This article was first published in Nexia Global Insights, August 2019.
Foreign companies are increasingly finding a market for their services in the economic powerhouse of China, but care is required to avoid being inadvertently caught in a tax trap.
China currently has Double Taxation Avoidance Treaties (DTATs) with more than 100 other countries, which is good news for firms that want to do business there.
In theory, companies in countries that have a DTAT with China can conduct cross-border service transactions in China without having their business profits taxed.
However, to benefit from this, the foreign company – known as a non-resident service provider (NRSP) – must not create a permanent establishment in China. While there are some differences from treaty to treaty, a permanent establishment is created if the NRSP’s employees or dedicated agents carry out activities for six months or longer within any 12-month period.
Armed only with the limited definitions contained in treaties, NRSPs doing business in China are often surprised when Chinese corporate income taxes are withheld by the recipients upon payment.
China’s tax rules mandate that DTAT benefits do not automatically apply. Whether submitted by the service recipient or a representative of the NRSP, an application for DTAT benefits, including evidence that no permanent establishment has been created, must be submitted to, and approved by, the tax authorities at the recipient’s location.
So, given that official interpretations of what constitutes a permanent establishment are not included in the DTATs themselves, how are such unwelcome surprises best avoided?
Savvy NRSPs need to include service contract clauses requiring the recipient to submit applications on the NRSP’s behalf.
An NRSP may avoid permanent establishment status both by controlling the time its employees spend in China and by understanding how the recipient’s local tax bureau calculates that time.
For example, in one location a tax official may count a single day of employee presence as a full month, while in another location, only the exact number of days might be counted.
Other issues to consider include the nature of the services, how the services are described in a contract, whether employees are subject to personal taxation, and whether back-to-back or related service contracts may be in place.
No matter whether an NRSP provides services in China for a day or an extended period, the transaction requires planning before the service contract is executed.
An early draft of the contract should be properly reviewed for potential red flags and discussed with the relevant tax bureau.
While the service recipient in China may be able to help with this, experience indicates that such assistance is often not reliable.
Engaging a knowledgeable professional will ensure the highest probability of a positive outcome – with no surprises.
For more information, please contact:
Director of Global Expansion & Tax Advisory,
Nexia TS Shanghai
Dr Scott Heidecke
Senior Consultant, Nexia TS Shanghai