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The People's Republic of China (PRC) is the second largest economy by nominal GDP in the world after the US. In recent years, the PRCs economic growth continued in spite of the world economic crisis. The PRC remains an attractive investment destination for overseas investors, and it has ranked first among developing countries for attracting foreign capital for 23 consecutive years.
However there are a number of issues which you must consider when you are looking to set up your business in China. This document takes you through some of the common questions we come across and gives you practical information about the issues you need to consider.
What type of Business Structure should we use?
There are advantages and disadvantages to all of them, and there is no one correct answer, it's all dependent on your specific business circumstances and needs. A brief overview of the main structures is below:
Establishment (a branch of your overseas business):
- Not a separate legal entity but an extension of the overseas parent company
- No limited liability or ring-fencing of the PRC operations
- If have a permanent establishment in the PRC then profits from this PE are liable to the PRC Corporate Income Tax (CIT)
- Parent company accounts shall be filed under certain circumstances where they are required by the PRC laws or regulations
- Provides limited liability and ring-fencing to the PRC operations
- Gives a perception of a local business, with longevity
- CIT to be paid on company profits
- Accounts shall be filed in CIT annual filing
- Accounts require auditing for certain types of companies, such as public listed companies and foreign investment companies
Limited Liability Partnership:
- Members (partners) have limited liability
- Taxable income is allocated to members who then pay Income Tax on their taxable income respective
- The tax residence of the member, and where the taxable income in the LLP originated will determine in what jurisdiction and how these profits are taxed
How much Corporation Tax will the business pay?
Current Corporation Tax rates in the PRC are:
Tax rate (%)
Taxable profit (CNY)
Small co rate
0 - 100,000
Small scale enterprises, where taxable income does not exceed RMB 100,000 are liable for more preferential incentives. Income of such enterprises can be included in taxable income based on 50% of their income and applied tax rate is 20% until 31 December 2016.
For Advanced and New technology enterprises eligible for key support from the state, CIT is levied at a reduced rate of 15%.
CIT payers are classified as resident enterprises and non-resident enterprises. A resident enterprise shall pay CIT on its income from sources within and outside the PRC. A non-resident enterprise with an establishment or place of business (establishment) in the PRC is subject to CIT on its PRC-sourced income derived by such establishment and on its foreign-sourced income which is effectively connected with such establishment. A nonresident enterprise without an establishment in the PRC is subject to CIT only on its PRC sourced income.
Important industries and projects whose development is supported and encouraged by the state may enjoy various CIT incentives. CIT on income from the following may be exempted or reduced:
- Projects in the agriculture, forestry, husbandry and fishery industry
- Investment in and business operations of public infrastructure projects supported by the state
- Projects of environmental protection, energy or water conservation
- Qualified technologies transfer
What if we use China to set up our holding company?
When certain conditions are satisfied, foreign investors may establish holding companies in the PRC, besides holding equity interests, the holding company may also trade goods manufactured by its investees and provide certain shared services such as financing, marketing, staff recruitment and consulting, etc. A holding company can further apply for ?Regional Headquarters' status if it meets specified criteria, which allows a broader scope of services and certain tax benefits.
The PRC holding companies and their subsidiaries are separate entities and are taxed respectively. They do not file a consolidated tax return.
Qualified dividends derived by a resident enterprise from another resident enterprise are exempt from CIT. However, dividends derived by a foreign company from its Chinese investee will be subject to 10% withholding tax, and the foreign company may apply for tax treaty relief if it qualified as a beneficial owner.
Capital gains derived by a foreign company from disposal of its Chinese investee will be subject to 10% withholding tax, and the qualified foreign company may apply for tax treaty relief.
As above mentioned, a resident enterprise shall pay CIT on its income from sources within and outside the PRC, while qualified foreign tax payment may be a credit against the CIT payable by the enterprise.
What if we make cross-border transactions between group companies?
The PRC follows internationally recognized Transfer Pricing(TP) rules where cross-border trading and financial transactions between affiliated entities have to be conducted on an arm's length basis. The price and terms should be the same as if the transactions had been between completely independent parties.
Typical transactions between affiliated entities that are covered by TP regulations are:
- Sale and purchase of goods
- Provision of management services
- Property rental charges
- Transfer of intangible assets e.g. trademarks, patents
- Sharing of knowledge, expertise, business contacts etc.
- Provision of financial support e.g. inter-group loans and charging a 'market' interest on loans
The new PRC CIT Law reinforces the TP documentation requirements. A business will need to prepare certain Transfer Pricing documents proving the arm's length basis of transactions. The documents may be Related Party Transaction Forms submitted to the tax bureau together with the enterprise's annual income tax returns or contemporaneous documentation, which will include a functional and risk analysis, analysis of the adopted pricing model and benchmarking of the arm's length basis.
SME's are generally less covered under the PRC transfer pricing regime. The following enterprises may be exempted from preparation of the contemporaneous documentation (1) Enterprises with aggregate related party transactions below RMB 200 million of related party purchase or sale transactions and other related party transactions below RMB 40 million; (2) The related party transactions fall in the scope of certain advanced pricing arrangements; (3) Foreign shares constitute less than 50% and related party transactions are limited to related parties in China. Otherwise, the enterprise must prepare contemporaneous documentation on an entity level on or before 31 May of the year following the year in which the related party transactions took place and shall provide it within 20 days on tax authorities' request.
However even if an entity is exempt from the PRC's transfer pricing regime it may fall under the scrutiny of the other international tax jurisdictions where it transacts. There may also be other tax regulations which ensure transactions are undertaken at a commercial value.