Representative offices in China are subject to two main taxes, business tax and enterprise income tax. The business tax rate is 5% of turnover and the enterprise income tax rate is 33% of the profit of the representative office.
PRC law prohibits most representative offices from engaging in directly profitable business activities. Activities of a representative office are considered indirectly profitable because liaison activities in China would be intended ultimately to contribute to the turnover and the profit of its parent company. Two devices are used for determining the probable amount of the contribution of the representative office to the parent company's profit or economic welfare.
Two Common and One Unusual Taxation Method of Calculation:
The tax authorities use one of the following three methods to estimate business turnover and a deemed "profit" of a representative office:
1. The business turnover and the profit of the representative office may be inferred from the expenditures of a representative office. The tax authorities use the following formula:
Business turnover = expenditures divided by 85%
Example: If the salaries, rental, and other expenditures of one month add up to RMB 20,000.00 Yuan,
- The deemed business turnover of the representative office of that month will be RMB 20,000.00 divided by 85%;
- The profit of the representative office in that month will be RMB 20,000.00 divided by 85% x 10%;
- The business tax payable in that month will be RMB 20,000.00 divided by 85% x 5%; and
- The enterprise income tax payable in that month will be RMB 20,000.00 divided by 85% x 10% x 33%.
This method may be applied to any representative office, and is commonly used for offices that are not allowed to profit directly from activities in China.
2.The parent company can negotiate with the tax authorities to determine a "deemed profit" as if the head office had contracted the operation of the representative office at a fixed price by an agreement between the parent company and the representative office. If this deemed or contracted amount is accepted by the tax authorities, the business turnover of the representative office is deemed to be that fixed price and the profit of the representative office will be deemed to be 10% that fixed price.
If the tax authorities agree to tax a representative office by this method, they will not look at the expenditures. This method is most often used where the tax authorities determine that it would be difficult for them to audit actual expenses.
3. The business turnover reported to the tax authorities by a small number of representative offices, for example offices of accounting or law firms, can be the actual income of the representative office. The profit of the representative office will be the difference of the actual turnover minus the actual expenditures of the representative office. Representative offices, which are not permitted to incur direct income cannot use this method of calculating taxable income.
Among the three methods, the first method is widely used. This method is a disincentive to spending. Since encouraging expenditures by foreign companies in China is a priority, it is sometimes possible to negotiate for permission to use method number two.
The second method is very advantageous to a representative office, especially if expenditures are big.
The last method can also result in lower taxes, especially for start-up operations (money making representative offices which have not yet reached break even) or for representative offices, which lose money. There are no plans to expand the scope of usefulness of this method to representative offices not permitted to earn direct income.
For more information, please contact Luke Filei on [email protected] or + 86 21 628 96363.