When setting up in China, foreign investors are confronted with myriad complex issues, from local regulatory variances, to confusing tax compliance issues and licensing procedures. With all the complexities over submitting business license applications, scant regard is often paid to one of the most important parts of overall business planning, the mechanism to facilitate the effective repatriation and maximization of profits. This is something that should be dealt with during the planning stages of setting up in China.
Above-the-line distributions are a key part of any profits repatriation strategy and should be built into company articles of association prior to approval of the business license. Above-the-line distributions are expenses charged to China operations, usually by the foreign parent directly, and thus are legitimate fees for which an invoice is presented to the China business as part of its normal operational procedure.
These can include: royalty charges for trademarks or patents owned by the parent; "foreign management expertise," full expenses and pay for any head of office or overseas personnel visiting China, even if just for a short period; royalty fees for technology transfers; interest on loans, including penalties for late payment.
Above-the-line distributions need to be agreed upon and identified in the articles prior to submission to the authorities for approval of an operation's business license. When levying such charges onto a China business, it is important to be aware that such payments are subject to Chinese tax (amounts vary depending upon the service), prior to the China entity being able to remit back to the foreign parent. But even accounting for this, the amount of money able to be remitted back to the parent pre-tax can be quite significant with careful preparation and planning.
Prices charged between associated enterprises established in different tax jurisdictions for their inter-company transactions are becoming an important part of any multinational's tax compliance. The State Administration of Taxation's promulgation of transfer pricing measures detailing the administrative rules for all special tax adjustments are intended to ensure high standards and consistency throughout the various local tax bureaus in China, making the administration and enforcement of transfer pricing-related issues uniform. The new rules will act as a foundation for future policy changes to China's transfer pricing regime.
When choosing a transfer pricing method, companies will need to take into account the characteristics of the assets or services involved in the transaction, the functions and risks of each transactional party, the terms of the contract, the economic circumstances and their business strategies.
It should be noted that the tax authorities will investigate companies that tend to have the following characteristics: significant amounts or numerous types of related party transactions; long-term losses, low profitability, or fluctuating patters of profit and loss; below average profitability than industry standards or profits that do not match the companies' functions; business dealings with companies established in tax havens; absent or incomplete transfer pricing documentation; or obvious violations of the arm's length principle.
Interest paid on borrowings is tax-deductible in China. This is useful as part of an overall, longer-term financing strategy for China operations as it means companies are able to identify the intended form of distribution of any profit, then re-lend it back to their China operations with interest. It is also possible for partners to provide loan guarantees to China operations in favor of the China business itself, thereby being able to achieve both cash profit distribution but also re-investment, and the associated incentives, at the same time.
Working out a profit maximization and repatriation strategy involves a technical tax and legal issues that many investors ignore. This is a mistake as many investors are not as tax- and profit-efficient as they should be. It is very important to pay attention to the articles of association; these are the company rules and set out exactly what, and how, the company can operate. It is usually not a problem to incorporate an effective tax and profit structures in them from the start.
Understanding just what taxes a company is required to pay, and what taxes can be withheld will also help an enterprise in China to maximize profits. Following the implementation of the new Enterprise Income Tax Law on January 1, 2008, China has issued many important circulars regulating withholding taxes and the procedures to withhold taxes for non-resident enterprises.
According to the new Enterprise Income Tax Law, a non-resident enterprise is an enterprise that is set up in accordance with the laws of a foreign country and whose place of effective management is not located in China but has an establishment or place in China, or that does not have an establishment or place in China but derives income from sources within China.
The author is the Senior Legal Associate of Dezan Shira & Associates' Beijing Office (www.dezshira.com)