Welcome back to our Entity Essentials series! The latest blog tackles a topic that many often overlook as a risk, even though it isn’t the most popular subject. However, we don’t want to leave any stone unturned, and what lies beneath this rock can be pretty ugly if not addressed from the outset.
When receiving enquiries about The China Desk, they usually come from companies considering their options for setting up an operation in China. Companies that come to Kinyu SCM are generally looking for the following functions:
- Hiring employees on the ground.
- Establishing an export and trading company function to take advantage of tax rebates.
Setting up your branch entity in China would be a logical strategy to fulfil these requirements. However, it’s important to understand the impact of international agreements on Permanent Establishment and how China’s Corporate Income Tax (CIT) fits into this.
What is a Permanent Establishment?
China has bilateral agreements with most major economies regarding the “establishment” as described by PWC:
An “establishment or place” is defined in the CIT regulations as an establishment or place in China that engages in production and business operations, including the following:
- Management organisations, business organisations, and representative offices.
- Factories, farms, and places where natural resources are exploited.
- Places where labour services are provided.
- Places where contractor projects, such as construction, installation, assembly, repair, and exploration, are undertaken.
- Other establishments or places where production and business activities are conducted.
- Business agents who regularly sign contracts, store, and deliver goods, etc., on behalf of the non-TRE.
Many articles address permanent establishment, but they typically target multinational companies. However, how can this impact SMEs?
What Does This Have to Do with Tax in China?
The entire issue of permanent establishment is all about tax, specifically paying the appropriate corporate tax in China. If you have a “Permanent Establishment” (PE), then the profit generated, which is tied to the operation of that PE, may be subject to the CIT in China.
China has bilateral agreements with most major countries regarding this matter. For instance, you can reference Article 5 of the United States-The People’s Republic of China Income Tax Convention.
Moreover, if you aim to export out of the China entity and benefit from the VAT rebate on exports, you might need to add a significant profit margin to the goods within China. Subsequently, you would pay tax on that margin. The standard corporate income tax rate in China stands at 25%.
Therefore, it’s crucial to carefully consider your strategy and seek advice on whether your plan to establish an entity is tax-viable.
Turn Your ‘Man on the Ground’ into ‘Management on the Ground’
Another concern revolves around having boots on the ground. If you contract with a freelancer in China, there’s a chance you might trigger a permanent establishment. This could mean that a portion of your HQ profits, attributable to the operation in China, might be subject to CIT. The method by which authorities determine the portion attributable to the operation in China can be arbitrary, with the outcome likely favouring the tax coffers.
Therefore, when considering the reasons for setting up a team on the ground, it’s crucial to be mindful of the concept of permanent establishment. Outsourcing your management operations can help distance your organisation from triggering a PE. There are various methods to achieve this, each with its own implications. Thus, it’s essential to seek advice from an accountant who specialises in this sector.
In the end, the concept of permanent establishment should be a consideration in your global organisational structure and decision-making process.
Please note, this article does not constitute advice. China can change its policies over time, so you might find the information in this article outdated when you read it. Kinyu SCM is not responsible for any actions taken based on this article. If you wish to learn more about this topic from Kinyu, and how Kinyu can assist, please feel free to book a call here.
