Foreign investors need to understand China’s indirect taxes, especially its withholding taxes and VAT reforms. China relies greatly on these for its revenue base, thus enforcement of these taxes is strict. This article reviews these indirect taxes and identified major current issues.

Withholding Tax

Withholding tax is a tax levied on overseas companies providing services to China-based businesses.

For companies based outside of China, but who are supplying services to clients in China (this can include a China-based subsidiary), your invoices are in effect �China-derived income� and the Chinese tax authorities levy taxes on these amounts. These are withheld by your client in China, being deducted from your gross invoice amount. This is why many overseas companies without a legal presence in China cannot receive the total gross amount due on their invoices to the China entity

The withholding income tax rate for non-tax resident enterprises in China for passive income is 20 percent under the corporate income tax law. This was reduced to 10 percent under the detailed implantation regulations of the CIT law. From January 1, 2008, this rate shall be applied to the dividends that a non-resident company receives from a resident company, unless otherwise prescribed in the tax treaty with the relevant foreign government. If the rate in the tax treaty is higher than 10 percent, 10 percent of dividends shall be adopted according to current rules; if the rate in the tax treaty is lower than 10 percent, the rate in the tax treaty should be adopted. For Example:

a) Dividends � A 10% withholding tax, which is lowered from a 20% statutory rate, is imposed on dividends paid to a nonresident company unless the rate is reduced under a tax treaty.

b) Interest � A 10% withholding tax, which is lowered from a 20% statutory rate, applies to interest paid to a nonresident unless the rate is reduced under a tax treaty. A 5% Business Tax will also be imposed. Since the VAT is replacing Business Tax. the VAT will be imposed instead.

c) Royalties � A 10% withholding tax, which is lowered from a 20% statutory rate, applies to royalties paid to a statutory rate, applies to royalties paid to nonresident unless the rate is reduced under a tax treaty. A 5% business Tax is also applicable, but may be waived when royalties are paid for the transfer for qualified technology. Since China is planning a VAT reform, the VAT will be applicable instead of Business Tax.

Governments use withholding tax as a means to combat tax evasion, and sometimes impose additional withholding tax requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.

Some media reported recently that China would cut taxes on the profits that foreign companies take out of the country by up to 50 per cent after rules on withholding taxes were relaxed to encourage more overseas investment.

However, the Shanghai Securities News reported that the relevant personage of the financial department confirmed that there are clear provisions about the non-resident enterprise income tax in �The Law of the People� Republic of China on Enterprise Income Tax�. Article 91 of it provides that when the non-resident enterprise obtains the relevant income, it should pay the tax at the rate of 10%. The tax rate can’t be easily changed unless the law revised.

[VAT is taking the place of Business Tax (BT)]

In my opinion, VAT is taking the place of Business Tax covering the industries which include license royalties.

China has for a long time planned an overall VAT reform which will eventually allow VAT to take the place of BT. As an initial step in this significant and complicated reform, the State Council meeting on 26 October 2011 announced that, a Pilot Program was to be launched on 1 January 2012 for selected industries in Shanghai to gradually expand the scope of VAT gradually to cover industries that are currently subject to BT.

Covered Services: The Pilot Program is applied in the first instance to the transport industry and certain �modern service industries� in Shanghai.

Modern service industries include the following six main categories, each covering several specific types of services:

� R&D and technology services: R&D, technology transfer, technology consulting, energy contract management, and exploration and survey.

� Information technology services: software, circuit design and test, information system, and process management.

� Culture and creativity services: design, transfer of trademark, goodwill and copyright, intellectual property related, IP agent, advertisement, and conference and exhibition.

� Logistics auxiliary services: aviation ground services or special aviation services (e.g. aviation photography), port, rescue, transportation agency, customs agency, warehousing, and unload/upload.

� Tangible movable assets leasing services: operation and finance leasing. � Certification and consulting services: certification, assurance, and consulting.

[Pilot Reform in Beijing]

The VAT Pilot Reform has been implemented in Beijing since September 1, 2012. Replacing business tax with VAT is an effective way to improve the tax system, avoid duplicate taxation and reduce tax burdens, as well as to promote the coordinated development of the tertiary industry. So, the royalty payments to a foreigner will attract WHT and VAT (not Business Tax) in Beijing now.

The VAT rates in Beijing are as follows:

� Information technology services: software, circuit design and test, information system, and process management. ���������������..6%

A trademark license for a use on clothing belongs to Culture and creativity services. According to the above, VAT would be 6% for a trademark license for a use on clothing in Beijing.

Currently, China is experiencing a new round of tax reform. The VAT Pilot Reform has been implemented in Shanghai since January 1, 2012, and then in Beijing since September 1, 2012. Jiangsu and Anhui provinces have begun since October 1. The next extensions involved Fujian (including Xiamen city) and Guangdong (including Shenzhen city) provinces from November 1. Tianjin municipality and Zhejiang (including Ningbo city) and Hubei provinces will begin from December 1 this year. Therefore, it is important for both Chinese and foreign companies to follow the latest tax laws and regulations, as they may effect transactions which already have been entered into as well as future transactions.

ABOUT THE AUTHOR: Han Yuanyuan

Han Yuanyuan is an Associate in MMLC.