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Tax Aspects of Doing Business In China . TAX. Sou Ho, KPMG LLP 2009 California-China Trade & Investment Conference May 21, 2009.

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Tax Aspects of Doing Business In China

TAX

Sou Ho, KPMG LLP

2009 California-China Trade & Investment Conference

May 21, 2009


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ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.


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Agenda

  • Forms of Foreign Investments in China

  • Permanent Establishment

  • Advantages of Investing via an Intermediate Holding Company

  • Foreign Exchange Control

  • Capitalizing and Financing Operations in China

  • Repatriation of Profits


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Agenda (continued)

  • Transfer Pricing

  • Value Added Tax

  • Customs and Foreign Trade

  • Business Tax

  • Filing Obligations


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Glossary of Terms

  • FE –Foreign Enterprise

  • FIE–Foreign Investment Enterprise

  • RO–Representative Office

  • CIT–Corporate Income Tax

  • IIT –Individual Income Tax

  • WHT –Withholding Tax

  • VAT –Value Added Tax

  • BT –Business Tax


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Forms ofForeign Investments in China


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Forms of Foreign Investments

  • FE without establishment in China

    • Contracting

    • Licensing

    • Sourcing

    • Processing

  • FE with establishment in China

    • RO: no revenue generating activities are allowed to be conducted in China

    • Branch: only allowed to be set up by foreign banks and insurance companies

    • Permanent establishment (PE)

  • FIE

    • Equity joint venture (EJV)

    • Cooperative joint venture (CJV)

    • Wholly foreign owned enterprise (WFOE)


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Foreign Investment Guidelines

  • Foreign investments have been categorized into:

    • Encouraged, permitted, restricted or prohibited categories under the Foreign Investment Industrial Guidance Catalogue (2007)

    • WTO commitment

    • China-HK/Macau Closer Economic Partnership Arrangement (CEPA)

  • Scope of business – authorized


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Other Specific Forms of Foreign Investments

  • Foreign Invested Commercial Enterprise (FICE)

    • Retail, wholesale, franchise

  • Foreign Invested Holding Company (FIHC)

    • Holding company for multiple investments in China

    • High investment threshold

    • A broad range of business activities

  • Foreign Invested Partnership (FIP)

    • Conceptual framework

    • Lack of guidance


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Permanent Establishment (PE)


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Definition of PE

Comparison for select jurisdictions:

1. Under the 2nd Protocol signed between China and Hong Kong, the service period has been changed from 6 months to 183 days from 11 June 2008.


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Tax Implications

  • If a PE:

    • CIT

      • CIT at 25%

      • Actual profit method, or

      • Deemed profit method – 10% to 40% deemed profit rate

    • IIT

      • Progressive rates from 5% to 45%

      • Non-taxable allowances or reimbursements

      • Time apportionment for IIT liability may be available

    • Other taxes

      • BT, Stamp Duty, Import Duties and local surcharges


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Tax Filing and Reporting Requirements

  • Tax registration

    • Registration – within 30 days upon signing the contract

    • Deregistration – within 15 days upon completion of the contract

    • Amendment – within 10 days upon revision to the contract

  • Tax filing

    • Regular monthly or quarterly filing

    • Annual filing

    • Final settlement filing

  • Withholding obligation

    • Payor in China

    • Service recipient in China


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How to Mitigate Tax Impact of PE

  • Avoid PE

    • Limit the presence in China (e.g., furnishing of services aggregating less than 6 months within any 12-month period under the US-China treaty)

    • Limit the activities in China (e.g., qualifies for one of the exceptions provided under Article 5.4 of the US-China treaty)

  • Minimize China-sourced revenue (e.g., split contracts for onshore and offshore services)

  • Negotiate with tax authority for a preferential deemed profit rate

  • Streamline tax compliance process

  • Set up RO or FIE (e.g., WFOE)


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Advantages of Investing viaan Intermediate Holding Company


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Investment Holding Structure

  • Direct investment vs. indirect investment through holding company

Foreign Co

WHT on dividend?

Location of intermediate Holdco

WHT implication on repatriation of dividend to Foreign Co

Flexible exit strategies

WHT on cross-border payment?

Intermediate Holdco

WHT on cross-border payment?

PRC Co


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Taxation of Foreign Investor – Example of Select China DTAs

  • Corporate beneficial owner directly holds at least 25% of the capital of the company, subject to new criteria under Guoshuihan [2009] No. 81

  • Exempt WHT on interest received by government or other recognized authorities

  • Interest derived by banks or other financial institutions

  • Transferor holding less than 25% of shares and the entity being transferred is not land-rich

  • 25% shares should be shares held at any time within 12 months before the transfer (2nd Protocol)

  • Exemption applies irrespective of the assets held by the relevant PRC company


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Substance of Foreign Holding Company

  • General anti-tax avoidance rules, effective from 1 January 2008

  • “Substance-over-form” principle

  • Need substance in the foreign holding company to secure treaty benefits

    • Management

    • Operations

  • Physical presence / activities in China

    • PE concern


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Stricter Requirements forClaiming Treaty Benefit on Dividend

  • Guoshuihan [2009] No. 81, issued on February 20, 2009

  • To claim treaty benefit:

    • General qualification requirements for recipient (beneficial owner)

    • Specific qualification requirements for recipient holding at least 10% or 25% of the equity interest in a PRC company

      • Corporate recipient only

      • Direct ownership

      • 12-month holding period prior to the dividend payment

    • General anti-tax avoidance rules: a transaction or arrangement structured to enjoy treaty benefits

    • Reporting requirements


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Cross-Border Corporate Reorganization

  • New M&A tax rules (Caishui [2009] No. 59)

  • A qualified cross-border corporate reorganization that meets certain post acquisition requirements may elect tax-deferral treatment

  • E.g.,

Post-Reorg

Requirements

Foreign Co

Foreign Co

100% equity;

No boot paid

Foreign Holdco

100%

100% equity

PRC Co

PRC Co


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Foreign Exchange Control


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Foreign Exchange Control

  • State Administration of Foreign Exchange (SAFE)

  • Current account vs. capital account

  • Registration and approval from SAFE may be required

    • Foreign debt (i.e., total investment – registered capital)


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Foreign Exchange Control (continued)

  • Cash repatriation from China

    • Trade item – Customs declaration

    • Non-trade item – Tax clearance and others

  • Strengthening of foreign exchange control

    • Revised Foreign Exchange Administration Measures, effective from 5 August 2008


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Capitalizing and FinancingOperations in China


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Debt-Equity Ratio Requirement

  • Regular FIEs

    • Difference between total investment and registered capital is the maximum amount of foreign currency loan an FIE can borrow from foreign companies/financial institutions

    • Practically difficult to obtain the approval from the authorities to reduce the registered capital of FIEs


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Debt-Equity Ratio Requirement (continued)

  • Conversion of foreign debts to equity

    • Foreign debts must be registered with local SAFE

    • Approval from local SAFE and Ministry of Commerce (MOFCOM) is required, which could be difficult to obtain in practice


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Debt from Related Party

Debt

Direct

Indirect

Other with debt characteristic?

Total: X

Interest Deduction Limitation: Thin Capitalization

Equity financing

  • Registered capital

  • Capital reserve

  • Retained earnings

  • Revenue reserve

    • Total: Y


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Interest Deduction Limitation: Thin Capitalization (continued)

  • Interest is determined in accordance with CIT rules

  • Ratio: X/Y

    • Finance companies: 5:1

    • Others: 2:1

  • Exceptions

    • The transaction is at arm’s length and supported ; or

    • Effective CIT rate of PRC related lender is equal to or less than that of the borrower

  • If debt is in excess of the debt-to-equity safe-harbor ratio, documentations must be prepared

  • Debt to equity calculated based on monthly averages

  • If interest found to be non-arm’s length, treated as dividend distribution (non-deductible)


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Repatriation of Profits


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Fund Repatriation

  • Dividend

  • Service fee

  • Royalty

  • Interest

  • Cost sharing

Foreign

Enterprise/Investor

Dividend

Service provision

Technology transfer / license

Shareholder loan

Cost sharing contribution

PRC Co


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Tax Implications

  • Dividend

    • Pre-January 1, 2008 earnings: 0% WHT from FIEs to foreign shareholders

    • Post-December 31, 2007 earnings: 10% WHT to foreign shareholders

  • Royalty

    • 10% WHT

    • 5% BT, unless qualified for exemption

  • Interest

    • 10% WHT

    • BT effective from January 1, 2009

  • Reduced treaty WHT rate may apply to qualified recipient


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Tax Implications (continued)

  • Service fee

    • BT

      • Pre-January 1, 2009: no BT on fees for offshore services

      • Post-December 31, 2008: BT-able services @ 5% – New!

    • CIT

      • Without PE, no CIT

      • With PE, 25% CIT on deemed profit of PRC sourced services

  • Cost sharing – New guidance!

    • No CIT

    • BT?

  • Qualify for foreign tax credit

    • WHT/CIT: Yes

    • BT (indirect tax): No


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Foreign Exchange Implications

  • Generally subject to review by designated banks

  • Effective from 1 January 2009

    • Remittance of foreign exchange ≤ USD30,000 (previously, USD50,000), tax payment certificate not required

    • Remittance of foreign exchange > USD30,000, tax payment certificate should be submitted to bank

  • Registration requirement

    • Loan agreement for foreign debt

    • Royalty agreement


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Transfer Pricing


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Transfer Pricing

  • Special tax adjustment provision in the CIT Law

  • Chinese tax authorities are strengthening transfer pricing administration by formalizing and regulating transfer pricing analysis

  • Chinese tax authorities will carry out transfer pricing investigation targeting single function manufacturing FIEs

  • Implementation Measures of Special Taxation Adjustments (Trial) – Guoshuifa [2009] No.2

    • Advance pricing arrangement (APA)

    • Contemporaneous documentation

    • Cost sharing arrangement (CSA)


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TP Compliance Requirements

All Taxpayers

Qualified Taxpayers

Related Party Transactions Annual Reporting Forms

Contemporaneous Documentation

IncreasedTransfer PricingCompliance Burden, retroactively applicable to tax year 2008


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Value Added Tax(VAT)


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VAT

  • Taxable activities

    • Sale of tangible moveable goods (including electricity, heating power and gas) in China

    • Provision of processing and repair services in China

    • Importation of goods

  • VAT rates

    • 17% – general taxpayer

    • 13% – for sale and import of certain goods by general taxpayers

    • 0% – for exports (the effective VAT rate on export is not 0% due to the difference between the export refund rate and the VAT rate)


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VAT Reform

  • Revised VAT Provisional and Implementation Rules

    • Effective from January 1, 2009

  • Major changes

    • VAT on fixed assets creditable (Previously capitalized)

    • Abolishment of VAT incentives

  • Other changes

    • VAT levy rate for small-scale VAT payers reduced to 3% (Previously 4% / 6%)

    • VAT filing period extended to 15 days (Previously 7/10 days) after period end


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Customs and Foreign Trade


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Customs Duty

  • Taxable activities

    • Import / export of goods

  • Customs Duty rates

    • Rates on particular types of products determined according to the Customs Import and Export Tariff of the PRC

  • Taxation basis

    • Calculated based on the CIF value of goods or based on quantity

    • Inclusion of royalties?


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Processing Trade

  • Processing trade

    • Contract processing (toll manufacturing)

    • Import processing

  • Must be exported

  • Domestic sale

    • Special approval from the local office of MOFCOM

    • Pay duties and VAT to Customs before sale

    • Interest on deferred import taxes, i.e., Customs Duty and VAT

© 2006 KPMG Huazhen, the China member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in Hong Kong


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Processing Trade (continued)

  • Limitation on processing trade

    • “Prohibited” catalogue of products for processing trade

    • Import deposits on restricted goods under processing trade

  • Use of customs special areas

    • Free Trade Zones (FTZs)

    • Export Processing Zones (EPZs)

    • Bonded Logistic Parks (BLPs)


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Business Tax(BT)


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BT

  • Revised BT Provisional and Implementation Rules

    • Effective January 1, 2009

  • Taxable activities

    • Provision of services (except for processing and repair services) in China or Chinese payor

    • Transfer of intangible assets in China

    • Transfer of immovable properties in China

  • BT rate

    • 3-20% based on industry

    • 5% for most services provided in China


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BT (continued)

  • Taxation basis

    • Generally taxed on gross turnover

  • Filing location

    • Where business establishment is located, excluding construction service provider (Previously where service took place)


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Filing Obligations


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Tax Filings

  • General rule


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Withholding Obligations


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Statute of Limitations


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Liability

  • Administrative

    • Late payment surcharge of 0.05% per day for taxes overdue

    • Penalty ranging from 50% - 500% of the unpaid or underpaid tax liability

    • Penalty ranging from 50% - 300% for failure to withhold amount that should have been withheld or collected

  • Criminal – tax evasion

    • Imprisonment

    • Fine


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Suggestions under the rapidly changingtax legislation and compliance environment

  • Tax compliance is becoming more complicated and requires more information/disclosures

  • The new set of annual CIT returns can be challenging

  • Need to have tax specialists responsible for the preparation and submission of applicable monthly / quarterly and annual tax returns

  • Need to monitor latest local requirements (including unwritten rules) as local tax authorities may have special compliance requirements that can be more burdensome than those required by the state-level laws and regulations

  • Timely seeking professional assistance whenever needed to foster compliance


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Sou K. Ho

Partner

KPMG LLP

(650) 404 4825

[email protected]

www.kpmg.com

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