By Jack Grocott
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Circular 18 is just the starting point for foreign companies looking to invest in China |
Foreign investors with representative offices in China need to establish whether they are entitled to a tax exemption under new rules released by the country's tax authorities.
The State Administration of Taxation (SAT) unveiled the changes in circular 18, clarifying and updating the taxation policies for representative offices (ROs) in China.
The circular, which applies retroactively from January 1 2010, abolishes previous guidance governing ROs and sets out the method requirements for calculating tax and the tax filing procedures applicable to ROs.
ROs in China are seen as an initial step for foreign companies wishing to invest in and experience the local market.
Previous regulations stipulated that ROs that carried out market research, provided market information, and other preparatory and auxiliary activities in China for purposes of the manufacturing or sale of the products of their head offices were not subject to corporate tax.
"The circular represents a fundamental shift in tax liability for ROs in China and, as such, all ROs need to determine how it affects them and impacts upon their profitability," said Matthew McKee of Hwuason, a tax law firm.
In contrast, circular 18 only allows an RO to apply for a corporate tax exemption if there is a relevant tax treaty or arrangement.
"Practically speaking, it is a formidable challenge to prove to the satisfaction of the tax authorities that the activities carried out by an RO are only preparatory and auxiliary in accordance with a tax treaty or arrangement," said Kevin Ng, a managing partner at Deloitte.
The rules also state that an RO engaged in activities subject to VAT must file a VAT return. However, since ROs usually do not have the capacity to engage in trading activities, it is expected further clarification on this will be released by the SAT.
"The change is very new, and communication is of utmost importance," said a news alert from PricewaterhouseCoopers. "ROs should inform their overseas head offices about the changes and solicit support to improve their accounting books and records."
Circular 18 also increases a ROs deemed profit rate from 10% to 15%.
"ROs that believe they are entitled to an exemption should apply for approval as soon as possible. Where an RO does not meet the new requirements for exemption, converting the RO to a wholly foreign-owned company may be an alternative," said Ng.
