Provisional Measures for the Administration of Taxation of Foreign Enterprises' Resident Representative Offices

Issuing Body: State Administration of Taxation
Issuing Date: February 20, 2010
Effective Date: January 1, 2010

Six weeks after the State Administration of Industry and Commerce and the Ministry of Public Security tightened regulations governing the representative offices of foreign enterprises in China, the State Administration of Taxation (SAT) issued rules that effectively increase tax rates on representative offices and eliminate previously available tax exemptions. Like the Circular on Further Strengthening the Administration of Registration of Foreign Enterprise Resident Representative Offices, the Provisional Measures for the Administration of Taxation of Foreign Enterprises' Resident Representative Offices (Representative Office Tax Measures) make the representative office a somewhat less favorable structure for foreign companies that want to do business in China on a limited basis.

Over the past several years, China has significantly revamped its business tax structure through the Enterprise Income Tax Law (enacted in March 2007 and effective as of January 1, 2008), the Provisional Regulations on Business Tax and the Provisional Regulations on Value-Added Tax, as well as their respective implementing rules. The SAT likewise revised the rules governing taxes on foreign enterprises' resident representative offices in light of the changes contained in those laws. The Representative Office Tax Measures repeal previous rules regarding Representative Offices.

Background and General Rules

Representative Offices are common investment vehicles for foreign investors in China, in large part because they are easier and faster to establish than other legal structures, such as a wholly foreign-owned enterprise. However, Representative Offices operate under significant legal restrictions, as they do not enjoy legal person status and are limited to such business activities as research, coordination, and serving as a liaison. In addition, they are not allowed to generatebusiness revenues. This last restriction in some respects complicates the issue of taxes—a situation the SAT addresses through the concept of "deemed profit" (based on the notion that a Representative Office should have some economic value to the foreign enterprise which establishes and maintains it).

Representative Offices are subject to China's Enterprise Income Tax (EIT), Business Tax, and Value-Added Tax (VAT). By law, Representative Offices must register with the competent local tax authority within 30 days of obtaining a Registration Certificate from the Administration of Industry and Commerce. In case of any changes to items on the Registration Certificate, such as name, address, scope of business, name of the head office, or name of the chief representative, Representative Offices should update this registration in a timely manner.

Representative Offices are required to maintain complete accounting books and records and to exactly record the amount of taxable turnover. They are required to submit EIT returns and Business Tax returns quarterly and to submit VAT returns in accordance with the Provisional Regulations on Value-Added Tax and subsequent implementing rules.

Tax Collection Methods

The Representative Office Tax Measures allow for different methods of calculating taxes owed by Representative Offices:

• If the office maintains complete accounting books and records, it should pay tax based on its actual amount of turnover (actual amount method). 
• If a Representative Office does not maintain complete accounting records and cannot accurately account for its turnover or costs but is able to accurately record its operating expenses, tax authorities have the right to determine taxable turnover based on the office's operating expenses (expense-based method).
• If a Representative Office does not maintain complete accounting books and records and cannot provide an accurate accounting of its operating expenses but is able to accurately account for the office's turnover, authorities have the right to determine taxable turnover of the Representative Office based on its turnover (turnover-based method).

Both the expense- and turnover-based methods of calculating taxes rely on the concept of a "deemed profit rate" that is calculated by the government based on the operating situation of Representative Offices across China as well as the country's overall economic situation.

Under the expense-based method, turnover is calculated as follows:

• Turnover = operating expenses/1 – (deemed profit rate + business tax rate)
• Turnover subject to EIT = turnover * deemed profit rate * EIT rate

Under the turnover-based method, the formula is as follows:

• Turnover subject to EIT = turnover * deemed profit rate * EIT rate

It is noteworthy that the Representative Office Tax Measures increase the deemed profit rate from 10 percent to 15 percent. By the calculation of one professional accounting firm, this increase in the deemed profit rate will lead to tax increases of at least 24 percent for Representative Offices when tax is calculated on the expense-based method—obviously a significant deterrent.

If, however, a Representative Office first pays its taxes under either the expense- or turnover-based methods but later maintains complete accounting records and is able to accurately account for its taxable turnover, it can file with the competent tax authority and pay taxes under the actual amount method.

Tax Exemption Treatment

The Tax Measures for Representative Offices direct local tax authorities to reject applications for EIT exemptions, which were previously available to Representative Offices established by foreign governments, international organizations, nonprofits, and civil societies. In addition, the measures direct authorities to "review and revisit" already-granted exemptions.

If a Representative Office qualifies for and wants to benefit from special treatment in accordance with tax treaties, it must go through certain formalities to apply for such treatment, as required by the relevant tax treaty and the Tentative Administrative Measures on Tax Treaty Treatment for Non-Residents, which the SAT issued in August 2009. In that case, the Representative Offices must also submit tax returns under the actual amount method.

Conclusion

The Representative Office Tax Measures reflect the SAT's intention to strengthen tax collection and the administrative oversight of Representative Offices in China. As such, the new rules complement recent efforts by the State Administration of Industry and Commerce and the Ministry of Public Security to tighten regulation of Representative Offices. Detailed implementing rules for the Representative Office Tax Measures are expected in the near future.