Taxation of Representative Offices in China (2) – Tax-Exempt v Taxable Activities

2.1. Tax-exempt Activities

As reiterated in Circular Guoshuifa No. (1996) 165 and elaborated in Circular Guoshuifa No. (1997) 002 issued by State Administration of Taxation (SAT), the scope of tax-exempt activities for a RO are limited.

Where the head office is a manufacturer, the tax-exempt activities for its RO are:
– market study
– provision of commercial information
– liaison and other preparatory and supplementary services rendered at nil consideration for the manufacture and sale of the head office’s own products (i.e. the goods manufactured by the head office) into China.

Where the head office is a trader, the tax-exempt activities for its RO are:
– market study
– provision of commercial information
– other preparatory and supplementary services rendered at nil consideration for sale of the head office’s own goods into China.

Circular Guoshuifa No. (1997) 002 defines ‘sale of own goods’ as the trading activities that the head office has purchased, received and stored (the goods) before sale. The Permanent Representative Office should be able to prove, to the satisfaction of the tax bureau in charge, that its head office has autonomy and control over the pricing of the goods. In addition, the RO should be able to prove that its head office bears the business risks (e.g. inventory risks and risks of bad debts) that are normally expected for a trader of goods. For example, the tax bureau in China will not regard the following activities of the head office as ‘sale of own goods’ if:
– head office has firstly solicited and concluded a sale before it places the related purchase orders or production orders with suppliers (e.g. indent sale, back-to-back sale)
– the goods are purchased from the supplier and resold into China by head office at prices determined by the supplier.

In such instances the tax bureau will consider the head office as an agent for the suppliers / customers rather than a trader for tax purposes in China. As a result, the marketing and liaison activities carried out in China by the Permanent Representative Office will be considered taxable as agency services rendered to the head office’s suppliers / customers rather than to the head office.

Where a FE does not separately charge a service fee or commission fee, for example, from its supplier / customer, the tax bureau could consider that the ‘service income’ was taken into account and implicitly reflected in the prices of the goods purchased by the FE from its supplier or sold to its customer.

Where the head office is a financial institution, the tax-exempt activities for its Permanent Representative Office are:

(1) providing preparatory or auxiliary services to customers in China at nil consideration
(2) those connected with money lending between head office and its customers.

Where the head office is a government body or non-profit-making organisation the activities carried out by the Permanent Representative Office are tax-exempt. They are subject to the adjudication by the tax bureau in charge and the SATs final approval.

If the Permanent Representative Office believes that its activities could qualify for tax exemption they should apply to the tax bureau in charge for their adjudication and approval.

2.2. Taxable activities

If the activities of a Permanent Representative Office go beyond the tax-exempt activities mentioned above, the FE will be subject to Corporate Income Tax and Turnover Tax in respect of the income (e.g. commissions, rebates, handling fee income, service fees) derived from the activities performed in China by the Permanent Representative Office. This will be calculated on an actual or deemed basis. Listed below are examples of taxable activities of a RO (as detailed in Circular Guoshuifa No. (1996) 165):

(1) trade agency services performed by a Permanent Representative Office of a trading company
(2) all kinds of services provided by a Permanent Representative Office of a consulting company engaged in professional services (e.g. business, legal, tax or accounting consultation)
(3) all kinds of services rendered by a Permanent Representative Office of an investment holding company to its group companies
(4) advertising agency services carried out by a Permanent Representative Office of an advertising company
(5) all kinds of services (e.g. visa application, fee collection, air ticket booking, tourist guiding, arranging accommodation) performed by a RO of a travel agency company
(6) investment or other consultation services provided by a RO of a financial institution
(7) any level of transportation services rendered by a RO of a transportation company to customers
(8) any other taxable activities provided by a Permanent Representative Office.