The question of how to get money out of China is always one of the top priorities for MNCs operating in China. Carl Poon, Tax Director of LehmanBrown, discusses the latest updates and key issues that MNCs should evaluate in respect of their PRC operations.
Following China’s accession to the WTO, China has been progressively liberalising its market and offering tremendous business opportunities for MNCs (multinational companies) operating in the country. PRC (People’s Republic of China) subsidiaries of MNCs continue to receive various types of services from their overseas affiliates. Accordingly, intragroup transactions are rapidly growing in volume and becoming more complex.
Recently, the PRC State Administration of Foreign Exchange (SAFE) has taken a series of measures to simplify the procedures required for the remittance of service fees. Besides service fees, it is not uncommon for PRC subsidiaries to remit royalties, license fees and dividends to overseas affiliates.
In this article, we discuss the latest updates relating to the remittance of service fees, the processes that must be followed in order to obtain the necessary approval from the PRC governmental bodies and the related PRC tax implications. Then we briefly look at royalties, license fees and dividends.
As China does not allow management fees in the normal sense, this may present an obstacle to international companies that operate in China. Companies are, however, allowed to charge service fees for value added activities that are carried out by their head office. These service fees can also cover activities carried out by any associated enterprise that are of a value add nature. In regard to what can be classified as value add, this is open to interpretation.
For instance, a CFO spending time in preparing a strategic financial plan could be classified as value add, and charged to a China subsidiary. In terms of the basis of charging, the Chinese government does not like mere allocations or simple percentages of revenue. The latter could be used as a cap, but not the basis of calculating the fee. They prefer the calculation to be on an arm’s length basis, such as an hourly or a day rate. Additionally, it is important to differentiate between services carried out in China and those outside of China, as the former are subject to taxation.
Regulatory requirements and latest developments
The SAFE issued a notice, Hui Fa  No.19 (Notice 19), which came into effect from 1st May 2006. According to Notice 19, PRC entities only need to provide service agreements for the remittance of service fees amounting to $50,000 or less to foreign entities. For payments in excess of $50,000, tax payment certificates or tax exemption certificates are also required. However, irrespective of the remittance amount, the payer of the service fees (ie the PRC entities) should still have the withholding obligations for PRC taxes payable by foreign entities. Designated banks are the parties which review the requisite documents and approve the remittance of service fees to foreign entities.
The SAFE and the State Administration of Taxation (SAT) jointly issued a notice Hui Fa  No. 8 (Notice 8) to provide further relaxation on the procedures for remitting some types of service fees in Tianjin, Shanghai, Jiangsu, Sichuan, Fujian and Hunan (hereinafter collectively referred to as the ‘Six Regions’), effective from 1st April 2008 on a trial basis.
To facilitate the implementation of Notice 8 in the Six Regions, the SAT issued two supplementary notices, Guoshuihan  No. 219 and Guoshuihan  No. 258. These set out the trial procedures applicable to service type payments and some relevant administrative matters.
Advance filing for the Six Regions
According to Notice 8, when making a service payment exceeding $50,000 through a designated bank,companies established in the Six Regions will only need to file copies of the service agreement togetherwith registration forms with the in-charge state tax bureau before proceeding with actual remittance(hereafter referred to as ‘advance filings’). In other words, the tax compliance procedures now come afterthe actual remittance.
The payer is only required to submit the relevant service agreement at the first time of registration. Forsubsequent remittances, only registration forms are required.
Applicability of the advance filings
Advance filings are applicable to payments for following services:
Transportation (exclusive of international sea transportation).
Construction and installation.
Contracted labour services.
Financial services (including guarantee fees but excluding interest).
Computer and information technology services.
Licensing and royalty.
Cultural activities and entertainment.
Other commercial services and governmental services.
For payments which are to be made by instalments, advance filing is required for each individual payment.
Advance Filings are not applicable to:
PRC tax implications for remitting service fees
Corporate income tax
The PRC corporate income tax position of a foreign service fee recipient depends on whether it would beconsidered a permanent establishment (PE) under the applicable tax treaty with China.
Generally speaking, under major tax treaties between China and other territories, a foreign enterpriseconstitutes a PE in the PRC if it renders services, including consultancy services, through its employeesin the PRC for the same or a connected project, for a period or periods aggregating more than six monthswithin any twelve month period.
If the foreign entity constitutes a PE in the PRC by virtue of the activities carried out in the PRC, it would besubject to corporate income tax on its profits attributable to the PE created.
The PRC tax authorities would apply a deemed profit rate in estimating the taxable profits. No other PRC tax preferences will be made available to the PE created. Generally speaking, the deemed profit rate for the provision of services ranges from 10% to 40%. The PRC tax authorities would look at the underlying activities and compare them to the industry norm before determining the applicable deemed profit rate.
Example of PRC corporate income liability under a PE situation:
We assume that the service fee payable to the foreign entity is $100,000 and the deemed profit rate adopted by the in-charge tax bureau is 20%.
Business tax is a type of turnover tax which is levied on gross revenue derived from the provision of services in China. The applicable business tax rate for the provision of services is 5%.
Generally speaking, only corporate income tax and individual income tax are covered under the tax treaties with China. Hence, if the foreign entity does render services in China, it would be subject to business tax on the service fee attributable to services rendered in China irrespective of whether it would constitute a PE in China.
Using the above assumption, the business tax liability of the foreign entity is calculated as follows:
Suggestions for tax minimisation
If the service agreement does not specify the fee charged for the services performed outside the PRC, or if no accurate documentation can otherwise be provided for identifying such fee, the PRC tax bureau can have its own interpretation and may treat all revenue as onshore revenue. In other words, no profits may be excluded from PRC corporate income tax and no revenue may be excluded from business tax.
Hence, if the foreign entity provides services to a PRC entity both in and outside China, it is recommended that the foreign entity should enter into two separate contracts with the PRC entity – one contract for PRC services (PRC services contract) and the other for non-PRC services (non-PRC services contract). The amount of service fee stipulated in the PRC service contract and the non-PRC service contract should be commensurate with the services rendered inside and outside China with proper documentary evidence. Furthermore, the type and nature of services rendered under each contract should be clearly defined.
Technically speaking, the foreign entity should not be subject to any PRC corporate income tax and business tax under the non-PRC services contract as those services are rendered by it outside of China. The foreign entity needs to apply for tax exemption certificates for the remittance of service fee receivable under the non-PRC services contract. Documentary evidence should be in place to substantiate that the services stipulated under the non-PRC service contract are rendered outside of China.
Royalties or license fees
Basically, the regulatory requirements for remitting royalties or license fees are same as those applying to service fees. In addition, the royalty agreement/license agreement should be registered with the local Ministry of Commerce before the remittance of royalties or license fees.
PRC tax implications for remitting royalties or license fees
The foreign recipient of royalties or license fees would be subject to business tax and PRC withholding tax.
Business tax is levied at 5% on the gross amount of royalty/license fee.
PRC withholding tax on royalty is calculated as follows:
The withholding tax rate on royalties/license fees may be reduced under some tax treaties with China. For example, under the HK-PRC tax treaty, the withholding tax rate on royalties/license fees is reduced from 10% to 7%.
A foreign investment enterprise (FIE) can only pay dividends after tax settlement and allocation to the reserve fund. Thereafter, the FIE can apply for the repatriation of profit with the designated bank.
An FIE can only pay dividends out of its distributable profits. Distributable profits are basically profit after tax less any losses brought forward from previous years and the allocations to three kinds of reserve funds: the reserve fund, the enterprise expansion fund and the employee welfare and bonus fund.
An FIE is required to allocate 10% of its profit after tax to the reserve fund. No further allocation is however required if the fund reaches 50% of the registered capital of the FIE.
The amounts allocated to the enterprise expansion fund and the employee welfare and bonus fund are at the discretion of the FIE’s board of directors, or the legal representative in the absence of a board of directors.
The reserve fund can be used to offset prior and current years’ losses or to increase capital. The enterprise expansion fund can be used to expand production or operations and to increase capital. Both funds are non-distributable unless the FIE is in liquidation.
The employee welfare and bonus fund is used to pay bonuses of an extraordinary nature (such as special contribution award, annual award, etc) to the employees and to finance general welfare facilities for the employees of the FIE.
The dividend payable by the FIE is classified as a current account transaction that does not require the approval of the local SAFE. However, in general, the remittance of the dividend is not allowed if the registered capital of the FIE has not been paid up.
PRC tax implications for paying dividends
Starting from 1st January 2008, dividends payable by an FIE to its foreign investors are generally subject to PRC withholding tax at a rate of 10% unless a reduced withholding tax rate is stipulated under the applicable tax treaty, such as the Hong Kong-PRC tax treaty.
Undoubtedly, the advance filings can expedite the remittance of service fees to foreign entities. If the trial run in the Six Regions turns out to be an effective method of easing control, the new registration procedures may be extended to other regions or applied nationwide. However, there may be variations in local practice amongst different PRC tax authorities. Therefore companies established in the Six Regions should confirm with their in-charge tax bureau so as to ensure a smooth remittance process.
More and more MNCs are adopting different service fee charges in getting money out of China. They should evaluate and manage the relevant tax exposures, and comply with the latest regulatory requirements. In particular, proper documentation should be in place for intragroup service arrangements and to support the onshore/offshore service split arrangement.