Chinese Business Tax Regulations
The new Business Tax (“BT”) regulations took effect on January 1, 2009. The new tax significantly increases the tax liability for foreign service providers that provide services to Chinese clients. Here is a brief introduction to the new rules and how they may affect your business.
BT is a type of turnover tax, which is imposed on the provision of services and the transfer of intangibles and immovable properties within the territory of China. The business tax rates vary from 3 to 20 percent based on the type of services provided. For most services the tax is 5 percent of gross service fees.
Taxable services refer to the following business activities: Communication, transportation, construction, financial and insurance, postal and telecommunications, cultural and sports, entertainment and other service industries, which include: engineering, accounting, and legal services. However, the BT does not cover processing, repair, and replacement of parts; these activities are subject to the Value Added Tax (“VAT”).
Under the old rules, service providers were only subject to BT in China if the taxable service was rendered within China. Thus, when a U.S. Company provides service to Chinese clients and such services are conducted in the U.S., they would not be subject to BT in China. However, under the new rules, the definition of taxable services subject to BT has been expanded to include services performed outside of China if the service recipient is located in China. Therefore, if the service provider or the service recipient is located in China, the service will be taxable for BT purposes, regardless of where the service is performed.
For example, U.S. Company A, located in Michigan, provides product design services to US Company B’s subsidiary in China. The contract value was $50,000 and the service term was two months. All the information necessary to complete the work was provided by Company B, therefore Company A can finish the work without sending their staff to China. All work was done at Company A’s Michigan office. Under the old rules (prior to January 1, 2009), the design services provided from outside China to recipients in China were not subject to the BT. Company A receives the entire $50,000 paid by Company B’s Chinese subsidiary. However, under the new rules, Company A will be subject to the 5 percent BT because the service recipient was in China. As a result, $2,500 BT would be paid in China ($50,000 * 5%), and Company A would receive $47,500 as its net revenue.
You may question: how would Company A pay its tax assuming Company A has no appointed agency in China? Company B’s China subsidiary would be responsible for withholding the BT.
Another significant change is the impact on taxable income derived from mixed sales activities. Mixed sales activities refer to activities in which income may be subject in part to both BT and VAT. Under the new rule, if income is subject to BT or VAT, it should be properly recorded separately. Otherwise, the allocation of income that is chargeable to BT and VAT will be determined by the tax authorities.
For example, a U.S. company enters into a contract to sell manufacturing equipment to a Chinese customer. The U.S. Company will also provide installation services. In this case, the installation service revenue is subject to BT. The U.S. Company will be the taxpayer, and the Chinese customer will be the withholding agent. In contrast, the Chinese customer is the VAT payer on the purchase price of the equipment. Therefore, the values of the equipment and installation services need to be separately stated in the contract.
In practice, a U.S. Company may face some challenges when negotiating price with its Chinese customer on separating the value of the equipment and the installation service fee. The U.S. Company will pay less BT with a higher equipment value, but that will result in the Chinese customer paying higher VAT tax.