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.
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.
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.
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