Early last month we published an article discussing the Chinese tax authorities’ efforts on collection of taxes on incomes generated in China by non-resident enterprises (defined in the Enterprise Income Tax Law of China as “an enterprise incorporated in a foreign country or region with its actual management organization located outside China”). This was accomplished by issuing a handful of new tax rules (read the article here). To further strengthen these efforts, the State General Administration of Taxation issued another new tax regulation (the Methods of Administration of Checking and Ratification and Collection of Non-resident Enterprise Income Taxes (“Tax Checking and Ratification Methods”) on February 20, 2010. These Methods specifically target non-resident enterprises that have generated income from China but failed to maintain complete accounting records or documents associated therewith.
Right to Ratify Deemed Taxable Income. Based on the Tax Checking and Ratification Methods, the relevant tax authority will have the right to check and ratify taxable incomes according to certain applicable formulae. Different formulae apply to different kinds of checking and ratifying methods. For instance, the relevant tax authority would check and ratify an amount of taxable income based on the total revenue. The amount of taxable income will be equal to total revenue multiplied by a profit margin ratified by the tax authority. This formula applies to the situation where the total revenue could be reasonably calculated or deemed, but the relevant costs could not be assessed. There are also formulae that apply to circumstances where the amount of taxable income is computed based on cost accounting or appropriation expenditure.
Right to Ratify Profit Margins. The Tax Checking and Ratification Methods also give a relevant tax authority the right to confirm a profit margin based on a profit margin range stated in the Methods. The profit margins vary depending on the specific businesses involved. For example, the deemed profit margin for engaging in a management service business is from 30% to 50%, the deemed profit margin for engaging in a contracting engineering, designing or consulting business is between 15% and 30%, and the margin for engaging in other service businesses or beyond should not be lower than 15%.
Right to Ratify Service Income. One article in the Tax Checking and Ratification Methods is specifically dedicated to equipment or goods purchase contracts. This article states that where a non-resident enterprise and a Chinese resident enterprise sign an equipment or goods purchase contract whereby the non-resident enterprise shall provide services for equipment installation, supplies, technical training, guidance and supervision, and the contract fails to specify the related service charges or unreasonably prices the services, the relevant tax authority may reassess the service income by reference to fee standards charged by similar businesses. If there is no reference, the service income of the non-resident enterprise would be confirmed at no lower than 10% of the total contracting price set forth in the purchase contract.
Again, the various new tax regulations governing non-resident enterprises will subject these enterprises to the close scrutiny of Chinese tax authorities. Getting to know these regulations, seeking good advice and planning in advance will help reduce non-compliance risks.