Above-the-line distributions are expenses charged to China operations, usually by the foreign parent directly, and thus are legitimate fees for which an invoice is presented to the China business as part of its normal operational procedure.
These can include: royalty charges for trademarks or patents owned by the parent; ?foreign management expertise,? full expenses and pay for any head of office or overseas personnel visiting China, even if just for a short period; and royalty fees for technology transfers interest on loans, including penalties for late payment.
Above-the-line distributions need to be agreed upon and identified in the articles prior to submission to the authorities for approval of an operation?s business license. When levying such charges onto a China business, it is important to be aware that such payments are subject to Chinese tax (amounts vary depending upon the service), prior to the China entity being able to remit back to the foreign parent. But even accounting for this, the amount of money able to be remitted back to the parent pre-tax can be quite significant with careful preparation and planning.
Repatriation and Maximization of Profits in China(0)
When setting up in China, foreign investors are confronted with a myriad of complex issues, from local
The following article will present some issues to consider when preparing to repatriate profits out of China, as well as the way withholding and business taxes affect an enterprise in China. Understanding the processes and having proper structures in place from the beginning can vastly improve an enterprises ability to maximize and repatriate profits.
Transfer Pricing Audits and Enforcement(0)
[ By Steven Carey, Transfer Pricing Associates ]
Most of the audits conducted to date have focused on tangible good transactions, in particular those relating to contract manufacturing. Intangible transactions have not been a major area of focus for the tax authorities, until recently. However, the SAT has recently commenced a nation-wide tax audit exercise focusing primarily on royalty payments made by Chinese companies to overseas affiliates. These companies are generally from retailing and consumption goods and services industries.
In recent years, the SAT has adopted a national audit approach, whereby the authorities seek to audit MNCs with a number of subsidiaries with operations across different provinces in China. Such national audits concentrate on both cross border transactions and intra-China related party transactions.
With the release of Circular 363, many companies in a number of provinces and municipalities such as Beijing and Tianjin have received inquiries on transfer pricing matters from local tax bureaus. Furthermore, the Beijing State Tax Bureau has recently issued notices requesting detailed information on related party transactions to over 400 FIEs that are required to respond to the notice with the required information within ten days of receipt of the notice, otherwise a
In future, transfer pricing audits will become more rigorous as the Chinese tax authorities have been strengthening their administrative ability in tax collection, by using a greater degree of computerization in tax administration, the establishment of a rigorous tax inspection system and formalized tax legislation procedures for dealing with transfer pricing manipulation. As the volume of MNCs doing business in China continues to grow, and the Chinese government continues to draw on the experience of the developed economies in enforcing its own transfer pricing rules, it can be anticipated that the tax authorities in China will intensify their investigations of related party transactions over time to prevent the loss of future income.
The SAT has provided a very transparent list of audit targets to the local tax authorities, which has been evolving over the last few years. Local tax bureaus have been instructed to select the following key targets for transfer pricing investigation and audit:
The final category appears to be a catch-all provision to pick up any other transactions that are not caught within the specific criteria above. In addition to the above guidelines, contract manufacturers have particularly come under scrutiny.
As a response to the fact that a large proportion of contract manufacturers have been reporting losses despite having a limited function and risk profile, the SAT has identified such companies as specific audit targets. Entities with the following characteristics are being and will continue to be targeted:
There is an expectation that such entities earn a consistent (but potentially relatively low) level of profitability and are not subject to market or capacity risks. If this is not the case they are very likely to come under scrutiny from tax authorities.
Transfer Pricing Risk Management(0)
[ By Steven Carey, Transfer Pricing Associates ]
In Box 1, lack of clarity of the business model creates misalignment between business reality and the transfer pricing system, which can mean entities are remunerated in a manner inconsistent with their function and risk profile. For example, not clearly defining roles and responsibilities and remunerating a sales agent on a cost plus basis will not be consistent with the commercial objective of maximizing sales. In such case, a commission based transfer pricing model may be more appropriate.
The risk inherent in Box 2 is that economic, legal and this can give rise to is permanent establishment risk if, for example, the sales staff are negotiating, concluding and signing contracts on behalf of an entity resident in another jurisdiction and this is not consistent with the operational or economic allocation of functions, risks and profits between those entities.
Box 3 risks are well documented and understood, consisting of penalties for not complying with transfer pricing compliance obligations.
Box 4 refers to the risk of facing a transfer pricing investigation or audit. This is obviously very disruptive to an entity, in addition to the potential penalties and interest if the audit results in a transfer pricing adjustment.
Transfer Pricing Audits and Enforcement
Transfer Pricing in China(0)
Transfer pricing is a reality for any multinational company. Tax authorities need to protect their revenue base and are actively enforcing the arm?s length principle for pricing of intragroup transactions. This means that detailed transfer pricing documentation is required and that companies need to disclose related party information on tax returns, as well as prepare themselves for possible audits.
If designed and implemented early in a business life, a transfer pricing system can complement and support an MNC?s business model and commercial objectives, as well as optimizing its global effective tax rate.
Recent developments in China, including the release of comprehensive transfer pricing regulations in early 2009, have sent a very clear signal that the mainland is no exception to this rule.
This and the following articles explore transfer pricing, providing some practical guidance on how to document related party transactions, how to manage overall transfer pricing risk and how to defend a company’s position in the event of a government audit.
Transfer pricing concerns the prices charged between associated enterprises established in different tax jurisdictions for their intercompany transactions.
Multinational enterprises are growing in number and complexity and are increasingly integrating their operations globally. As a result, they transfer large quantities of goods and services among operating subsidiaries in different countries as well as engage in a range of transactions relating to services, intangible property and financing activities.
The pricing system for such transfers across borders within multinationals creates considerable managerial and tax problems owing to its direct effects on the profits of both parties and the taxable revenue of all countries involved in the transactions.
The diagram above gives an overview of the types of activities and the corresponding inter-company transaction that will be caught within the definition of transfer pricing.
Transfer Pricing Risk Management
China vat rates calculation(0)
VAT is the major source of fiscal revenue for the government of China, particularly the central government. In 2007, the revenue from VAT amounted to RMB15.47 billion, accounting for 33.9 percent of China?s total tax revenue for the year ? it accounted for the largest percentage of the China?s annual tax revenues.
The Chinese government rules that all enterprises and individuals engaged in the sale of goods, provision of processing, repairs and replacement services, and import of goods within China shall pay VAT. There are a few exemptions, such as self-produced agricultural products sold by agricultural producers, contraceptive medicines and devices, antique books, importation of instruments and equipment directly used in scientific research, experiment and education, importation of materials and equipment from foreign governments and international organizations as assistance free of charge, articles imported directly by the organizations of the disabled for special use by the disabled, and sale of goods which have been used by the sellers. However, pretty much every business will be liable for this tax.
The VAT rate for general taxpayers is generally 17 percent, or 13 percent for some goods (see table below). For taxpayers who deal in goods or provide taxable services with different tax rates, the sale amounts for the different tax rates shall be accounted for separately. If this is not done, the higher tax rate shall apply.
China VAT calculation for general taxpayers
The VAT payable shall be the balance of output tax for the period, after deducting the input tax for the period. The formula required:
VAT Payable = Output VAT ? Input VAT
Output VAT is calculated based on the value of the taxpayer?s sales, namely
A general taxpayer will usually purchase goods or receive taxable labor services during the course of doing business. The VAT paid by the general taxpayer is Input VAT. The Input VAT is used as a credit against the output tax levied on selling the goods.
China?s value-added taxes contribute a large percentage of China?s annual tax revenue and account for a significant proportion of tax liabilities for many Chinese enterprises. They affect companies that sell, manufacture, process or repair tangible goods in China and can be quite complex. In 2003, China began a massive reformation of its VAT system, launching pilot programs in Northeast China. Following the program?s success in the provinces of Heilongjiang, Jilin, and Liaoning, the central government implemented the VAT reforms nationally in 2009.
China started to implement VAT in 1984 on 24 specified taxable items and on December 13, 1993, the State Council promulgated “The Provisional Regulation of the People’s Republic of China on Value Added Tax” with the intent of ?unifying taxation management, equalizing the tax burden, simplifying the tax system, and guaranteeing financial revenue.? This law, which codified China?s VAT system, has been in use ever since.
In 2004, China introduced VAT reforms in the provinces of Heilongjiang, Jilin and Liaoning in an effort to revitalize the old industrial base of Northeast China. The method of ?increment deduction? was adopted and the scope of the reform confined to eight industries: equipment manufacturing, petrochemical, metallurgy, automobile, shipbuilding, new- and high-tech industries, and agricultural products processing. Following the success of the pilot reform in the Northeast, it was extended in 2007 to 26 old industrial base cities in the Central Chinese provinces of Henan, Hunan, Hubei, Shanxi, Anhui and Jiangxi. In the second half of 2008, five areas of eastern Inner Mongolia and the earthquake devastated region of Wenchuan in Sichuan Province were also designated as VAT reform pilot areas.
China?s move from a production?based VAT system to a consumption-based one began in earnest in 2009 when the government implemented VAT reform nationwide. With the exception of specific industries that the state has mandated are to be restricted, all industries in China now fall under the VAT reform system and companies are able to offset the full amount of input VAT paid on newly purchased machinery and equipment against VAT collected when they sell their products.
Infrastructure in China(0)
With inflation no longer a concern, both the central and provincial governments have a large volume of shovel-ready projects already on the books, and a significant portion of the RMB4 trillion stimulus package is going to the projects that were already slated for government funding.
For example, in 2008 the Ministry of Railways had originally planned to invest RMB300 billion in basic construction projects. However, Ministry of Railways Director Zhang Zhongmin told China Business News that in order to stimulate internal demand, the railway decided to add another RMB50 billion in 2008. In 2009, the ministry has nearly doubled its expected investment, allocating RMB600 billion for basic rail construction.
Future railway development will focus mainly on the construction of passenger and regional express rail lines and the reinforcement of heavily used main corridors such as the Beijing-Guangzhou, Beijing-Harbin and Beijing-Shanghai lines.
Director Yang has said the passenger lines between Beijing and the cities of Harbin, Shanghai and Guangzhou, and lines in the South China will be finished in three to five years and will constitute ?China?s express network,? connecting 70 percent of all Chinese cities with a population greater than half a million.
China?s investment in transport infrastructure has also halted declines in cargo traffic in the Yangtze River Delta. Cargonews Asia reported that the major ports along the Yangtze trunkline reported a year-on-year cargo throughput increase of 5.7 percent in January, the first monthly rise since August of 2008. Container throughput increased 19.6 percent to 550,000 TEUs, compared with 8 percent in November and 14 percent in December. According to the report, higher levels of government spending to construct railways, roads, bridge and subways are driving the demand for imported iron ore and steel, two major commodities shipped down the Yangtze.
China imported 443.7 million tons of iron ore in 2008, and that number is expected to increase as infrastructure construction ramps up. In late February, Australia’s third-biggest iron-ore miner, Fortescue Metals Group Ltd, agreed to quadruple its iron ore sales to Xiangtan Steel, an arm of Chinese steel maker Hunan Valin Iron and Steel Group. Fortescue said that, subject to production expansions, it would increase its supply to up to 4 million tons a year from 2010 onwards, up from the current 1 million tons a year.
The cooling Chinese economy, which saw growth slow to 9 percent in 2008 (down from 13 percent in 2007), is having a profound effect on the country. Millions of migrant laborers are losing their jobs and domestic stocks are on a roller coaster. As consumer demand for Chinese products dropped worldwide and factories all over South China began to close, Beijing became increasingly concerned with the economic and social stability of the country. In a move to boost the economy in the short term while providing for stable long-term economic development, the State Council, the governments highest executive body, announced a massive RMB4 trillion capital stimulus package on November 9, 2008.
While many details of the plan have yet to be publically disclosed, the National Development and Reform Commission, China?s macroeconomic management agency, did indicate where the bulk of the money will go ? towards infrastructure projects. The plan: RMB1.8 trillion is to be used for construction projects including railways, highways, airports and electrical grids; RMB1 trillion will go towards rehabilitating areas devastated by the Sichuan earthquake; RMB370 billion will be directed specifically to rural areas; RMB350 billion will go to the environment; RMB280 billion to prop up the housing market; RMB160 billion for independent innovation; and RMB40 billion for health care and education.
Global economic crisis(0)
With many businesses facing economic problems, the legal focus of business in China is shifting to an understanding of the implications of the new labor law, and specifically, its provisions for the reduction of staff salaries.
The Labor Contract Law is not specific on the reductions of salaries due to economic conditions. However, Article 41 of the law recognizes the reality of ?serious difficulties in production and/or business operations? in the context of terminating staff. When it comes to being faced with the choice of either terminating employment contracts, or reducing salaries, local governments in China are keen to see the staff retained. The Chinese government?s overriding concern is maintaining social stability ahead of economic concerns. Salary reduction is an alternative that both government and employer can agree upon rather than face stiff compensation penalties for terminating staff contracts.
The procedure, however, is not just a matter of agreement between the employer and employee and an amendment to the contract. While not specifically mentioned in China?s labor law, businesses are encouraged to ?consider the opinion? of the labor union and the relevant local labor administration bureau. In practice this means that a report, outlining the economic situation of the business, together with the required contingency plan over salary reductions, needs to be filed with, and agreed by both bodies. In fact, when faced with an economically bleak picture, the labor union may be able to help the company manage the transition. The approval of the Labor Union and the local labor authority will allow amendments to employment contracts to be made, then agreed upon.
China does see certain criteria as being important when it comes to the health of businesses. Key among these are maintaining profitability, employee retention and business sustainability. Businesses in China with a track record of success yet facing difficulties in maintaining salary levels would be well advised to enter into discussions with the labor union or the local labor authority and work with them to reach an effective compromise in staff retention.
The author is the Senior Partner of Dezan Shira & Associates. Companies requiring legal opinion on salary reductions in China may contact Marie Bi, Legal Counsel, Dezan Shira & Associates at firstname.lastname@example.org.
Liquidating a China business