Taxation of Permanent Representative Offices in China
Is a Permanent Representative Office subject to taxes in china?
A Permanent Representative Office is regarded as a permanent establishment (PE) of the head office in China. However, having a PE in China does not necessarily mean that the FE is subject to taxes in China. We need to examine whether the activities being carried out by the Permanent Representatove Office are tax-exempt or taxable in light of the prevailing tax regulations and practice in China. The major legislations include PRC Income Tax Law for Foreign Investment Enterprise and Foreign Enterprise , its Implementation Regulations, the PRC Business Tax Tentative Regulations , ministerial regulations and rules issued by the State Administration of Taxation of the People's Republic of China .
If the Permanent Representative Office is found to be carrying on a taxable activity – even though the Permanent Representative Office has not applied for proper business registration – the China-source service income will be subject to Corporate Income Tax and Turnover Tax in China. If the Permanent Representative Office only performs tax-exempt activities on behalf of its head office, neither of these taxes will be imposed. If the services are performed in China, the income is usually regarded as having a source in China – regardless of who the payer is, where the payer resides, or what the currency is.
Tax-Exempt v Taxable Activities
As reiterated in Circular Guoshuifa No. (1996) 165 and elaborated in Circular Guoshuifa No. (1997) 002 issued by State Administration of Taxation (SAT) , the scope of tax-exempt activities for a RO are limited.
Where the head office is a manufacturer, the tax-exempt activities for its RO are:
- market study
- provision of commercial information
- liaison and other preparatory and supplementary services rendered at nil consideration for the manufacture and sale of the head office's own products (i.e. the goods manufactured by the head office) into China.
Where the head office is a trader, the tax-exempt activities for its RO are:
- market study
- provision of commercial information
- other preparatory and supplementary services rendered at nil consideration for sale of the head office's own goods into China.
Circular Guoshuifa No. (1997) 002 defines ‘sale of own goods' as the trading activities that the head office has purchased, received and stored (the goods) before sale. The Permanent Representative Office should be able to prove, to the satisfaction of the tax bureau in charge, that its head office has autonomy and control over the pricing of the goods. In addition, the RO should be able to prove that its head office bears the business risks (e.g. inventory risks and risks of bad debts) that are normally expected for a trader of goods. For example, the tax bureau in China will not regard the following activities of the head office as ‘sale of own goods' if:
- head office has firstly solicited and concluded a sale before it places the related purchase orders or production orders with suppliers (e.g. indent sale, back-to-back sale)
- the goods are purchased from the supplier and resold into China by head office at prices determined by the supplier.
In such instances the tax bureau will consider the head office as an agent for the suppliers / customers rather than a trader for tax purposes in China. As a result, the marketing and liaison activities carried out in China by the Permanent Representative Office will be considered taxable as agency services rendered to the head office's suppliers / customers rather than to the head office.
Where a FE does not separately charge a service fee or commission fee, for example, from its supplier / customer, the tax bureau could consider that the ‘service income' was taken into account and implicitly reflected in the prices of the goods purchased by the FE from its supplier or sold to its customer.
Where the head office is a financial institution, the tax-exempt activities for its Permanent Representative Office are:
(1) providing preparatory or auxiliary services to customers in China at nil consideration
(2) those connected with money lending between head office and its customers.
Where the head office is a government body or non-profit-making organisation the activities carried out by the Permanent Representative Office are tax-exempt. They are subject to the adjudication by the tax bureau in charge and the SATs final approval.
If the Permanent Representative Office believes that its activities could qualify for tax exemption they should apply to the tax bureau in charge for their adjudication and approval.
If the activities of a Permanent Representative Office go beyond the tax-exempt activities mentioned above, the FE will be subject to Corporate Income Tax and Turnover Tax in respect of the income (e.g. commissions, rebates, handling fee income, service fees) derived from the activities performed in China by the Permanent Representative Office . This will be calculated on an actual or deemed basis. Listed below are examples of taxable activities of a RO (as detailed in Circular Guoshuifa No. (1996) 165 ):
(1) trade agency services performed by a Permanent Representative Office of a trading company
(2) all kinds of services provided by a Permanent Representative Office of a consulting company engaged in professional services (e.g. business, legal, tax or accounting consultation)
(3) all kinds of services rendered by a Permanent Representative Office of an investment holding company to its group companies
(4) advertising agency services carried out by a Permanent Representative Office of an advertising company
(5) all kinds of services (e.g. visa application, fee collection, air ticket booking, tourist guiding, arranging accommodation) performed by a RO of a travel agency company
(6) investment or other consultation services provided by a RO of a financial institution
(7) any level of transportation services rendered by a RO of a transportation company to customers
(8) any other taxable activities provided by a Permanent Representative Office .
If a Permanent Representative Office carries on any taxable activities in China, the income attributable to the taxable services performed in China will be subject to Enterprise Income Tax (EIT) and Business Tax (BT) . EIT is imposed on the assessable profits. The prevailing tax rate is 33% (including 3% local income tax). This is reduced to 15% – generally the 3% local income tax waived – if the Permanent Representative Office is registered and operates in one of the five Special Economic Zones in China (Hainan, Shantou, Shenzhen, Xiamen and Zuhai). In addition, BT is levied at 5% on the taxable revenue.
In general, a quarterly EIT return should be prepared. This should be based on the unaudited management / expenditure account of each quarter, and be filed within 15 days. Within four months after the end of a tax year (i.e. calendar year), an annual EIT return – supported by the audited financial statements or expenditure accounts for the year – should be filed for the reconciliation and finalisation of the tax liabilities for the year.
For BT, strictly speaking, a monthly return should be filed within 10 days of the end of each month. In practice, many tax bureaus allow the filing of BT returns of a RO on a quarterly basis. However, the taxpayer should check the prevailing local practice. In addition, tax bureaus in some locations also require the filing of the annual BT return for each year.
The Detailed Rules for Implementation of the Tax Collection and Administration Law of China states: ‘when a taxpayer has been approved for tax exemption, the tax returns prepared on a nil taxable income basis should still be filed with the tax bureau in a timely fashion'.
In addition to EIT and BT, the management of a Permanent Representative Office should also pay attention to:
- the import Customs Duty and import taxes (i.e. Value Added Tax and Consumption Tax ) on the importation of commodities into China
- Stamp Duty payable on the taxable documents in China
- the Individual Income Tax withholding and filing requirements in respect of the individuals working for the Permanent Representative Office .
Taxable Amounts – Actual Basis v Deemed Basis
If a Permanent Representative Office maintains the accounting books and business records (e.g. service agreements, vouchers and receipts) in China, these can be audited by a registered CPA firm to reasonably ascertain the income and profit amounts. The Permanent Representative Office may apply to the tax bureau to file the tax returns on the actual results basis.
In practice, many Permanent Representative Offices do not maintain a full set of accounting records in China. In addition, many FEs do not enter into separate contracts or charge a separate service fee for the work done by their Permanent Representative Offices in China for the FE's suppliers or customers. In such situations, the tax bureau prescribes the use of one of the following methods to estimate their taxable revenue and assessable profits for filing tax on a deemed results basis. Once the method is approved, it should be consistently applied.
This method is only useful if the revenue information is available and can be proved to the satisfaction of the tax bureau. It involves two steps:
1. ascertaining the China-source revenue attributable to the work done by the RO
2. deeming the profits in the absence of expense details.
Ascertaining the China-source revenue for the RO
If a Permanent Representative Office can provide documentary evidence (e.g. service contracts or sales contracts specifying the commission amounts) showing the accurate amount of the China-source revenue, the tax bureau will allow the use of that amount as taxable revenue.
However, if the total amount of China-source revenue for the RO is not explicitly available – but the Permanent Representative Office can submit all the relevant sales contracts between its head office and the customers in China for the goods sold into China – the tax bureau may deem 3% of the total sales amount as the revenue for the RO.
If the Permanent Representative Office can provide further documentary evidence substantiating the part of the sales agency services that are carried outside China by its head office, the tax bureau may approve to treat only 50% of the revenue as the taxable revenue for the Permanent Representative Office . After the determination of the taxable revenue, BT should be paid at 5%.
If there is no proof of the actual amount of expenses of the Permanent Representative Office , the tax bureau will generally estimate the taxable profit for the Permanent Representative Office by applying a deemed profit rate on the taxable revenue amount. The deemed profit rate for provision of liaison and promotional services in China is currently 10%.
A Permanent Representative Office in Beijing provides liaison and marketing services in China for the sale of goods into China by a company in Hong Kong (HKCo) for HK$934,580 (converted to RMB1 million). HKCo is a fellow subsidiary company of the head office of the Permanent Representative Office .
The tax bureau reviews the service agreement and agrees that the taxable revenue is RMB1 million. However, the RO is not able to provide any invoices for the expenses incurred in relation to the services rendered.
Accordingly, the EIT and BT payable by the RO will be as follows:
Taxable revenue = RMB1 million
BT payable = RMB1 million x 5%
Taxable profit = RMB1 million x 10%
EIT payable = RMB100,000 x 33%
Effective tax rate = 100% x (33,000 + 50,000) / 1,000,000
= 8.3% (of taxable revenue).
If the RO is registered and operates within a Special Economic Zone, the EIT and BT payable by the RO will be as follows:
BT payable = RMB50,000
EIT payable = RMB100,000 x 15%
Effective tax rate = 100% x (50,000 + 15,000) / 1,000,000
= 6.5% (of taxable revenue).
A Permanent Representative Office in Shanghai carries out taxable activities in China. The total sale of goods that its head office sold into China in connection with the liaison and marketing effort of its Permanent Representative Office is US$200,000 (US$1 = RMB8.3). The sales contract did not state the commission income amount for the head office and its Permanent Representative Office . The RO could not provide any supporting evidence for its expenses, but could provide documentary evidence to substantiate that about half of the liaison and marketing work in respect of the total sales in China was done outside China by its head office.
The EIT and BT payable by the Permanent Representative Office will be as follows:
Deemed commission income = US$200,000 x 8.3 x 3% = RMB49,800
China-source revenue = RMB49,800 x 50% = RMB24,900
BT payable = RMB24,900 x 5%
Taxable profit = RMB24,500 x 10%
EIT payable = RMB2,490 x 33%
Effective tax rate = 100% x (1,245 + 822) / 24,900
= 8.3% (of taxable revenue).
The revenue-based method is not commonly used. This is due to the administrative burden and considerations of business information sensitivity in submitting the original sales contracts to the tax bureau for examination.
This is currently the method preferred by tax bureaus. It is used for almost all ROs set up after the implementation of Circular Guoshuifa No.(1996) 165 . Tax bureaus require taxpayers to adopt this cost-plus methodology in the following situations:
(1) where the Permanent Representative Office is unable to present valid documentation or proof to accurately distinguish its taxable and tax-exempt activities
(2) where the Permanent Representative Office often provides services to customers together with its head office, and is unable to present valid documentation or proof to substantiate the respective share of the revenue of head office and its Permanent Representative Office
(3) circumstances in which the Permanent Representative Office fails to report its taxable amounts properly and accurately.
This method involves three steps:
1. ascertaining the total expenses of the Permanent Representative Office
2. deeming the taxable revenue in the absence of the revenue information
3. estimating the assessable profit based on the taxable revenue calculated.
Ascertaining the total expenses
The ‘total expenses' of a Permanent Representative Office normally include:
- the remuneration paid to Permanent Representative Office staff (irrespective of the payment locations)
- telecommunication expenses
- travelling expenses
- rental expenses
- entertainment expenses
- costs and freight charges for purchases of sample goods in China for its head office.
The full amount should be included in the total expenses in the tax reporting period when expenditure is incurred for additions to fixed assets and leasehold improvements. If the lump sum included in the total expenses during one tax reporting period is large – causing hardship – the taxpayer can apply to use the depreciation and amortisation charges for each period in calculating the total expenses for that period. In this instance the tax bureau must be satisfied that proper and complete accounting books and records are maintained.
Office equipment, vehicles, furniture and fixtures should be depreciated over five years. Buildings should be depreciated over twenty years. The straight-line method should be used for depreciation calculations. No residual value is required on these fixed assets. Leasehold improvement expenditure can be spread evenly over a maximum of five years.
Certain items cannot be included in the calculation of the ‘total expenses' of a Permanent Representative Office . These include:
(1) tax late-payment surcharges and penalties
(2) qualifying charitable cash donations for China
(3) expenses paid on behalf of the head office (not directly related to the RO's own activities), for example:
– airline expenses for staff visiting the head office
– hospitality, accommodation and transportation costs and entertainment expenses incurred by delegates from head office visiting China (not directly related to any discussion or conclusion of any business contracts)
– rental expenses for meeting venues used by head office to hold conferences (not directly related to any discussion or conclusion of any business contracts)
– advertising and exhibition expenses, customs duty and import taxes on imported samples of goods and local delivery expenses (in relation to large exhibitions held in China by the head office)
– compensation payments made to customers of head office, in relation to the head office's non-compliance of the contract terms of its goods sold in China.
Interest income of the Permanent Representative Office cannot be used to set off expenses of the RO. You should also note that expenditure accounts audited by a registered CPA in China are required to be submitted to the tax bureau on an annual basis in support of tax filings using this method.
The following gross-up formula is prescribed by the tax bureau to estimate the taxable revenue from the costs of the Permanent Representative Office :
Taxable revenue =
Total expenses of the RO
(1 - BT - Deemed profit rate)
This may be an easier way to understand the rationale behind estimating tax revenue. BT should also be regarded as part of the expenses of a Permanent Representative Office . A business is expected to make a profit. The tax bureau believes that a RO is expected to earn:
Estimated taxable revenue (R)
= (Total expenses + BT) + Deemed profit margin
= Total expenses + R x 5% + R x 10%
= Total expenses / (1 - 5% - 10%)
= Total expenses / 0.85
Accordingly, the revenue is about 117% of the total expenses (not including BT). The mark-up rate is 10% of the taxable revenue but is indeed more than 17% of the total expenses. A cost mark-up rate of 17% for ‘low-value' liaison and marketing services is at the high end in international business practice.
Estimated assessable profit
= Estimated taxable revenue x Deemed profit rate (currently at 10%)
Since ‘total expenses' of a Permanent Representative Office is used in the above estimation, the taxable revenue for the Permanent Representative Office could be overestimated if part of the RO's expenses is attributable to the tax-exempt activities of the Permanent Representative Office . If such a case does happen, representatives from the RO may wish to discuss with the tax bureau in charge to ensure the Permanent Representative Office is fairly treated.