Taxes in China M & A – Lexology

introduction

The tax system of the People's Republic of China has evolved over the past 70 years. At the beginning of the republic's establishment in 1949, China introduced few types of taxes, as before 1978 most companies were either state-owned or collectively owned by a group of farmers. In the mid and late 1980s, China reformed its tax system and began to impose corporate taxes on state and collective companies in addition to private company income tax.

Over the next 20 years or so, China also gradually revised its indirect taxation of corporations, including state and collective enterprises. From the beginning of 2018, China began to levy VAT on commercial company revenues from the provision of services, with the business tax (a gross income tax on services) being abolished. Since the beginning of 2018, the provision of services, the sale of intangible assets and the sale or import of products have been subject to general VAT. China also imposes an excise tax on the manufacture, sale, and import of certain specially listed luxury goods. In addition, China levies transaction taxes such as stamp duty and deed tax on the sale, purchase, exchange or gift of real estate.

This chapter is not intended to cover all of the taxes China imposes on taxpayers or to provide an overview of China's tax history. Instead, it focuses on taxes in China, which specifically affect FDI in China, cross-border mergers and acquisitions, and provides some observations on tax structuring or restructuring issues.

Brief overview of the main taxes in the PRC
Corporation tax

Income taxation of companies in China is now subject to the Income Tax Law of the People's Republic of China and the detailed regulations for the implementation of the Income Tax Law of the People's Republic of China and is supplemented by various tax circulars or bulletins issued by the Ministry of Finance of the PRC, the State Tax Administration (SAT), or both (together the Income Tax Act).

China is a jurisdiction that levies corporate tax based on both taxpayers 'tax residence and taxpayers' source of income. In other words, the income tax consequences of a Chinese taxpayer will depend on whether that taxpayer is (or considered to be) a Chinese resident. and if not, whether the income in question is from China. Although it takes pages to explain how China's procurement rules work, the rule of thumb is that if a taxpayer:

manufactures or sells products in China or imports goods to China;
offers services within China;
Licenses or transfers of technology, trademarks or other intellectual property rights to a licensee who uses such intellectual property in China; or
derives passive income (e.g., dividends, interest and capital gains) other than royalties for the use of intellectual property rights.

Resident versus non-resident

Under the Income Tax Law, companies incorporated in the PRC and companies incorporated outside the PRC but having a place of effective administration in the PRC (2) (collectively resident companies) are subject to corporate income tax (EIT) at a general rate of 25 percent worldwide. Companies incorporated outside the PRC and having no place of effective management in the PRC (non-resident companies) would only be subject to the Chinese EIT for their income derived from:

their respective branch (3) (BE) through which they carried out their business activities in the PRC; or
the passive income such as capital gains, dividends, interest, and royalties that they receive from companies or individuals in the PRC.

Taxation of Resident Companies

Domestic corporations such as foreign-invested companies (which include Foreign Owned Companies (WFOEs), Sino Foreign Equity Joint Ventures, and Sino Foreign Equity Joint Ventures) are subject to the EIT for their worldwide income, whether or not that income comes from the Sino Domestic or foreign originates outside of China. If a portion of a resident company's income comes from abroad (e.g. dividends, interest and royalties received from a non-resident company), the Corporate Income Tax Act allows the resident company to pay foreign income taxes paid on such overseas companies, to credit. Income received against EIT that would otherwise have to be paid if this income originated in China and were subject to 25 percent of the EIT.

Because this book focuses on legal, tax, and other issues relating to M&A transactions in China, other aspects of resident corporate income taxation are not discussed in detail in this chapter.

Income taxation of non-resident companies
Business presence – active income

Under the Corporate Income Tax Act, non-resident companies are subject to an EIT of 25 percent of their taxable income (as) in relation to their active income from conducting business in China through a location or establishment therein. "Place or facility" includes an administrative office, business facility, representative office, factory, site for the extraction of natural resources, a place where services are provided, a site for the operation of a construction, installation, assembly, Repair or exploration project and the location of business of an agent who has the authority to habitually sign contracts and who is authorized to enter into contracts on behalf of the non-resident company; Unlike resident corporations, non-resident corporations would generally be subject to income tax based on assumed profits (generally 30 percent but in some cases up to 50 percent of their gross sales as assumed profit) or in the case of non-resident PRC representative offices, mostly on a cost-plus basis. (4)

No business presence – passive income

Under the Income Tax Act, non-resident companies that are not domiciled or have a branch in China, but who generate “Chinese-sourced income”, are subject to 10 percent withholding tax. “Income from sources within China” for non-resident companies who are not resident or established in China typically include:

After-tax profits (dividends) of companies in China;
China-derived interest on deposits, loans, bonds, provisional prepayments on someone else's behalf, or deferred payments;
Leasing of assets to be rented to and used by parties in China;
Royalties arising from the provision of patent rights, proprietary technologies, trademarks, copyrights and other such rights for use in China;
Income from the allocation of assets such as buildings, structures and their ancillary facilities and land use rights; and
Other income from China determined to be taxable by the Treasury Department and the SAT.

Special rules for representative offices

Subject to the exemption provisions of the applicable bilateral tax treaty, China imposes non-resident corporate representations in China (ROs) (and VAT – discussed later) on EIT in relation to the following activities:

Carrying out liaison activities, negotiations and introductory services carried out in China on behalf of clients from their respective headquarters outside of China;
Conducting market research, collecting commercial information and providing advisory services in China on behalf of customers, whether customers pay for these services on a loyalty basis or otherwise; and
Participation in liaison activities and negotiations, mediation and introduction in China on behalf of other companies.

In the above three scenarios, it doesn't matter whether the customers or third party companies pay a service fee directly to the RO or their overseas headquarters. However, an RO would be exempt from income tax (and VAT):

if the head office of the RO is a foreign manufacturer and the RO acts exclusively for its head office by limiting its activities to carrying out market research, promoting the sale of the products of the head office in China or establishing some other business relationship for the head office; or
when it generates revenue for services primarily provided outside of China on behalf of companies based in China.

In theory, ROs can be taxed with:

the "actual income and expenditure" method; (5)
the “assumed profit” method (6) or
the “cost plus” method. (7)

In practice, most ROs have been taxed on a cost-plus basis for the past three decades, with the exception of those from foreign legal, accounting and consulting firms.

VAT

China's VAT system was modeled on the European VAT systems, but it is somewhat different from its European counterpart. Two of the main differences between these two VAT systems are:

Only large VAT payers (8) are allowed to offset their input tax against their input tax. and
China's VAT regulations do not allow VAT exemption for export goods from the beginning of the production chain to export. Instead, they exempt final exporters from VAT only when the products are actually exported, while exporters have to reclaim their input tax after export, and often at a rate lower than the VAT rate a few months later.

In general, VAT is levied on revenue from the sale of goods (e.g. physical assets) or intangible assets, and from the provision of processing, repair, maintenance, transportation, professional service and other services. VAT is also levied on imported goods, unless there is a special VAT exemption for the imported goods.

The standard VAT rate on the sale of goods is 13 percent, while a VAT rate of 9 percent applies to the sale of granted land use rights or other real estate, as well as certain specially listed services, and a VAT of 6 percent is levied on revenue from the provision of services.

Property tax

A property tax is levied on the added value of the transfer of state-owned land use rights, aboveground structures and the associated facilities, which is levied at the established tax rate. The taxpayer submits the tax return within seven days of the conclusion of the property transfer agreement to the competent tax authority where the property is located and pays the property tax within the deadline set by the tax authority.

In general, the following four progressive tax rates apply to the appreciation of the land:

the tax rate is 30 percent for the portion of the increase in value that does not exceed 50 percent of the total of the deductible items;
the tax rate is 40% for that part of the increase in value that exceeds 50% but not 100% of the total of the deductible items;
The tax rate is 50% for that part of the increase in value that exceeds 100%, but not more than 200% of the total of the deductible items. and
The tax rate is 60 percent for the portion of the increase in value that exceeds 200 percent of the total of the deductible items.

The above deductible items include:

the amount paid for the acquisition of the granted land use rights;
Costs and expenses for the development of the country;
Costs and expenses of constructing new buildings and facilities or the estimated value of used property and buildings on the property;
Taxes in connection with the transfer of real estate; and
other deductible items as determined by the Treasury Department.

The relevance of capital appreciation tax in the context of M&A transactions depends on whether the tax is applicable to the parties to the transactions in a stock or equity deal (as opposed to an asset deal). In other words, whether property tax is payable depends on property transferring ownership as part of the transaction.

Deed tax

Deed tax is payable by the grant recipient, acquirer or buyer in one of the following scenarios:

Acquisition of granted land use rights from the state;
Transfer of granted land use rights, either by sale, exchange or gift; or
Buying and selling, exchanging or donating real estate on land.

Bringing capital into a company in the form of granted land use rights or real estate located on such granted land, settling debts by transferring ownership to the obligee or acquiring ownership of land upon winning an offer for granted land use rights to a land are considered a taxable transfer.

The tax rate for deeds is between 3 and 5 percent and is adjusted by the provincial governments and the four municipalities directly under the central people's government.

Stamp duty

China also imposes stamp duty on certain specifically listed legal documents. The introduction of stamp duty is primarily based on the People's Republic of China's provisional stamp duty regulations enacted by the State Council under the approval of the National People's Congress (NPC), China's legislature. However, many foreign investors are unaware of China's stamp duty and often overlook it in the context of mergers and acquisitions.

The following categories of documents are subject to stamp duty:

Documents issued for purchase and sale transactions, general contracts or transactions, leasing of real estate, transportation of goods, storage and safekeeping of goods, loans, property insurance, technology contracts and other documents of a contractual nature;
Ownership transfer documents;
Business books;
Documentation of rights or licenses; and
other documents classified as taxable by the Ministry of Finance.

The table below provides a detailed description of the taxable instruments and documents and the corresponding stamp tax rate as of 2019.

No.	Taxable	scope	tax rate	taxpayer
1	Purchase and sales contracts	Contracts for delivery, pre-sale, procurement, combined purchasing and cooperative manufacturing agreements, balancing trade, barter trade, etc.	0.03% of the value of the purchases	Contracting parties
2	Processing of contracts and contracts for temporary work	Contracts for processing, custom-made, repair and maintenance, printing, advertising, surveying or testing, etc.	0.05% of the income from these contracts	Contracting parties
3	Engineering and construction, project surveying and construction contracts	Contracts for surveying and design	0.05% of service fees paid and received	Contracting parties
4th	Construction and installation contracts	Contract for construction and installation	0.03% of the contractually agreed amount	Contracting parties
5	Real estate leases	Contracts for the leasing of buildings, ships, airplanes, motor vehicles, machines, devices and tools and equipment	0.1% of the lease. Any amount less than 1 yuan will be postmarked as 1 yuan	Contracting parties
6th	Goods transport contracts	Contracts for transport by civil aviation, rail transport, maritime transport by inland waterway, land transport, and transport using any combination of the above means of transport	0.05% of the transport fee	Contracting parties
7th	Storage and retention contracts	Storage and / or retention contracts	0.1% of storage and / or retention fees	Contracting parties
8th	Loan agreements	Contracts concluded by banks and other financial institutions and borrowers, with the exception of interbanks, offer loan agreements	0.005% of the loan amount	Contracting parties
9	Property insurance contracts	Insurance contracts for property, surety, surety and credit companies, etc.	0.1% of the insurance premium	Contracting parties
10	Technology contracts	Contracts for technology development and transfer, consulting and other services	Stamp as 0.003% of the stated amount	Contracting parties
11	Transfer of ownership agreements	Transfer of documents for property and copyrights, trademarks, patents, the right to use proprietary technology; Contracts for the grant and transfer of land use rights and other property transfer documents	0.05% of the specified amount	Parties executing the document or documents
12	Business books	Production and business operations books	For ledgers to record the funds received from the taxpayer: 0.05% of the total amount of the original value of fixed assets and own working capital; for other books of account: 5 yuan each	Companies with business books
13	Certificates and licenses	Certificates of ownership relating to ownership of buildings; Business licenses issued by the competent authorities for business operations; Registration certificates for trademarks, patents and land use rights issued by the relevant authorities	5 yuan per document	Scholarship holder

China's tax legislation and regulation

China is a federal jurisdiction in that, with a few exceptions, all statewide laws, administrative rules and regulations are enacted by the national legislature, the NPC or, where appropriate, its Standing Committee (or the State Council or one or more of the departments under it). However, it differs from the US federal system in that each of the provinces has no legislative power, and only autonomous regions like Inner Mongolia have limited powers to pass local laws regulating matters that contain certain positive actions that have particular benefits for Minorities create peoples in the respective autonomous regions.

In China, laws such as the Enterprise Income Tax Law are enacted by the NPC, while the implementing rules for any national law are always complemented by implementing rules issued by the State Council in accordance with the approval or rules of the NPC and other written interpretations (i.e. circulars the competent department of the State Council). In practice, each relevant department of the State Council proposes new legislation or amendments to an existing law to the state (together with the proposed implementing provisions for the new law or amendments to the existing implementing provisions, if applicable) Council.

Chinese tax implications for foreign investment
Greenfield investment projects

When China began opening up to foreign investment in the late 1980s and early 1990s, almost all foreign investment in China was in either a stock joint venture or a contractual joint venture. There were very few WFOEs. At that time there were three separate tax laws, each regulating income taxation for each type of foreign invested company. Essentially, under China's previous separate income tax law, stock joint ventures, contract joint ventures and WFOEs, as well as foreign companies doing business in China, were taxed differently and at different rates for each type of foreign invested company. Under the Income Tax Act, all resident and non-resident companies with active income from China are subject to the same 25 percent tax rate.

Contractual joint ventures, which were established as quasi-partnerships and are very rare these days, were treated as partnerships for tax purposes. The foreign party, parties, or corporate partners of contractual joint ventures were essentially treated as non-China based companies, and the foreign party, parties, or partners of contractual joint ventures are now subject to a Chinese EIT of 25 percent on an assumed profit basis for their active business Received income from conducting business through a BE under Chinese law or a permanent establishment under an applicable tax treaty or a withholding tax of 10 percent on its passive income such as dividends, royalties, interest and capital gains from sources within China.

In addition to the EIT, resident and non-resident companies are subject to VAT in relation to the importation and sale of goods, the provision of services, and the transfer and licensing of intellectual property rights for use by Chinese licensees, the sale or leasing of real estate sales other intangible assets. VAT and other indirect taxes or transaction taxes are not covered by bilateral tax treaties that China has with other countries.

Tax structuring before investments

As with all cross-border investment projects, structuring the tax before investing is imperative as the tax ramifications can affect the bottom line of the investment projects and can make such an investment project financially impossible and less financially rewarding for investors. Given that the corporate tax rate in China is fixed except for a few tax holidays, it is vital for China-based investors to put in place effective tax structures to minimize the aggregate income tax burden resulting from both economic double taxation and judicial taxation Double taxation results.

A typical example of economic and judicial double taxation on the same income is that China imposes a 25 percent tax on the profits of a resident company and generally a 10 percent withholding tax on dividends payable to the shareholder of a non-resident company the after-tax profits of the resident company. In addition to the 25 percent and then 10 percent EIT, the home country of the non-resident company in question, such as the United States, would also impose corporate tax on dividends that the non-resident company receives from the resident company in China (although in countries like the United States the Internal Revenue Code without the U.S.-China tax treaty unilaterally allows foreign tax credits for the U.S. company that receives dividends from the resident company that paid dividends).

While economic double taxation is just a matter of Chinese domestic law, and such double taxation can only be abolished under Chinese domestic law, bilateral tax treaties between China and other countries would help eliminate most of the double taxation due to cross-border investment and movement of goods and services (ie judicial double taxation). Hence, it was common practice to purchase contracts, i.e. invest from a tax jurisdiction (e.g. Hong Kong) with a lower withholding tax rate on dividends, interest, royalties and capital gains. From the late 1990s to the early 2000s, Mauritius and Barbados were popular jurisdictions for foreign investors to set up intermediate holding companies for interests in Chinese operating companies (share joint ventures, cooperative joint ventures, or WFOEs), as either of those two Countries entered into a tax treaty that exempts 10 percent Chinese withholding tax on capital gains made by intermediate holding companies in those countries from the disposal of their interests (shares) in the underlying operating companies in China. After China signed a new bilateral tax treaty with these two countries that abolished the withholding tax exemption on capital gains, foreign investors now typically choose Hong Kong or Singapore as the jurisdiction in which to set up their intermediate holding companies.

In any event, the primary goal of foreign investors investing in China through an intermediate holding company or multi-tier intermediate holding company is to minimize the total income tax burden that would result from cross-border investment and doing business, thereby maximizing the bottom line of investing and doing business in China . This structuring of the tax before the investment is crucial in both greenfield projects and M&A transactions in which the acquiring party directly or indirectly acquires interests (shares) of the desired Chinese target.

Tax structuring – lessons learned

For some foreign investors, the investment and tax structure has been created through the use of an intermediate holding company in one of the favorable jurisdictions mentioned above, but the tax structure within China has been overlooked. An example of this failed control structure is shown in the following table.

Tax treaties do not deal with economic double taxation resulting from the two-tier Chinese corporate structure presented above and cannot be invoked. The disastrous result is that capital gains would be taxed at 25 percent (in withholding tax) in the hands of the Chinese investment holding company (China Holdco) and 10 percent in the hands of the Barbados Intermediate Holding Company if the foreign investor were in the above hypothetical case sold a division that is distributed among the operating companies among the Chinese holding companies.

The foreign investor in the above hypothetical case could have avoided the 25 percent EIT on capital gains if they had taxed restructuring and moved and consolidated the business to one or two subsidiaries of the Chinese investment holding company and initiated the before the division was sold Holding company to transfer its stake in these subsidiaries to the intermediate holding company in accordance with the tax-free reorganization rules of China. Or even better, if the foreign investor had originally created a parallel participation structure in which an offshore intermediate holding company holds direct stakes in the operating companies that are exclusively or mainly active in a business area of the foreign investor.

Taxes Applicable on Mergers and Acquisitions

M&A deals with Chinese operating companies can differ dramatically depending on whether the proposed acquisition or merger is an asset deal or an equity deal – in other words, whether the M&A goal is Equity or the shares of a company, or all or part of the company, are assets of a company. If it is a stock deal, no legal title to the target company's assets changes hands. Instead, only the equity or shares of the target company are bought and sold. In the case of an asset deal, all or part of a company's assets would be sold to the buyer or one of the offshore buyer's subsidiaries in China.

Stock business

In the context of an equity transaction, the acquiring company would acquire shares in the target company or in companies domiciled in China (an onshore equity investment) or shares in the intermediate holding company in an offshore jurisdiction (an offshore equity investment) and thus indirectly acquire the equity of the target company in China . Since only the equity of the target company changes hands as part of an onshore equity deal, indirect taxes such as VAT and transaction taxes such as property taxes and deed taxes (which apply to the sale and purchase, exchange, or gift of property) can be avoided .

If the selling company in a stock deal is a resident corporation with a non-resident shareholder, the applicable taxes are 25 percent EIT on a net basis payable by the resident corporation and 10 percent withholding tax on the non-resident shareholder of the outgoing dividends paid out Gewinnen aus der Veräußerung solcher Aktien gezahlt wurden. Wenn der Verkäufer ein nicht ansässiges Unternehmen ist, muss der Verkäufer eine Quellensteuer von 10 Prozent auf seine Kapitalgewinne zahlen, die sich aus der Veräußerung solcher Aktien oder Anteile ergeben. In beiden oben beschriebenen Szenarien wäre sowohl vom Verkäufer als auch vom Käufer eine Stempelsteuer von 0,05 Prozent zu zahlen.

Eine weitere Komplikation der chinesischen Kapitalertragssteuer ergibt sich aus dem Verkauf seiner Anteile an der Offshore-Zwischenholdinggesellschaft durch einen ausländischen Investor, die 100 Prozent der Anteile an ihrem WFOE oder einen Teil der Anteile an einem Joint Venture hält, wodurch das Ziel erreicht wird indirekte Veräußerung seiner Beteiligung an der WFOE oder dem Joint Venture (indirekte Aktienübertragung). Nach den chinesischen Steuervorschriften für indirekte Aktienübertragungen (Enterprise Income Tax Law und SAT Bulletin 7 (2015)) würden mit wenigen Ausnahmen alle indirekten Aktienübertragungen zu einer einzigen Onshore-Transaktion zusammengefasst, als hätte der ausländische Investor sein Eigenkapital direkt übertragen Auf die vom Veräußerer erzielten Kapitalgewinne würde eine Beteiligung an der WFOE und eine Quellensteuer von 10 Prozent erhoben. (9) Es wäre jedoch keine Stempelsteuer fällig und zu zahlen, da keine direkte Übertragung des rechtlichen Eigentums an der WFOE erfolgt Beteiligung an der WFOE.

Asset Deal

Im Falle eines Asset-Deals würde der Verkäufer sein gesamtes Vermögen oder einen Teil davon an ein anderes ansässiges Unternehmen verkaufen oder seine chinesische Tochtergesellschaft veranlassen, dies im Rahmen eines größeren globalen M & A-Deals oder im Rahmen eines einfachen Onshore-Asset-Deals zwischen dem Verkäufer und Käufer. Angesichts der Tatsache, dass physische und immaterielle Vermögenswerte im Rahmen eines Asset Deals gekauft und verkauft werden, können zusätzlich zu EIT aus den Gewinnen aus dem Verkauf der Vermögenswerte je nach den besonderen Umständen jeder Transaktion auch die folgenden Steuern anfallen:

13 Prozent Mehrwertsteuer für den Verkauf des Inventars, obwohl sowohl der Verkäufer als auch der Käufer ihre Vorsteuer mit ihrer zulässigen Vorsteuer verrechnen dürfen;
6 Prozent Mehrwertsteuer auf die Einnahmen aus der Übertragung des geistigen Eigentums und den kalkulatorischen Goodwill im Zusammenhang mit dem Verkauf von Vermögenswerten;
2 Prozent effektive Mehrwertsteuer auf den Erlös aus dem Verkauf von physischen Vermögenswerten (z. B. Produktionsanlagen);
Grundsteuer zum geltenden Satz, der vom Immobilienverkäufer zu zahlen ist;
vom Käufer zu zahlende Urkundensteuer in Höhe des geltenden Satzes (in der Regel 3 bis 5 Prozent), der von der örtlichen Regierung festgelegt wird, die für die an den Käufer zu verkaufenden Immobilien zuständig ist; and
0,05% Stempelsteuer, die vom ansässigen Unternehmenskäufer auf den erhöhten Betrag des Grundkapitals (Äquivalent des eingezahlten Kapitals) zu zahlen ist, der sich aus Vermögenswerten ergibt, die im Rahmen einer M & A-Transaktion gekauft oder erworben wurden.

Aktuelle Trends bei der Steuererzwingung

Das SAT, das Zweigstellen und Unterzweige auf Provinz-, Kommunal- und Kreisebene hat, ist die zentrale Regierungsbehörde, die mit der Verwaltung der Steuererhebung beauftragt ist. Neben der Veröffentlichung verschiedener Ankündigungen und Bulletins, die die lokalen Zweigniederlassungen und Unterzweige bei der Steuererhebung leiten, entscheidet der SAT auch über den Schwerpunkt der Bemühungen zur Durchsetzung der Steuervorschriften. In den letzten Jahren haben der SAT und seine lokalen Niederlassungen und Unterzweige erhebliche Ressourcen für die Untersuchung der Einhaltung von Steuervorschriften bei indirekten Aktienübertragungstransaktionen, die Ermittlung und Durchführung von Verrechnungspreisprüfungen und die Durchführung von Steuerprüfungen ausgewählter Branchen wie der Filmproduktion, in denen Steuerhinterziehung stattfindet, erweitert war weit verbreitet.

Der SAT hat auch die Rechtmäßigkeit und Abzugsfähigkeit von Verbindlichkeiten zwischen Unternehmen zwischen dem Hauptsitz multinationaler Unternehmen (MNC) und chinesischen Tochtergesellschaften in Frage gestellt, als er Mitte der 1980er Jahre feststellte, dass eine Reihe von MNCs Gebühren zwischen Unternehmen erhoben hatten viewed such arrangements as a way of transferring out of Chinese pre-tax profits that would otherwise be taxable in the hands of the Chinese subsidiaries of these MNCs.

Concluding remarks

Over the past 40 years or so, China’s tax system has evolved into a fairly complex system, under which a direct (income) taxation regime coexists with an indirect tax scheme containing VAT and consumption tax, and a parallel transaction taxes net. This complex tax system, coupled with the involvement of multiple tax jurisdictions in relation to China-inbound investment, makes thoughtful and thorough tax planning and both pre- and post-investment tax structuring a must. In the absence of such tax planning and structuring, foreign investors will no doubt eventually encounter Chinese tax problems of one kind or another that are difficult to solve, and may find themselves forced into a corner where they have no choice but to pay unnecessary taxes that could have been legally avoided in the first place.

Footnotes

(1) David Liu is a partner at Duan & Duan.

(2) ‘Place of effective management’ refers to the place where the material and overall management and control over the business, personnel, accounts and assets of the enterprise are exercised.

(3) This is a Chinese domestic law concept that is similar to the permanent establishment (PE) concept in bilateral tax treaties, except there is no grace period under BEs, although there is generally a grace period of 183 days or six months in a calendar year or any 12-month period before a non-resident enterprise would be deemed to have a PE in the host country.

(4) See description of the ‘cost-plus’ taxation method in footnote 7.

(5) Under the actual revenue and expense method, an RO must report to the tax authorities its revenues and expenses for the tax period in question, supported by relevant contracts and expense vouchers and receipts. Gross revenue is generally subject to a 6 per cent VAT and profits are subject to EIT at 25 per cent.

(6) Under the deemed profits method, gross revenues are subject to 6 per cent VAT, and profit is deemed generally at 10 per cent of the gross revenue, and the deemed profit is then subject to EIT at 25 per cent.

(7) Under the cost-plus method, revenues are generally deemed to be 117.65 per cent of the office’s expenses for the tax period. VAT must be paid on deemed revenue generally at the rate of 6 per cent, and 10 per cent of the deemed revenue is subject to EIT at 25 per cent.

(8) Under Chinese VAT regulations, as a general rule, VAT taxpayers whose annual gross sales total is less than 5 million yuan, and would otherwise be subject to a 13 per cent VAT, would generally be subject to a 3 per cent levy rate on their gross sales, without the right to offset their input VAT against their output VAT.

(9) Under the Enterprise Income Tax Law and SAT Bulletin 7, it is not entirely clear if a non-resident enterprise transferee would have the legal obligation to withhold the 10 per cent withholding tax from its payment of the purchase price to the transferor. Bulletin 7 also does not mandate that parties to the indirect share transfer shall report to the competent tax authority of the transaction, but provides for heavy penalties should both parties to the transaction fail to voluntarily report the indirect share transfer to the competent tax bureau.