In view of the stricter administration of ROs, the limited business scope, and the increased tax costs brought about, foreign investors may need to revisit their strategies in China.
Representative Offices (“RO”) have been a popular form of business utilized by foreign investors entering the Chinese market. ROs were well known as having a simple registration process: no capital registration requirement, less stringent business regulatory requirements, relatively low tax costs, non-complex tax compliance, and easier exit procedures.
Effective January 1, 2010, new tax measures were released by the State Tax Administration and are significantly different than the previous tax rules. In addition, the State Administration of Industry and Commerce and the Ministry of Public Security jointly issued a notice around the same time to govern the procedures for the set up and on-going supervision of ROs.
Below are some of the major changes in relation to the new rules on RO taxation and administration.
Taxable income of an RO is subject to Corporate Income Tax (“CIT”), Business Tax (“BT”), or Value Added Tax (“VAT”). Under the old rule, how an RO would pay tax was determined by the industry the RO’s head office belonged to. Under the new measures, ROs are required to keep proper accounting records to ascertain the actual revenue/profit and file their tax return in the same method. The reported profit should be commensurate with the function and risk undertaken by the RO. In other words, the RO should determine and record fair market value of the services provided to its immediate head office or affiliates. As a result, ROs are required to file tax returns based on “actual basis”; it appears the tax authority in China has a presumption that ROs are set up with the objective of carrying on taxable activities in China and should have proper accounting records to determine the actual revenue and profits for their business purpose.
Under the new rule, only when the in-charge tax bureau examines an RO and agrees an RO has failed to maintain accurate accounting records, or the RO is unable to file their tax liabilities on an actual basis, would the in-charge tax bureau agree to allow the RO to use the deeming method. The deeming method includes the cost-plus and actual revenue deemed profit methods. (Existing ROs typically utilize the cost-plus method.) ROs utilizing the deeming method will face a heavier tax burden because the deemed profit rate is a minimum 15% (an increase from 10%). It should be noted the new deemed profit rate of 15% is not simply a fixed rate, but a minimum. The local tax authority could determine a profit rate higher than 15%.
The new tax measures have invalidated previous tax circulars governing various taxation treatments for ROs. Specifically, ROs will not be tax exempt unless they are under treaty treatment protection. Under the new law, if the RO only carries on exempted activities per the applied tax treaty, the foreign enterprise which set up the RO would not be considered to have a permanent establishment in China and should not be subject to CIT in respect of the activities of the RO. However, the applied ROs are required to follow the relevant procedures under Circular 124 in claiming treaty benefits.
In January 2010, the State Administration of Industry and Commerce and the Ministry of Public Security jointly issued a notice to govern the procedures to set-up the RO and on-going supervision. Comprised with rules from before, the main changes are summarized as follows:
- The immediate head office of the RO must have been established for at least two years before the application
- The validity period of the Registration Certificate for the RO is only one year; it subject to annual renewal
- The maximum number of representatives in an RO is four, including the chief representative
These new rules will have a significant impact to ROs in China, and may put ROs in a very difficult position from a tax and administration angle. On one hand, ROs are not allowed to carry on income-generating business as restricted by the Chinese business registration regulations and can only carry out coordination and liaison activities for their overseas head offices. While, on the other hand, the Chinese taxation rules treat them as carrying on income-generating business and ask them to pay tax accordingly.
The changes are very new, and further clarification is expected. We will continue to monitor any relevant developments and share updates as they occur.