If a Permanent Representative Office maintains the accounting books and business records (e.g. service agreements, vouchers and receipts) in China, these can be audited by a registered CPA firm to reasonably ascertain the income and profit amounts. The Permanent Representative Office may apply to the tax bureau to file the tax returns on the actual results basis.
In practice, many Permanent Representative Offices do not maintain a full set of accounting records in China. In addition, many FEs do not enter into separate contracts or charge a separate service fee for the work done by their Permanent Representative Offices in China for the FE’s suppliers or customers. In such situations, the tax bureau prescribes the use of one of the following methods to estimate their taxable revenue and assessable profits for filing tax on a deemed results basis. Once the method is approved, it should be consistently applied.
4.1. Revenue-Based Method
This method is only useful if the revenue information is available and can be proved to the satisfaction of the tax bureau. It involves two steps:
1. ascertaining the China-source revenue attributable to the work done by the RO
2. deeming the profits in the absence of expense details.
Ascertaining the China-source Revenue for the RO
If a Permanent Representative Office can provide documentary evidence (e.g. service contracts or sales contracts specifying the commission amounts) showing the accurate amount of the China-source revenue, the tax bureau will allow the use of that amount as taxable revenue.
However, if the total amount of China-source revenue for the RO is not explicitly available ¡V but the Permanent Representative Office can submit all the relevant sales contracts between its head office and the customers in China for the goods sold into China ¡V the tax bureau may deem 3% of the total sales amount as the revenue for the RO.
If the Permanent Representative Office can provide further documentary evidence substantiating the part of the sales agency services that are carried outside China by its head office, the tax bureau may approve to treat only 50% of the revenue as the taxable revenue for the Permanent Representative Office. After the determination of the taxable revenue, BT should be paid at 5%.
Deemed profits
If there is no proof of the actual amount of expenses of the Permanent Representative Office, the tax bureau will generally estimate the taxable profit for the Permanent Representative Office by applying a deemed profit rate on the taxable revenue amount. The deemed profit rate for provision of liaison and promotional services in China is currently 10%.
Example 1
A Permanent Representative Office in Beijing provides liaison and marketing services in China for the sale of goods into China by a company in Hong Kong (HK Co) for HK$934,580 (converted to RMB1 million). HK Co is a fellow subsidiary company of the head office of the Permanent Representative Office.
The tax bureau reviews the service agreement and agrees that the taxable revenue is RMB1 million. However, the RO is not able to provide any invoices for the expenses incurred in relation to the services rendered.
Accordingly, the EIT and BT payable by the RO will be as follows:
Taxable revenue = RMB1 million
BT payable = RMB1 million x 5% = RMB50,000
Taxable profit = RMB1 million x 10% = RMB100,000
EIT payable = RMB100,000 x 33% = RMB33,000
Effective tax rate = 100% x (33,000 + 50,000) / 1,000,000 = 8.3% (of taxable revenue).
If the RO is registered and operates within a Special Economic Zone, the EIT and BT payable by the RO will be as follows:
BT payable = RMB50,000
EIT payable = RMB100,000 x 15% = RMB15,000
Effective tax rate = 100% x (50,000 + 15,000) / 1,000,000 = 6.5% (of taxable revenue).
Example 2
A Permanent Representative Office in Shanghai carries out taxable activities in China. The total sale of goods that its head office sold into China in connection with the liaison and marketing effort of its Permanent Representative Office is US$200,000 (US$1 = RMB8.3). The sales contract did not state the commission income amount for the head office and its Permanent Representative Office. The RO could not provide any supporting evidence for its expenses, but could provide documentary evidence to substantiate that about half of the liaison and marketing work in respect of the total sales in China was done outside China by its head office.
The EIT and BT payable by the Permanent Representative Office will be as follows:
Deemed commission income = US$200,000 x 8.3 x 3% = RMB49,800
China-source revenue = RMB49,800 x 50% = RMB24,900
BT payable = RMB24,900 x 5% = RMB1,245
Taxable profit = RMB24,500 x 10% = RMB2,490
EIT payable = RMB2,490 x 33% = RMB822
Effective tax rate = 100% x (1,245 + 822) / 24,900 = 8.3% (of taxable revenue).
The revenue-based method is not commonly used. This is due to the administrative burden and considerations of business information sensitivity in submitting the original sales contracts to the tax bureau for examination.
4.2. Cost-Based Method
This is currently the method preferred by tax bureaus. It is used for almost all ROs set up after the implementation of Circular Guoshuifa No.(1996) 165. Tax bureaus require taxpayers to adopt this cost-plus methodology in the following situations:
(1) where the Permanent Representative Office is unable to present valid documentation or proof to accurately distinguish its taxable and tax-exempt activities
(2) where the Permanent Representative Office often provides services to customers together with its head office, and is unable to present valid documentation or proof to substantiate the respective share of the revenue of head office and its Permanent Representative Office
(3) circumstances in which the Permanent Representative Office fails to report its taxable amounts properly and accurately.
This method involves three steps:
1. ascertaining the total expenses of the Permanent Representative Office
2. deeming the taxable revenue in the absence of the revenue information
3. estimating the assessable profit based on the taxable revenue calculated.
4.3. Ascertaining the total expenses
The ‘total expenses’ of a Permanent Representative Office normally include:
– the remuneration paid to Permanent Representative Office staff (irrespective of the payment locations)
– telecommunication expenses
– travelling expenses
– rental expenses
– entertainment expenses
– costs and freight charges for purchases of sample goods in China for its head office.
The full amount should be included in the total expenses in the tax reporting period when expenditure is incurred for additions to fixed assets and leasehold improvements. If the lump sum included in the total expenses during one tax reporting period is large causing hardship the taxpayer can apply to use the depreciation and amortization charges for each period in calculating the total expenses for that period. In this instance the tax bureau must be satisfied that proper and complete accounting books and records are maintained.
Office equipment, vehicles, furniture and fixtures should be depreciated over five years. Buildings should be depreciated over twenty years. The straight-line method should be used for depreciation calculations. No residual value is required on these fixed assets. Leasehold improvement expenditure can be spread evenly over a maximum of five years.
Certain items cannot be included in the calculation of the ‘total expenses’ of a Permanent Representative Office. These include:
(1) tax late-payment surcharges and penalties
(2) qualifying charitable cash donations for China
(3) expenses paid on behalf of the head office (not directly related to the RO’s own activities), for example:
-airline expenses for staff visiting the head office
-hospitality, accommodation and transportation costs and entertainment expenses incurred by delegates from head office visiting China (not directly related to any discussion or conclusion of any business contracts)
-rental expenses for meeting venues used by head office to hold conferences (not directly related to any discussion or conclusion of any business contracts)
-advertising and exhibition expenses, customs duty and import taxes on imported samples of goods and local delivery expenses (in relation to large exhibitions held in China by the head office)
-compensation payments made to customers of head office, in relation to the head office’s non-compliance of the contract terms of its goods sold in China.
Interest income of the Permanent Representative Office cannot be used to set off expenses of the RO. You should also note that expenditure accounts audited by a registered CPA in China are required to be submitted to the tax bureau on an annual basis in support of tax filings using this method.