A representative office (RO) achieves the purposes that a foreign investor could establish a PRC presence in a relatively short time period and that the foreign investor is 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 for an exit option for the foreign investor to test the water.
According to the PRC Income Tax Law for Foreign Investment Enterprise and Foreign Enterprise, its Implementation 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.
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% on the total gross amount of monthly overheads incurred by the RO. The business tax is filed at monthly interval [the business tax has now been appealed]. Corporate Income tax is imposed at a rate of 33% [now reduced to 25%] on the deemed income. The deemed income is assessed at a rate of 10% on the total gross amount of overheads incurred by the RO during the relevant period. The RO must file income tax at a quarterly interval. 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 [Note: the 5% business tax rate has been abolished since the VAT reform, but the income tax rate has been revised upward. the income tax rate is determined by the local tax authority.]
- Business tax = RMB94118 * 5% [business tax has been appealed]
- Income tax = RMB 94,118 * 10% (deemed profit) * 33% [33% has been reduced to 25% since 1st Jan 2008.]
The income tax rate will be reduced to 15% 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: -
- Acting as a merchandise trade agent;
- Consulting services relating to business, legal, tax and accounting;
- Services performed for a resident fellow subsidiaries of the same non-resident holding company;
- Acting as advertising agents;
- Providing services relating to visa handling, fee collecting, ticketing, tour operator, and hotel accommodation for non-resident tourist companies;
- Consulting services given on behalf of non-resident financial institutions;
- Providing services within the business scope of a transport company;
- Other taxable activities the RO performs for the clients.
The following activities are not subject to income tax and business tax:-
- 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;
- Resident representative offices taking instructions from resident companies to act for them as agent, and the agency activities are mainly performed outside the PRC.
In defining the business activities, the State Administration of Taxation, the State Administration of Industry and Commerce, and the Ministry of Foreign Trade and Economic Cooperation (The MOFTEC is now called the Ministry of Commerce) 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. (Specifically, the restrictions on income-earning business activities undertaken by RO's in respect of legal, accounting, taxation, and management consulting are lifted in the WTO agreements China has acceded to.) 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 types of activities an RO is allowed to do as stated in the scope of activities in the business licence . 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.
The table below may help analyze the issue:
||Scope of activities
||Are they taxable?
Indirect business activities
|Business liaison, product introduction, market research, and technical exchange
||They are not taxable.
||Taxable if they are performed for third party, or client of head office on a fee basis.
|Direct business activities
||The types of taxable activities listed out as per SAT circular 1996 (165)
||They are taxable.
1.Subject to provisions in tax treaties China has entered into, or
2. Performing agency activity outside PRC on behalf of resident principles.
Taxation on Employees
The RO has the legal obligation to deduct from its payroll the income tax and pay them to the local tax office. In addition, the RO and the staff have to bear certain social security contributions respectively including pension fund, hospitalization, unemployment, injury, and birth planning insurances. Please see the Individual Income Tax that follows on the income tax issue for foreign nationals and employees from Hong Kong , Macau and Taiwan .