On 1 August 2014, the “Provisional Measures on the Collection of Tax on Non-Resident Taxpayers Engaged in International Transportation Business” (2014 No.37 Notice, the “New Regulations”) came into force. The New Regulations could have a significant impact on owners as they seek to streamline and tighten up the regulations in respect of tax obligations on “non-resident taxpayers” engaged in “international transportation business”.
The main aspects of the New Regulations are summarised briefly below.
Scope of “international transportation business” and “non-resident taxpayers”
Under the New Regulations, “international transportation business” includes the carriage of cargo and passengers in and out of Chinese ports by non-resident companies through vessels, charter slots and aircraft. The chartering of ships on voyage charters or time charters (and leasing aircraft out on a wet lease basis) for income generation from such activity are now classified as “international transportation business”.
Any non-resident companies that earn income from international transportation business, as defined in the New Regulations, are potentially subject to PRC corporate income tax (“CIT”).
Under the New Regulations, non-resident companies that engage in international transportation business are required to register with one of the PRC local tax authorities within 30 days of the conclusion of the charter and the New Regulations set out detailed rules and procedures regarding tax registration.
Non-resident companies may complete tax registration either by themselves or by their appointed local agents and can choose one tax authority to complete all filings for calls at all PRC ports.
“Appointed” withholding agents
If the non-resident taxpayer fails to register and pay tax voluntarily, the PRC authorities can appoint the Chinese contract counterpart, amongst others, as the withholding agent of the non-resident taxpayer and require such agent to withhold the tax before making payment to the non-resident taxpayer.
Calculation of taxable income
Non-resident taxpayers that have completed tax registration in China must establish and maintain records and accounts in accordance with PRC tax laws and rules to properly calculate the taxable income.
Taxable international transportation income is calculated by deducting “deductible expenses” from the gross revenue earned from the carriage of cargo and passengers. Deductible expenses comprise the reasonable expenses actually incurred to earn the revenue received.
For non-resident companies that cannot accurately calculate their taxable income, the tax authority will apply a “deemed profit ratio” to the gross income to calculate the taxable income. Previously, the “deemed profit ratio” was set at 5% of the total income earned for carrying cargo or passengers from China. Under the New Regulations, the “deemed profit ratio” shall range from 15% to 50% of the gross income earned carrying cargo or passengers in and out of Chinese ports.The CIT rate (25%) will then be applied to the taxable income in order to calculate the tax payable.
Double Taxation Agreements (“DTA”) and Shipping Income Agreements (“ISA”)
The New Regulations also set out detailed procedures for non-resident taxpayers to apply to the PRC tax authorities for exemption/benefits under any applicable double taxation treaties between their place of tax residency and China. A failure to comply with the required registration procedures could result in an owner being denied tax relief under a DTA or ISA.
The requirements include a tax residency certificate issued by the country of which the relevant DTA or ISA is applied.
As a result of the clarification that “international transportation business” includes carriage of cargo and passengers both in and out of Chinese ports as explained above, there is the potential for an increase in the tax payable by non-resident owners. However, it is not clear how the taxable income will be calculated in the complicated context of international shipping. For freight earned from a single voyage in respect of cargo to/from China, there may be little doubt that the voyage falls within the scope of “international transportation business” under the New Regulations. However, things become complicated with, for example, long term time charters under which the ship occasionally calls at Chinese ports and questions then arise as to whether and to what extent hire earned under the time charter will be considered as income earned from the “international transportation business” and what expenses fall within the scope of “deductible expenses” under the New Regulations.
The New Regulations are in their infancy. There is at present uncertainty surrounding their scope and the extent to which and manner in which they will be enforced. There is a risk that different local tax authorities will apply the New Regulations differently. What does seem clear is that they serve as a signal that the Chinese tax authorities intend to tighten up the regulations regarding income tax payable by non-PRC resident companies that engage in international transportation business that includes the provision of services within Chinese territorial waters. Consequently, the New Regulations are likely to have a significant potential impact on owners with vessels chartered to Chinese counterparts. Such owners will need to seek advice quickly on their registration obligations and the extent to which they might be able to avoid or reduce their tax exposure by complying with the registration and documentary requirements to trigger any applicable double-taxation treaties.
For future contracts with Chinese counterparts, owners should carefully review the tax clause to ensure that it adequately protects the owners from being required to pay Chinese corporate income tax and also turnover tax (i.e. VAT). Significant tax reforms were introduced from 1 August 2013 that added transportation activities into the chargeable scope of VAT at the rate of 11% or 17%, depending upon the type of transportation service performed within China. Whereas CIT is payable on taxable income, VAT is calculated by reference to the gross revenue.