TAXATION OF OUTBOUND DIVIDEND PAYMENTS
16 April 2020 | Corporate Finance, Tax, Dividend | Written by Dr. Richard van Ostende | Reading time: 10 minutes
The most well-known and commonly applied profit repatriation method out of China is via dividend payments. Dividend payments are subject to Withholding Tax and Corporate Income Tax. The bilateral agreement between China and the contracting country or non-state tax jurisdictions, might affect the overall tax burden of both the China-based subsidiary company and the foreign parent company.
In this article the regulations on taxation of dividend payments are discussed, as well as the process to assess a company’s tax liability position, followed by an example of a net dividend calculation.
RESIDENT ENTERPRISES VS. NON-RESIDENT ENTERPRISES
In Mainland China the Corporate Income Tax Law categorizes organizations as either “resident enterprises” or “non-resident enterprises”.
Resident enterprise refers to a company established in accordance with the law within the territory of the People’s Republic of China, or established in accordance with the law of a foreign country (region) but whose actual administration institution is located within the territory of the People’s Republic of China.
Non-resident enterprise refers to a company established in accordance with the law of a foreign country or region whose actual administration institution is located outside the territory of the People’s Republic of China but with “organizations or establishments” within the territory of the People’s Republic of China; or without organizations or establishments within the territory of the People’s Republic of China but which have income derived from the territory of the People’s Republic of China.
The term “organizations or establishments” part of the definition of “non-resident companies” refers to the establishments and places in China engaging in production and business operations, including:
Management organizations, business organization and representative offices;
Factories, farms and places where natural resources are exploited;
Places where labor services are provided;
Places where contractor projects such as construction, installation, assembly, repair and exploration are undertaken; and
Other establishments or places where production and operation activities are undertaken.
If a non-resident enterprise entrusts a business agent to carry out production and business activities in the territory of China, including entrusting a company or individual to regularly sign contracts, store or deliver goods on its behalf, such business agent shall be considered as the establishment or place of the non-resident enterprise in China.
CORPORATE INCOME TAX LIABILITY ON OUTBOUND DIVIDEND PAYMENTS
Mainland China’s Corporate Income Tax Law stipulates that dividend, bonus and other equity investment proceeds paid to investors are not deductible when computing the taxable income, hence dividend payments made by China-based subsidiary companies (i.e. “resident companies”) to their offshore parent companies (i.e. “non-resident companies”) are subject to Corporate Income Tax (CIT).
In China, the standard rate for CIT has been set at 25%. Per January 2019 preferential tax policies for small and low-profit enterprises have been implemented. An organization qualifies as a small-scale taxpayer when it meets one of the following conditions i) less than 300 employees, ii) annual sales less than RMB 30 million or iii) holds assets less than RMB 50 million. According to the government, the preferential CIT rates will apply to 95% of corporate taxpayers and lower the total tax burden for qualified companies by 5 to 10%.
If the foreign parent company is a tax resident of a jurisdiction, foreign country or region that has concluded a Double Tax Agreement (DTA) with China, it may be able to claim exemption from CIT if the organization’s establishment or venue does not constitute a Permanent Establishment (PE) pursuant to the PE article under the relevant DTA.
DTAs aim to prevent income from being taxed by two or more states through providing tax credits, exemptions, and/or reduced tax rates for specific income types such as interests, royalties, and dividends. DTAs further provide certainty by defining the taxation right of each jurisdiction on various types of income arising from cross-border economic activities.
First step in assessing the foreign parent company’s tax liability position and its possibility to claim exemption from CIT is to confirm whether a Permanent Establishment has been constituted. In China four types of Permanent Establishments exist, which are described below.
Fixed Place PE
The term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. It includes especially a place of management, a branch, an office, a factory, a workshop and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
Permanent establishments can also take the form of a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than 183 days. The start and end dates of the period is determined based on the actual implantation date of the project contract. Implementation includes all preparation activities, until the completion of the project (including trial operations).
If a non-resident enterprise engages an agent to carry out business activities in China on its behalf, the engagement of such a business agent will be considered as if a permanent establishment is constituted. The location where the agent performs it activities for the non-resident enterprise will be considered as the establishment or the place of the non-resident enterprise in China.
A non-resident enterprise shall not be deemed to have a permanent establishment in China only because it carries on business in China through a broker, general commission agent or any other agent of an independent status, provided that such parties are acting in the ordinary course of their business. However, when the activities of these parties are devoted wholly or almost wholly on behalf of that enterprise and conditions are made or imposed between that enterprise and the agent in their commercial and financial relations which differ from those which would have been made between independent enterprises, he will not be considered as an independent agent.
Permanent establishments are also constituted when a non-resident enterprise provides services via its employees and other personnel engaged by the enterprise in China for a period accumulating more than 183 days a year. “Employees and other personnel engaged by the enterprise” are employees of the company and other individuals controlled by and receiving instructions from the company. “Services” include professional activities such as engineering, technology, management, design, training and consulting services.
Further relevant in confirming whether a permanent establishment has been constituted as well are “Connected projects”. Assessment of projects confirm whether:
The projects are covered by a framework or master agreement;
Contracts have been concluded by the same or related person in the event the projects are covered by separate contracts?
The execution of a project a prerequisite is to another?
The nature of work the same is under different projects? and
Whether the services under different projects are performed by the same group of people?
Any of the occasions listed below do not result in the constitution of a Permanent establishment.
The use of facilities is solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
The maintenance of a stock of goods or merchandise belonging to the enterprise is solely for the purpose of storage, display or delivery or for the purpose of processing by another enterprise;
The maintenance of a fixed place of business is solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise or for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;
The maintenance of a fixed place of business solely for any combination of activities mentioned above), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
Further, when a company is a resident of a contracting state to a DTA and controls or is controlled by a company which is a resident of the other contracting state, or which carries on business in that other state (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.
CHECKLIST CIT EXEMPTION
Table 2 provides a checklist on the preconditions that must be met in order to become eligible for CIT exemption in accordance with the content of the prevailing DTA. In order to qualify all preconditions must be answered with “Yes”.
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