Businesses face taxing issues
Overseas and Hong Kong enterprises with mainland operations, such as representative offices and foreign partnerships, are subject to various taxes.
The tax liability of branch offices or subsidiaries on the mainland, set up by Hong Kong-based corporations, varies according to the business, says Clement Yuen, China south, tax leader at Ernst & Young. 'Only financial institutions, such as banks, and companies specialising in petroleum exploration are allowed to open branch offices in China,' he says. 'The others can set up operations such as subsidiaries [considered separate legal entities] and representative offices. The latter has limited operational scope, except for law firms.
'The representative offices opened by law firms are allowed to engage in profit-making business activities and regarded as branch offices on the mainland.'
Subsidiaries and branch offices of Hong Kong-based companies are required to keep full sets of accounting records. They need to pay the 25 per cent enterprise income tax and turnover tax, such as business tax for services rendered or value added tax for sales of products, Yuen adds.
'Their employees in China are subject to the individual income tax. These local branches and subsidiaries also need to pay local levies.'
Christopher Xing, principal, tax, at KPMG China, says that under the mainland's Individual Income Tax (IIT) regulations and the Hong Kong-mainland Double Tax Arrangement (DTA), where the HK secondees do not qualify for the DTA IIT exemptions, a mainland entity to which HK employees are seconded has IIT withholding and reporting obligations with respect to the secondees. The secondees may also be required to file IIT returns.
Under revised taxation policy, companies are required to pay tax for their representative offices on the mainland. 'Representative offices opened by Hong Kong companies have tax liabilities, even though they might have been established solely for liaison purposes. Under the Double Taxation Treaty between Hong Kong and the mainland, companies may apply for tax exemption for their representative offices mainly performing preparatory or auxiliary functions. Successful applications are rare,' Yuen says.
Anthea Wong, a partner of tax and China business advisory services at PricewaterhouseCoopers, says representative offices on the mainland now pay the 'expense-plus tax' which is calculated based on the deemed profit tax rate of no less than 15 per cent. 'In the past Hong Kong companies opened representative offices on the mainland because they had the least administrative burden. Now, they need to consider if representative offices are the most tax-efficient mode of operation. Because the operation of representative offices has a lot of restrictions, enterprises should see whether representative offices are the most suitable option for their long-term business development.'
Foreign-invested subsidiaries, that include wholly foreign-owned enterprises, equity joint ventures and co-operative joint ventures, have more flexibility than representative offices because companies can apply to expand the scope of operation, Wong says.
The mainland imposes withholding tax on mainland-sourced dividends, interest, royalty and gains on transfer of assets received by a non-resident, according to Joyce Leung, tax director at Deloitte China. 'The current withholding tax rate is 10 per cent unless reduced by a double tax treaty,' she says.
From last month, foreign enterprises may choose to form 'foreign partnerships' on the mainland with Chinese residents, foreign individuals or an enterprise under the Foreign Partnership Measures promulgated by the State Council. A partnership only requires business registration, while the application to establish a foreign-invested enterprise requires vetting and approval by government departments.
The mainland does not have comprehensive partnership taxation rules or foreign partnership tax rules. 'Individual and corporate partners are subject to Individual Income Tax and Enterprise Income Tax, respectively, on income from the Chinese partnership in which they are partners, i.e. the partners instead of the partnership would be subject to China taxes on the partnership income they have earned,' Leung says. 'While such a flow-through tax treatment appears to present a significant benefit to set up a foreign partnership, tax related uncertainties and issues remain. There is no guidance on how a foreign enterprise that is a partner should compute the tax and whether the after-tax profits would be subject to tax when the funds exit China.'
It is unclear whether the undistributed after-tax profits will be added to the basis of the partnership interest when working out any gain or loss on the sale when a foreign partner sells its partnership interest, Leung adds. 'It is not certain if a foreign partnership is allowed to make investments, whether the permanent establishment issues will arise for the foreign partners as a result of these investment activities in China.'
Also of concern to companies in Hong Kong is the taxation concept of a virtual permanent establishment under the Double Taxation Treaty. Companies considered to have permanent establishments on the mainland need to pay the Enterprise Income Tax and the Turnover Tax, Wong says.
The definition of permanent establishment has three features. 'It can be a fixed place of business which carries out parts or all business activities of a Hong Kong enterprise.
Or it can be defined as a service permanent establishment such as a Hong Kong employee of a local company who travels to the mainland and carries out business activities on behalf of his employer for more than 183 days within a 12-month period. The third one is dependent agent permanent establishment. Say for example a Hong Kong corporation renders its services or signs contracts in China through an agent.'