Key Points:

  • “Withhold at source” rule adopted for income generated by nonresident companies
  • New contract filing requirement for Chinese payers
  • Numerous registration and filing requirements introduced for nonresident companies, withholding agents and PRC-resident contracting parties
  • Issue unresolved as to whether requirements apply to projects/services outside China requiring visits to China by nonresidents  

The State Administration of Taxation (“SAT”) recently issued two circulars: Tentative Measures for the Administration of Source Withholding of Corporate Income Tax for Nonresident Companies (Guo Shui Fa [2009] No. 3) and Tentative Measures for the Tax Administration of Contract Projects and Service Provisions for Nonresidents (Decree [2009] No. 19). These two regulations, which are targeted at nonresident companies, demonstrate the tax authority’s determination to strengthen the tax administration for nonresident companies in China.  

Tentative Measures for the Administration of Source Withholding of Corporate Income Tax for Nonresident Companies (“Circular No. 3”)

China is adopting the “withhold at source” rule for income generated by nonresident companies: i.e., the Chinese payer must act as the withholding agent for nonresident companies and deduct any applicable tax from its China source income – such as dividend, interest, rent, royalties or capital gains derived from the disposal of property – before sending the payment out of China. In addition to this withholding obligation, Circular No. 3 introduces a new contract filing requirement for the Chinese payer. Within 30 days after the execution of the agreement by the PRC resident company and nonresident company, the PRC resident company (“PRC company”) must file a contract registration form, a copy of the agreement and other related documents with the tax bureau. If the agreement is subsequently amended, supplemented or extended, the PRC company must file the changes with the tax bureau within 30 days after the amendment, supplement or extension takes place. In addition, the PRC company should maintain a contract file and a separate account for recording the withholding information.

Circular No. 3 is significant because it officially clarifies that taxes should be paid by a nonresident company on capital gains derived from offshore transfer of equity interest in a PRC company. Under PRC tax law, capital gains derived from the sale of shares of a PRC company are considered PRC source income and thus subject to withholding tax in China. This circular acknowledges that in this situation, the nonresident transferor is responsible for paying the tax. The target PRC company does not have a statutory obligation to withhold any tax on behalf of the nonresident transferor, and it should not be held liable if the nonresident transferor fails to pay the tax. The nonresident transferor must file the taxes either by itself or through a designated agent with the tax bureau where the target PRC company is located. However, the circular requires the target PRC company to submit the equity transfer agreement to the tax bureau when it files its application to change its tax registration. Although the circular indicates that the target company should assist the tax bureau in collecting taxes from the nonresident transferor, it fails to provide any details as to what kind of assistance the target company should provide.

According to Circular No. 3, if the PRC company and nonresident company agree that the Chinese payer will accept the tax liabilities of the nonresident company, the net income received by the nonresident company will be grossed up when calculating its tax liability; i.e., the tax borne by the PRC company will be considered taxable income for the nonresident company and thus subject to PRC tax.  

Tentative Measures for the Tax Administration of Contract Projects and Service Provisions for Nonresidents (Decree [2009] No. 19) (“Decree No. 19”)

Decree No. 19, targeted at regulating nonresident contract project companies and service providers in China, introduces numerous registration and filing requirements not only for nonresident companies but also for withholding agents and PRC-resident contracting parties (“PRC companies”).

Nonresident companies contracting to provide project services including construction, installation, assembly, finishing or utility, or rendering other services in China, are now required to register with the tax bureau where the project is located or when they provide those services within 30 days after the execution of their agreement with the PRC company for which they are providing the service. They must also deregister with the tax bureau within 15 days of the completion of the project or service.

The PRC company, for its part, must submit the registration form, agreement and tax registration certificate of the nonresident company within 30 days after the execution of its agreement with the nonresident company. It must also file a change application with the tax bureau within 10 days after any change in the agreement. Additionally, the PRC company must submit to the tax bureau a photocopy of the invoice it obtained from the nonresident company within 30 days after receipt.

Decree No. 19 further requires the nonresident company to file provisional corporate income tax quarterly and final corporate income tax annually except for certain situations for which it may obtain an exemption: for example, if the company worked on the contracted project or provided its services for less than one year, its work was completed before the end of the year and all relevant taxes have been fully paid, or it completed deregistration during the annual filing period.1 If the nonresident company is responsible for paying the business tax or value added tax (VAT) and has a business establishment in China, it must report those taxes itself. If it does not have an established business in China, it may appoint an agent to report its tax; if it fails to designate an agent, the Chinese party must act as the withholding agent.

Decree No. 19 significantly increases the administrative burdens of the nonresident company as well as the PRC company. In addition to its tax registration requirement as imposed under the previous law, the nonresident company carrying out a contract project or providing services in China must submit a detailed project report when filing its tax return on which a great amount of information is requested, including date of entry into and exit from China, project or service period, work description, remuneration information and expense information.

In practice, it is difficult for most nonresident companies to keep track of this information, as they usually do not maintain records in China. As outlined above, Decree No. 19 also imposes a heavy responsibility on the Chinese contracting party by requiring it to submit information to the tax bureau during various stages of the project.

Nevertheless, Decree No. 19 leaves one important issue unanswered. The law stipulates the registration and filing requirements to which a nonresident company rendering services or conducting projects within China is subject. However, it is unclear whether these requirements apply in situations in which the entire project is to be completed, or the service rendered, outside China, but an individual or individuals from the nonresident company must visit China on a number of occasions in the course of the work. Subsequent regulations should clarify this outstanding issue.