This article looks at how foreign investors are taxed in the People’s Republic of China (PRC) under the enterprise income tax (EIT), regardless of whether the investor is operating as a wholly foreign-owned enterprise, equity joint venture or legal person cooperative joint venture (collectively foreign-invested enterprises or FIEs).
Taxation of a foreign investor
For purposes of the diagram, it is assumed that the parent company is a company established in South Africa and a nonresident enterprise of China (i.e., its place of effective management is outside China).
Business profits
If the South African parent company has a permanent establishment (PE) in China, all income effectively connected with that PE will be subject to EIT at the standard rate of 25 percent. A PE refers to a fixed place of business in China through which the business of the parent company is wholly or partly carried on. The equivalent concept under the PRC domestic law is “establishment,” as discussed above, but where there is an applicable treaty, such as the China-South Africa treaty in our example, we will use the concept of PE as defined in the relevant treaty. The FIE, as a subsidiary of the parent company, is not considered a PE of the parent company. The parent company will be treated as having a PE in China if it otherwise has a fixed place of business in China, such as an office or a construction site, or if the parent company engages personnel to provide services in China.
A nonresident enterprise with a PE in China is required to maintain accounting books and accurately calculate the profits of the PE, which should reflect the actual functions performed and the risks borne by the PE. However, in practice, it may be difficult for a nonresident enterprise to record and prove the profits of its PE in China. Thus, a nonresident enterprise with a PE in China usually is taxed on a deemed basis, i.e., using expenditure of the PE and a deemed profit rate to calculate the taxable income of the PE. The deemed profit rates prescribed in PRC tax rules vary according to the nature of the business the PE is engaged in. The deemed profit rates are as follows:
• For construction projects, design or consulting services: 15-30 percent;
• For management services: 30-50 percent; and
• For other services and business operations: no less than 15 percent.
If the parent company does not have a PE in China, its business profits will not be subject to EIT in China.
Dividends
Dividends distributed by the FIE to the South African parent company will be subject to income withholding tax in China at a domestic rate of 10 percent, assuming the parent company does not have a PE in China. Under the China-South Africa treaty, the withholding tax rate may be reduced to 5 percent if the parent company is considered the beneficial owner (BO) of the dividends. Under PRC domestic tax rules, a BO means the person who possesses ownership and control over the income or over the property from which such income was generated. The PRC tax authorities generally require a BO to engage in substantive business operations; a mere conduit company will not be considered a BO. If the parent company fails to satisfy the BO criteria, the preferential withholding tax rate will not apply.
Interest
No preferential tax treatment is provided for in the China-South Africa tax treaty in respect of interest. As a result, China’s domestic rate of 10 percent will apply.
Royalties
No preferential tax treatment is provided for in the China-South Africa tax treaty in respect of royalties, except for fees paid for the use of, or the right to use, industrial, commercial or scientific equipment, for which the rate is reduced to 7 percent. To be eligible for this reduced rate, the parent company also must qualify as the BO, as discussed above. The PRC domestic withholding tax rate is 10 percent.
(Our next article will discuss the PRC income taxation of representative offices and partnerships and also give an overview on China’s non-income taxes.)
For further information, contact Kevin Ng (kevng@deloitte.com.cn) and Delia Ndlovu (delndlovu@deloitte.co.za) |