All material subject to strictly enforced copyright laws. © 2022 ITR is part of the Euromoney Institutional Investor PLC group.

Two tax enforcement cases highlight PE risk in China

Sponsored by

sponsored-firms-kpmg.png
literature-3091212-1920.jpg

Lewis Lu of KPMG China looks at two case studies of how the Chinese tax authorities have interpreted permanent establishment rules strictly.

COVID-19 has resulted in severe travel restrictions being imposed by countries around the world. For businesses, this has led to a situation where many staff, including key executives and technical personnel, have been ‘stranded’ in various countries.

This has created a series of potential tax risks, notably in relation to permanent establishments (PE). While several countries have set out guidance for the COVID-19 disruption period, by granting a more lenient PE interpretation to foreign enterprises whose staff are compelled by circumstances to stay for an extended period in those countries, China has not done so to-date. It is against this backdrop that a book just published in March by the Chinese State Taxation Administration (STA), which includes details of cases on PE interpretation, which may be of special interest.



In the book, the STA collates a large number of cross-border tax enforcement cases, handled by local tax bureaus (TBs). For each one, the STA sets out their thinking on why the manner in which the case was handled and the rules applied, were appropriate. Very few tax cases make it to court in China, meaning there is little precedent, and the meaning of many China international tax and treaty rules is ambiguous. As such, the positions set out in these cases may be very useful for taxpayers in assessing their positions and risks and in dealing with local TBs.



Case studies 



Among the cases are two concerning foreign companies – one German, one Japanese – which dispatched staff to China to provide technical support in relation to the installation of factory equipment. Both companies sought to manage their PE risks by the time-worn expedient of keeping individual staff present in China under 183 days within a 12 month period, i.e. the threshold for service PE and construction PE in most Chinese treaties. 



The TBs, however, pointed to the interconnected nature of the activities conducted by the various staff and aggregated their presences to exceed the 183 day threshold and assert the existence of China PEs. Part of the salaries of the dispatched foreign staff, while paid overseas, were consequently treated as China sourced and subject to China individual income tax (IIT). With the inclusion of these cases in the book, the STA is giving notice to foreign enterprises to consider carefully their China PE positions.



In the case of the German auto company, 1000 staff members had come to China over a period of six years, in ten separate batches, under ten separate contracts. Of key importance was that all the contracts related to work on the same engine production line at the Germany company’s China joint venture, with each separate contract being the next step of the production line setup process, and all staff coming from the same technical department in the German company. The TB saw this as basis to treat all the contracts as interlinked and push the service PE assertion.



In the case of the Japanese company, which was engaged in a much smaller project, 15 staff came to China over a two year period. A Chinese customer had purchased several pieces of equipment from the Japanese company under separate contracts, and then received installation support services from the same company under another series of contracts. The TB pushed for the service contracts to be considered together as they all related to the installation of all the pieces of equipment in the same workshop. As all of the pieces of equipment had to be set up together to be of use in manufacturing, so equally, all the related installation technical service agreements should be considered interconnected. 



This addressed the PE time test, but a further issue arose in relation to the application of a special provision in the China-Japan treaty, which excludes consultancy services provided in connection with the sale or lease of machinery or equipment from PE exposure. On this, the TB asserted that the Japanese company’s staff did more than just provide consulting advice to the Chinese customer’s staff on installing the equipment; they effectively took charge of the installation process. As such, the exclusion did not apply, a PE existed, and the salaries of the dispatched Japanese staff were subject to China IIT. 



Future interpretation



The STA’s inclusion of these cases in their book informs foreign enterprises of the need to take greater care with PE risks in China, and not automatically assume that individual staff presences of less than 183 days are immune from tax risk. The Chinese tax authorities can look to review in detail the substance of the entire commercial arrangement. 



However, by the same token, there is reason to believe that where a foreign enterprise, due to COVID-19 disruption, ends up with staff being stranded for a prolonged period in China, then the STA may give a hearing based on the substantive intent of the arrangements. 



Lewis Lu

T: +86 21 2212 3421

E: lewis.lu@kpmg.com





more across site & bottom lb ros

More from across our site

Energy ministers agreed on regulations including a windfall tax on fossil fuel companies to address high gas prices at an extraordinary Council meeting on September 30.
The European Parliament raises concerns over unanimity in voting on pillar two, while protests break out over tax reform in Colombia.
Ramesh Khaitan speaks to reporter Siqalane Taho about tax morality, transfer pricing regulations, Indian tax developments, and the OECD’s two-pillar solution.
Join ITR and KPMG China at 10am BST on October 19 as they discuss the personal, employment, and corporate tax-related implications of employees working from overseas.
Tricentis and Boehringer Ingelheim, along with a European Commission TP specialist, criticised the complexity of pillar one rules and their scope at an ITR event.
Speakers at ITR’s Managing Tax Disputes Summit said taxpayers can still face lengthy TP audits, despite strong documentation preparation
Gig economy companies in New Zealand will need to fully account and become liable for the goods and services tax of underlying suppliers on their platforms, under new proposals.
Join ITR and Thomson Reuters at 2pm (UAE) / 11am (UK) on October 13 as they discuss how businesses can prepare for Tax Administration 3.0 and future-proof against changes such as e-invoicing and increasing digitisation.
ITR has partnered with global TP leaders from Deloitte to discuss transfer pricing controversy around the globe, and to share advice on how to navigate an increasingly uncertain and risky TP landscape.
Sources say they are not satisfied with pillar one protections in the marketing and distribution safe harbour, even though it was designed to give businesses greater tax certainty.
We use cookies to provide a personalized site experience.
By continuing to use & browse the site you agree to our Privacy Policy.
I agree