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Taxation of Repre sentative Offices in the PRC

Foreign investors wishing to establish a presence in the PRC in a relatively short time with minimal investment can consider setting up a representative office (RO).  Such investors are not required to make any commitment to bring in capital either in cash or in kind. Furthermore, the fact that an RO's approval certificate can be valid for a one-year period provides an exit option for foreign investors to test the waters.

According to the PRC Income Tax Law for Foreign Investment Enterprise and Foreign Enterprise, its Implementation Regulations, the PRC Business Tax Tentative Regulations, ministerial regulations and rules issued by the State Administration of Taxation, an RO that carries on business activities within the PRC is subject to tax on income derived from sources in the PRC irrespective of whether they are paid by any sources inside the PRC. The RO has a legal obligation to file the business tax return on a monthly basis, and the income tax return quarterly.

There are three methods to determine the taxable income of an RO: the actual income method, the deemed income method, and the cost-plus method. In the absence of complete and accurate information relating to the RO's PRC-source income, the PRC tax authority normally adopts the cost plus method to ascertain the taxable income for practical reasons.

The major category of tax includes business tax and income tax. Business tax is imposed at a rate of 5 percent on the total gross amount of monthly overheads incurred by the RO. The business tax is filed at monthly intervals. Corporate income tax is imposed at a rate of 33 percent on the deemed profit. The deemed profit is assessed at a rate of 10 percent on the total gross amount of overheads incurred by the RO during the relevant period. The RO must file income tax at quarterly intervals. For example, if the monthly overhead is RMB80,000, the business tax and income tax will be calculated as follows:

Gross amount = RMB80,000 / (1-10%-5%) = RMB94,118

Business tax = RMB94,118 x 5%

Income tax = RMB 94,118 x 10% (deemed profit) x 33%

The income tax rate of 33 percent including 3 percent local income tax will be reduced to 15 percent if the RO is located within the special economic zones or other designated areas.

The State Administration of Taxation (SAT) lists the following types of taxable activities that a representative office may perform:

1. Acting as a merchandise trade agent;

2. Consulting services relating to business, legal, tax and accounting matters;

3. Services performed for fellow subsidiaries of the same non-resident holding company;

4. Acting as advertising agents;

5. Providing services relating to visa handling, fee collecting, ticketing, tour operator, and liaison for non-resident tourist companies;

6. Consulting services given on behalf of non-resident financial institutions;

7. Providing services within the business scope of a transport company;

8. Other taxable activities the RO performs for the clients.

The following activities are not subject to income tax and business tax:- 

1. Resident representative offices performing services of market research, providing business information, liaison, consulting for the non-resident head offices on a free of charge basis;

2. Resident representative offices taking instructions from resident companies to act for them as an agent, and the agency activities are mainly performed outside the PRC.

Legal rules on business and taxable activities

In defining the activities that an RO may perform, the State Administration of Taxation (SAT), the State Administration of Industry and Commerce (SAIC), and the Ministry of Foreign Trade and Economic Cooperation (the MOFTEC) have different provisions. The SAT prescribes what constitutes a taxable activity while the SAIC stipulates that the RO should be engaged in non-direct business activities, subject to provisions in the international agreement. (We shall later discuss these provisions specifically). The MOFTC also provides that the RO's may only be engaged in non-direct business activities in respect of business liaison, product introduction, market research, and technical exchange on behalf of their heading office.

To determine whether certain activities are taxable, one has to consider the income tax rules rather than the functional role an RO is to play within the organization as stated in the scope of its business. If the RO performs those non-direct activities for the client of its non-resident head office or other non-resident foreign companies on a fee basis, then the income derived from those activities is taxable under the PRC income tax rules.

The representative offices that do not carry on business activities or the RO's that carry on non-taxable activities, can submit applications to the tax authority for the granting of a tax exemption certificate. However, the exemption does not apply to the income earned by the staff of the RO including the chief representative. Their PRC-source income is taxable whether or not they are paid by the representative offices.

The RO also has the legal obligation to deduct from its payroll income taxes and pay them to the local tax offices. In addition, the RO and all the staff have to bear certain social security contribution respectively including pension fund, hospitalization, unemployment, injury at work, and birth planning insurances. According to the Tentative Provisions issued by the State Council, the RO has to appoint a designated Foreign Enterprises Service Company to do the payroll and social security administration.

International and bilateral agreements

The international agreements China has acceded to may have different provisions from the domestic laws and regulations in respect of the scope of business activities. The international agreements should take precedence in case of inconsistency. China pledged to liberalize the service sector in her commitment to WTO accession in 2001. Specifically foreign investors are allowed to set up representative offices inside the PRC to engage, to a limited extent, in revenue-generating activities in the field of legal, accounting, tax practices and management consultation.

In some bilateral tax treaties the Chinese government has entered into, the provisions for taxable and non-taxable activities are not necessarily identical with the PRC domestic tax rules. In case of inconsistency, the provisions in bilateral tax treaties should take precedence.

Alfred China is Director of China Tax & Investment Consultants Limited. He can be reached at, alfredchan@kkchan-cpa.com.hk