Cash flow is important when operating or investing in a business. Investors care not only how much profit they can obtain from an investment, but also the amount of time it takes to repatriate the profit, especially when the investment is in a foreign country.
China’s strict foreign exchange control has been a common concern among many foreign investors. Understanding the common ways to repatriate profits from China and the pros and cons of each method will help foreign investors bring profits back to their home countries and avoid unpleasant surprises.
This is the most legit and common way to distribute profits. However, it is subject to various prerequisites and not all profits can be repatriated. The following conditions must be met for a foreign subsidiary in China to pay dividends to its parent company:
- The registered capital has been funded in a timely manner under the company’s Article of Association.
- The 25% corporate income tax has been paid on its earnings and any pending income tax liabilities must be settled.
- A company can only distribute dividends out of its accumulated profits. If there is an accumulated loss carried forward from a prior year, it must be settled.
- It must have an external annual audit done by a Chinese accounting firm.
- A wholly foreign-owned enterprise (WFOE) also has to place at least 10% of its annual after-tax profits in a reserve fund until it reaches 50% of the registered capital.
- Finally, a 10% withholding tax is generally applied to a dividend distribution to a foreign investor. However, if the foreign investor is a qualified beneficial owner of a tax treaty between the foreign investor’s native country and China, the withholding tax rate could be lowered by the tax treaty.
In China, the State Administration of Foreign Exchange (SAFE) administers China’s foreign exchange control regulations and supervises the movement of funds in and out of China. To make the administration of foreign exchange capital translations more efficient, SAFE has delegated many of its review and approval powers to the banks, such as profit distribution. Banks require specific documents from the Chinese subsidiary to process dividend payments, including but not limited to business license, annual external financial statement audit report, audit report of paid-in capital, a board resolution on the dividend payment, certificate of tax filing and tax payment receipt.
Royalty or Service Fee Payment
Compared to dividend distribution, intercompany payment (i.e., royalty or service fee) has fewer prerequisites and is another common way for multinational companies to repatriate profits. However, transfer pricing can become an issue here. It generally bears more risk for a tax audit since related party transactions are strictly regulated and the pricing is required to be arm’s length. Contracts and invoices between the parties, and maintaining the detailed transaction documents are important to demonstrate the legitimacy of the transaction in case it is challenged. Withholding tax and Value Added Tax (VAT) are generally applicable to the royalty or service fee payments to a foreign person.
Loans to the Foreign Parent
The Chinese subsidiary may also make funds to the foreign parent through a loan arrangement. This would be temporary repatriation since the loan is expected to be paid back to the Chinese subsidiary within five years and interest is required to be charged at an arm’s length rate. Some prerequisites need to be met: the borrower and lender need to have an equity relationship; the Chinese entity must be established for one year before it can make loans; both the Chinese entity and foreign parent must have a good record in complying with the foreign exchange rules and a case-by-case SAFE examination and approval are required if the lending amount exceeds 30% of the owner’s equity.
Companies may use a combination of different methods to reach their goal of profit repatriation. Planning early will help companies develop strategies to meet their specific needs. For additional advice on profit repatriation or global structural tax planning, please reach out today.