Setting Up a Representative Office in China (III): Less Exemptions and More Taxes! The New Tax Treatment is here!

Considering setting up a Representative Office (R.O.) in China? You may need to revise your numbers.
The Notice from the State Administration for Industry and Commerce and the Ministry of Public Security “Further Strengthening the Administration on Registration of Resident Representative Offices of Foreign Enterprises” (Jan 4th, 2010)[1] is not the only cloud on your horizon. On February 20th 2010 the State Administration of Taxation (SAT) issued a circular announcing the new tax treatment for foreign R.O.s “Tentative Measures for the Administration of Taxation on Representative Offices of Foreign Enterprises” (Guoshuifa[2010] No.18 (Circular 18)) [2].

Two main changes are worth highlighting:

  1. Exemptions
    Local tax authorities are requested to review existing tax exemptions granted under the old rules.  Till now, R.O.s’ expenses related to activities like market research, liaison and other preparatory sales and manufacturing activities for their head offices products could enjoy tax exemptions. And it is believed that often R.O.s were getting exemptions even if their expenses did not fall into these categories.
    Under the new tax treatment, exemptions will only be applicable if there is a relevant tax treaty or agreement.
    … So, reassess your situation, and if you believe you still qualify apply a.s.a.p.
  2. Deemed profit rate increase from the current 10% to a minimum of 15% of the operating expenses (when using the cost-plus method/ for R.O.s that can accurately detail expenses)
    Deloitte has published in its China newsletter a very comprehensive analysis that shows that this change in the taxable income ratio will mean an increase in tax costs of no less than 24% (you can read the detailed analysis in the link at footnote # 2).
    And the most confusing part here is that this 15% that everybody is now hoping for is just “a minimum”. So one wonders how will the local tax authorities evaluate whether an R.O. ‘s profit should be deemed 15% or 50% …

These changes will definitely affect companies deciding or reassessing what legal entity best works for their China business. Ana Inchausti, from Inventta, also touched on that point when I approached her for my previous post on how SAIC’s new regulations would be affecting R.O.s. I quote bellow a summary of her comments on the tax changes:

“…To the question if we still consider R.O.s a practical approach to establish businesses in China, we would say yes, R.O.s are still an interesting approach but maybe to a more reduced group of projects than in the past. The tax increase is, in our opinion, the major change affecting the decision making process…We would advice our clients to set up a R.O when they are going to keep a small medium structure with low costs and just a few employees and overall if, after doing the math, to pay tax based on their expenses is still more interesting and competitive than to pay a profit based tax, as its compulsory to the WOFEs.”

These next two weeks are going to be very interesting. R.O.s will be submitting their quarterly EIT (Enterprise Income Tax) and BT (Business Tax) for the first time under the new regulations so there may be not-so-nice surprises. I’m planning to follow up with some R.O.s to find out what these changes have meant to them. Maybe it is time to go WFOE!

Would you like to share how the new regulations are affecting your R.O.?

[1] Link to the State Administration for Industry & Commerce of the People’s Republic of China. Notice of changes in Registration of Foreign Representative Offices – English reference translations:

[2] Deloitte Tax Analysis on the new Tax Treatment issued by SAT “Tentative Measures for the Administration of Taxation on Representative Offices of Foreign Entreprises” (Guoshuifa[2010] No.18 (Circular 18))

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