prior to incorporation as some can impact directly upon your immediate cash-flow needs. Issues such as the ratio of cash investment to equipment need to be considered, as do items for smaller investors, such as the placing of any bonds with customs in lieu of duty liabilities. There are too many aspects for one article to go into in any detail, however Dezan Shira & Associates annual China Tax Guide is one of the most successful and widely read books on the subject and is now in its seventh edition.  It is an excellent handbook both for the new-to-China executive and for China CFO’s and CEO’s as a “go to” for easy understanding and practical advice.

Tax, Accounting & Audit in China
This Guide has now become a standard part of the Business Executives library and contains a full breakdown, explanation and calculation introduction to all the taxes that a foreign investor can expect to have too deal with when investing in China. In easy to understand language it provides exact calculations, practical advice and solutions to handling your accounting, tax and financial compliance in China.

On-Going Tax and Financial Administration 

Beyond the standard and on-going issues concerning tax in China, there are additional considerations that come into play. This includes transfer pricing issues, and the provision of services by the foreign parent or other subsidiaries to the China operations. The Chinese tax bureau is becoming increasingly interested in such provisions.

VAT is also a key topic, not least because the Chinese tax bureau is changing its structure and inclusiveness, but also because this tax can be partially claimed back upon export of goods from China. 

International Related Party Transactions
In this issue of China Briefing, we turn to the issue of international transactions, specifically those between related parties. Within, we focus on HQ-WFOE service agreements: how to plan for them, their tax obligations, the service fee remittance process and how a service permanent establishment (PEs) may be established by sending HQ staff to work in China for more than a brief period of time. We also provide an overview of China’s transfer pricing obligations. What is the definition of related parties? What are basic transfer pricing obligations? What is the meaning of contemporaneous documentation requirements and advance pricing arrangements (APAs)? Finally, we examine the cross-border RMB settlement project, part of the push to internationalize the RMB – one of the hottest topics in international payments today.

Re-visiting China’s VAT Reforms
In which we discuss China’s VAT reforms and how these impact upon foreign investors and export manufacturers in particular. We examine sectors covered by the Pilot Reform Tax Rates, Taxpayer Status and Calculating VAT Implications of the VAT Pilot Reform, in addition to claiming VAT rebates.

An important part of structuring any investment into China is to look at how different taxes can be managed to minimize your overall tax exposure and thereby increase your profitability. Given that China’s economy is slowing and money supply is becoming tighter, this subject has never been as valid as it is now. Following certain mechanisms can save 15 percent on your overall tax bill.

Strategies for Repatriating Profit from China
In this issue of China Briefing, we guide you through the different channels for repatriating profits, including via intercompany expenses (i.e., charging service fees and royalties to the Chinese subsidiary) and loans. We also cover the requirements and procedures for repatriating dividends, as well as how to take advantage of lowered tax rates under double tax avoidance treaties.

Finally, how does China stack up when compared to other Asian destinations? In the quest to look at China alternatives in the light of rising production costs in China, this has become an important topic.

The 2015 Asia Tax Comparator
In this issue of Asia Briefing, we compare and contrast the most relevant tax laws applicable for businesses with a presence in Asia, including corporate income tax, individual income tax, VAT and other relevant taxes. We analyze the different tax rates of 13 jurisdictions in the region, including India, China, Hong Kong, and the 10 member states of ASEAN, which consists of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. We also take a look at some of the most important compliance issues that businesses should be aware of, and conclude by discussing some of the most important tax and finance concerns companies will face when entering Asia.

Tax is at best a dry subject, and at worst impenetrable and boring. This is why it remains a difficult subject for many blogs to cover. At China Briefing, we write for the business executive and try to make the subject easy to understand and indicate how it impacts upon your China investment. While tax is a subject many dread, it is an inevitability, and can be used in creative, yet legal ways in order to minimize your overall tax bill. At Dezan Shira & Associates, we estimate that about 80 percent of all China foreign invested enterprises are not as tax efficient as they could be due to a lack of strategic planning when it comes to assessing tax impact upon your business.  Tax is always a subject that should be reviewed, and if necessary checks taken to ensure both compliance, as well as efficiency are built into your business model. 

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