Avoid Double Taxation

The People's Republic of China has issued two circulars providing detailed compliance requirements aimed at reaching foreign service providers with clients in China. These new provisions will likely cause U.S. and multinational law firms with clients in China to reconsider existing practices and client engagement procedures in order to avoid the possibility of double taxation.

New Requirements for Paying Business Tax and Corporate Income Tax

The Chinese State Administration of Taxation (“SAT”) recently released two circulars that set forth detailed compliance requirements for non-resident contractors/service providers providing services within China:

1. Provisional Measures of Tax Administration for Non-resident Engaged in Contracting Projects and Provision of Services (SAT Order [2009] No. 19); and
2. Notice Regarding Publication of the Administrative Measures of Annual CIT Filing for Non-resident Enterprises (Circular GuoShuiFa [2009] No. 6).

It is anticipated that the new requirements will have a significant administrative and economic impact on non-resident contractors/service providers and their Chinese project owners/service recipients.

Administrative Requirements

Under Order 19, both the non-resident service providers and the Chinese service recipients (normally, the withholding agent) are required to register their service contracts with the local tax authorities within 30 days after the contract is concluded. Discussions with SAT officials indicate that the registration by non-resident service providers could be exempt where all services are provided outside China, but this has not been formally acknowledged by SAT.

In the past, the local tax authorities were probably not aware of service contracts concluded between the non-resident service providers and Chinese service recipients unless tax certificates were required to be submitted by the Chinese client for foreign exchange remittance purposes. Thus, the local tax authorities were not aware when service fees were settled offshore. Now, due to the various filing obligations imposed by Order 19, the local tax authorities can easily track down the taxation status of each service contract (even if the service fees are paid offshore) and they may either require the non-resident service providers or the Chinese service recipients to take appropriate actions in reporting the project and relevant taxes.

Potential Double Taxation in the Case of Joint Services

Essentially, the new circulars have not only created more administrative burden for the non-resident service providers and the Chinese service recipients, but they may also result in further tax inefficiencies or double taxation. For instance, if the head office of a U.S. multinational law firm located in the United States contracts with a Chinese client and provides services jointly with its Beijing office, Order 19 requires the head office to register the contract and perform tax filings ' Corporate Income Tax (“CIT”) and Business Tax (“BT”) ' with the local tax bureau “where the project is located.” The U.S. head office may choose to designate the Chinese client as its withholding agent in lieu of performing its own registration and filings.

In this example, the overall BT burden on the U.S. multinational firm for the project should comprise: 1) 5% on 100% of the U.S. head office's fees receivable from the client, as a result of the new BT regulation, regardless of where the services are provided; and 2) 5% on the allocated revenue reported by the firm's Beijing office in relation to its efforts in this project. This will result in double taxation with respect to the BT on the portion of revenue allocated to the Beijing office. It may be worthwhile to consider issuing separate bills from the U.S. head office and the Beijing office to minimize the BT.

With respect to CIT, the head office should consider negotiating with the local tax authority at the project location for a favorable income tax computation and settlement method (for example, a favorable deemed profit rate or tax based on actual profit). It is important to note that Chinese clients would normally not bother to obtain favorable computations from the tax authorities on behalf of the non-resident service providers, if they are designated as withholding agents.

Circular 82 and Order 19: Conflicts or Not?

The differences between the requirements listed in Circular 82 and Order 19, which are both applicable to foreign law firms' operations in China, are clear. Using the example from above, according to Circular 82, in the case of joint services the U.S. multinational firm's overseas (ex-China) office's revenue should be combined with the Beijing Office's revenue and reported taxes by the Beijing Office. However, according to Order 19, the overseas office should report taxes to the in-charge tax authority “where the project is located,” here, the Chinese client's location. Thus, each of the two regulations calls for taxes to be reported to a different location. While the Beijing tax authority still follows the principles of Circular 82 in determining the CIT of the Beijing Office, many problems arise in relation to the taxation jurisdiction, tax clearance certificate issuances, etc.

The Beijing State Tax Bureau (Municipal level) (“BSTB”) International Tax Division has been notified of this conflict. The BSTB is preparing a tax circular regarding implementation of Order 19 in Beijing. It is hoped that this issue will be addressed.

Another important inconsistency arises in connection with Order 19. It states that when a project in China is located in a different location from the foreign enterprise's China establishment (i.e., the Beijing Office in our example), the in-charge tax authorities of these two locations should communicate to resolve disputes, if any. In Beijing, a taxpayer should be able to seek assistance from the tax authority at the municipal level to coordinate and resolve differences among the tax authorities of the different districts. However, from a practical standpoint, this process may be quite time consuming, and cross-province communication among the tax authorities would likely lead to further issues and delays.

There are still uncertainties with the application of the new circulars, and the local tax authorities are working on their own versions of local implementation rules. Multinational law firms should check with the relevant local tax authorities on the local practice of implementing Order 19 before concluding any contracts with Chinese clients.

Conclusion

The change in requirements for paying China's BT and CIT will increase the level of complexity involved in the payment of Chinese taxes by multinational law firms with clients in China. However, with the right level of planning this change should not present a problem.

Stanley Kolodziejczak is Co-Chair of the Law Firm Services group of PricewaterhouseCoopers LLP and has more than 25 years of business, tax, and accounting experience. His current experience is working with law firms that are facing the challenges of growth in a changing global market. He can be reached at 646-471-3160 and [email protected]. Nancy Regan is a Director in the Law Firm Services group with 10 years of experience as an attorney in and around global law firms. She can be reached at 646-471-6104 and at [email protected].

The People's Republic of China has issued two circulars providing detailed compliance requirements aimed at reaching foreign service providers with clients in China. These new provisions will likely cause U.S. and multinational law firms with clients in China to reconsider existing practices and client engagement procedures in order to avoid the possibility of double taxation.

New Requirements for Paying Business Tax and Corporate Income Tax

The Chinese State Administration of Taxation (“SAT”) recently released two circulars that set forth detailed compliance requirements for non-resident contractors/service providers providing services within China:

1. Provisional Measures of Tax Administration for Non-resident Engaged in Contracting Projects and Provision of Services (SAT Order [2009] No. 19); and
2. Notice Regarding Publication of the Administrative Measures of Annual CIT Filing for Non-resident Enterprises (Circular GuoShuiFa [2009] No. 6).

It is anticipated that the new requirements will have a significant administrative and economic impact on non-resident contractors/service providers and their Chinese project owners/service recipients.

Administrative Requirements

Under Order 19, both the non-resident service providers and the Chinese service recipients (normally, the withholding agent) are required to register their service contracts with the local tax authorities within 30 days after the contract is concluded. Discussions with SAT officials indicate that the registration by non-resident service providers could be exempt where all services are provided outside China, but this has not been formally acknowledged by SAT.

In the past, the local tax authorities were probably not aware of service contracts concluded between the non-resident service providers and Chinese service recipients unless tax certificates were required to be submitted by the Chinese client for foreign exchange remittance purposes. Thus, the local tax authorities were not aware when service fees were settled offshore. Now, due to the various filing obligations imposed by Order 19, the local tax authorities can easily track down the taxation status of each service contract (even if the service fees are paid offshore) and they may either require the non-resident service providers or the Chinese service recipients to take appropriate actions in reporting the project and relevant taxes.

Potential Double Taxation in the Case of Joint Services

Essentially, the new circulars have not only created more administrative burden for the non-resident service providers and the Chinese service recipients, but they may also result in further tax inefficiencies or double taxation. For instance, if the head office of a U.S. multinational law firm located in the United States contracts with a Chinese client and provides services jointly with its Beijing office, Order 19 requires the head office to register the contract and perform tax filings ' Corporate Income Tax (“CIT”) and Business Tax (“BT”) ' with the local tax bureau “where the project is located.” The U.S. head office may choose to designate the Chinese client as its withholding agent in lieu of performing its own registration and filings.

In this example, the overall BT burden on the U.S. multinational firm for the project should comprise: 1) 5% on 100% of the U.S. head office's fees receivable from the client, as a result of the new BT regulation, regardless of where the services are provided; and 2) 5% on the allocated revenue reported by the firm's Beijing office in relation to its efforts in this project. This will result in double taxation with respect to the BT on the portion of revenue allocated to the Beijing office. It may be worthwhile to consider issuing separate bills from the U.S. head office and the Beijing office to minimize the BT.

With respect to CIT, the head office should consider negotiating with the local tax authority at the project location for a favorable income tax computation and settlement method (for example, a favorable deemed profit rate or tax based on actual profit). It is important to note that Chinese clients would normally not bother to obtain favorable computations from the tax authorities on behalf of the non-resident service providers, if they are designated as withholding agents.

Circular 82 and Order 19: Conflicts or Not?

The differences between the requirements listed in Circular 82 and Order 19, which are both applicable to foreign law firms' operations in China, are clear. Using the example from above, according to Circular 82, in the case of joint services the U.S. multinational firm's overseas (ex-China) office's revenue should be combined with the Beijing Office's revenue and reported taxes by the Beijing Office. However, according to Order 19, the overseas office should report taxes to the in-charge tax authority “where the project is located,” here, the Chinese client's location. Thus, each of the two regulations calls for taxes to be reported to a different location. While the Beijing tax authority still follows the principles of Circular 82 in determining the CIT of the Beijing Office, many problems arise in relation to the taxation jurisdiction, tax clearance certificate issuances, etc.

The Beijing State Tax Bureau (Municipal level) (“BSTB”) International Tax Division has been notified of this conflict. The BSTB is preparing a tax circular regarding implementation of Order 19 in Beijing. It is hoped that this issue will be addressed.

Another important inconsistency arises in connection with Order 19. It states that when a project in China is located in a different location from the foreign enterprise's China establishment (i.e., the Beijing Office in our example), the in-charge tax authorities of these two locations should communicate to resolve disputes, if any. In Beijing, a taxpayer should be able to seek assistance from the tax authority at the municipal level to coordinate and resolve differences among the tax authorities of the different districts. However, from a practical standpoint, this process may be quite time consuming, and cross-province communication among the tax authorities would likely lead to further issues and delays.

There are still uncertainties with the application of the new circulars, and the local tax authorities are working on their own versions of local implementation rules. Multinational law firms should check with the relevant local tax authorities on the local practice of implementing Order 19 before concluding any contracts with Chinese clients.

Conclusion

The change in requirements for paying China's BT and CIT will increase the level of complexity involved in the payment of Chinese taxes by multinational law firms with clients in China. However, with the right level of planning this change should not present a problem.

Stanley Kolodziejczak is Co-Chair of the Law Firm Services group of PricewaterhouseCoopers LLP and has more than 25 years of business, tax, and accounting experience. His current experience is working with law firms that are facing the challenges of growth in a changing global market. He can be reached at 646-471-3160 and [email protected]. Nancy Regan is a Director in the Law Firm Services group with 10 years of experience as an attorney in and around global law firms. She can be reached at 646-471-6104 and at [email protected].