AROUND THE WORLD WITH SEYMOUR J. MANSFIELD
Legal News with an International Perspective
Seymour J. Mansfield, Attorney at Law
SIMON BAI ON CHINA WITHHOLDING TAX
As part of Mansfield Tanick & Cohen's continued efforts to bring awareness of the legal issues in one of the world's fastest growing markets, namely China, I am pleased this month to introduce you to another of my good lawyer friends, Simon BAI, of the WINNERS Law Firm in Tianjin, China. He is our esteemed guest author of the following article: Withhold under China's New Enterprise Income Tax Law. Mr. BAI and his Firm are also members of our international legal network, Lawyers Associated Worldwide ("LAW"). The high quality lawyers in LAW's member firms, such as Mr. BAI, are a core component to Mansfield Tanick & Cohen's global presence, and our affiliation with these fine firms allows us to provide a seamless connection for Minnesota businesses needing local counsel in another state or country.
Simon BAI is a Partner with the Winners Law Firm in Tianjin, China. Having practiced in both China and Brussels for 8 years, Simon now specializes in general corporate, banking, labor law and mergers and acquisitions. He has published articles on various topics in both Chinese and English in a variety of journals, and was one of three Chinese lawyers selected as an International Bar Association (IBA) Scholar, as well as for being a recipient of other prestigious scholarship programs. Simon holds LL.M. degrees from both Oxford University and Leuven University, Belgium.
It is my pleasure to feature Simon's work in this edition of Around the World. We look forward to working with him and his Firm, as well as our other professional colleagues throughout the PRC, in assisting our clients through our China-U.S. LAW Connections (CULC) Program.
A founding shareholder of Mansfield Tanick & Cohen, P.A., with 39 years of diverse lawyer experience, Seymour Mansfield now focuses on business, complex and class litigation, mediation, executive employment and employee benefits, trade secrets and restrictive covenants, international business law and acts as legal counsel to emerging medical device companies. He is the firm's primary representative to Lawyers Associated Worldwide (LAW), an association of 100 independent commercial law firms located in 55 countries and 148 key cities, comprising over 3500 lawyers worldwide, and served on LAW's Executive Committee (governing board) from 2002 through 2008. LAW empowers our firm to serve the needs of our clients in domestic and foreign markets worldwide.
WITHHOLDING UNDER CHINA'S NEW ENTERPRISE
INCOME TAX LAW
By Simon BAI
Partner, WINNERS Law Firm, Tianjin China
•I. Scope of Withholding Tax under Enterprise Income Tax Law
The PRC Enterprise Income Tax Law (EITL), together with the Implementing Rules of the PRC Enterprise Income Tax Law (IR), entered into effect on 1 January 2008, creating a level playing field for all businesses both domestic and foreign-funded. The new provisions for withholding tax (WHT) in EITL and IR differ from previous laws.
One of the most important features of EITL is that enterprises are classified as resident enterprises and non-resident enterprises.
Article 2 of EITL and Articles 3-4 of IR define a non-resident enterprise as an enterprise established within the territory of another country or other tax region pursuant to foreign laws, whose actual management or control is located outside of China but who has an establishment in China, or even if it does not have an establishment in China, has income derived from China. Whereas a resident enterprise refers to an enterprise that is established in China in accordance with Chinese law or even if established pursuant to foreign law but which has its effective management inside China.
Effective management in accordance with Article 4 of IR refers to establishment that performs substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise.
As provided in Article 5 of IR, "establishment" refers to any entity or place that is engaged in manufacturing and business operating activities within the territory of China, including:
•1. An office or institution of management, operation or administration;
•2. A farm, factory or place of extraction of natural resources;
•3. A place for provision of services;
•4. A place for construction, installation, assembly, repair and exploitation of natural resources, etc.;
•5. Other establishments engaged in manufacturing and business operating activities.
Where a non-resident enterprise retains a business agent to engage in manufacturing and business operating activities within the territory of China, including where the entrusted entities or individuals sign contracts, or warehouse and deliver commodities on behalf of the non-resident enterprise on a regular basis, the business agent shall be regarded as an establishment of the non-resident enterprise within the territory of China.
In accordance with paragraph 3 of Article 3 and Article 19 of EITL as well as other regulations, non-resident enterprises without establishments in China are subject to foreign enterprise income tax on a withholding basis on the following categories of income:
- 1. Dividends derived from enterprises in China;
- 2. Royalties generated by providing patent rights, proprietary technology, trademark rights, copyrights and other know-how for use in China;
- 3. Interest derived from China on deposits, loans, bonds, advance payments made provisionally on another person's behalf;
- 4. Rental income from assets leased to and used by parties in China;
- 5. Earnings from transfer of assets of an enterprise in China, such as real estate properties including buildings, structures and their auxiliary facilities and land use rights; and
- 6. Any other income derived from inside China which may be deemed as taxable such as gains derived from the transfer of equity interest in a foreign investment enterprise, e.g. capital gains.
Non-resident enterprises with establishments in China deriving the above-listed income which is not effectively connected with that establishment are also subject to foreign enterprise income tax on a withholding basis at source.
Royalty income subject to WHT includes the following:
- Drawing and information fees;
- Technical service fees;
- Personnel training fees;
- Other fees received by the supply of patent rights or proprietary technology.
Interest income includes arrangement fees, guarantee fees and agent fees.
Rental income may include finance lease, operating lease, lease of vessels and leasing of real estate properties.
II． Tax Rate
Under Article 4 of the new EITL, the general withholding tax rate is 20%. This general rate could be exempted or reduced in accordance with Article 27 of EITL, which creates flexibility for State Council to make interpretations on qualifications of such exemption or reduction. Thus, this explains the fact that this general rate is further reduced to 10% under IR (promulgated by State Council) Article 91.
Under the former Foreign Enterprise Income Tax Law (FEITL, abolished in January 2008) , withholding tax on dividends from foreign investment enterprises to their foreign investors was exempted (Article 19), while the WHT rate for other passive income (royalties, rentals income, service fees, etc.) was provisionally reduced from 20% to 10%.
Although the new EITL and IR state that the general WHT rate will be reduced to 10%, it remains unclear whether the previous dividend WHT exemption has been kept intact.
According to Article 91 of IR, the following income may be exempt from enterprise income tax:
1. Interest income on loans made from foreign governments to the Chinese government;
2. Interest income on loans made by international financial organizations (such as International Monetary Fund, World Bank, Asia Development Bank, International Development Association, International Fund for Agriculture Development and European Investment Bank) to the Chinese government (including State banks) and resident enterprises; and
3. Other income approved by the State Council.
III. Withholding at Source
Pursuant to Article 37-38 of EITL and Article 103-104 of IR, the withholding agent who makes payment to non-resident enterprises that are subject to WHT is required to withhold the applicable amount of tax from each payment made to non-resident enterprises.
Withholding agent refers to entities or individuals directly having the obligation to make the payments to non-resident enterprises, in accordance with relevant laws or provisions of contracts. Here "payments" may be made in monetary form or in-kind, such as payments of cash, payments through account transfers or payments using equity interests.
Derivation of income is determined on the following principles:
1. For sales of goods, income source is determined in accordance with the place where the trading activities occur;
2. For rendering of services, income source is determined in accordance with the place where the service activities occur;
3. For income from transfers of immovable properties, source is determined in accordance with the place where the immovable properties are located; for income from transfers of movable properties, source is determined in accordance with the place of the transferring enterprise or establishment which transfers the movable properties; for income from transfers of equity interests, source is determined in accordance with the place where the invested enterprise is located;
4. For income from equity interests such as dividends, source is determined in accordance with the place of the enterprise which makes the distribution;
5. For income from interest, rental and royalties, source is determined in accordance with the place of the enterprise or establishment which pays the income, or with the place of domicile of the individual who pays the income;
6. For other income, source will be determined by the government taxation authorities.
Where there are multiple locations from which income is derived within the territory of China, the taxpayer may make a choice as to where to file enterprise income tax returns from one of the locations.
IV. International Treaties
In accordance with Article 58 of EITL, in cases where there arises discrepancy or conflict between the provisions of EITL and international treaties that China has entered into with other countries, such treaties shall prevail.
WHT thus can be reduced by applicable tax treaties. For example, WHT that applies to dividends received by residents of Barbados and Mauritius is only 5% according to the relevant treaties.
