On September 24, 2014, China Taxation News11 reported that a foreign corporation acting as a limited liability partner in a foreign invested partnership (“FIP”) established in Jinzhou, Liaoning province, was subject to 25% EIT because the FIP’s fixed place of business was deemed to be the limited liability partner’s permanent establishment (“PE”) in China.
The FIP had two partners: a Hong Kong investment company as limited liability partner with a 99 percent partnership interest in the FIP and a Shanghai consulting company as general partner with a 1 percent partnership interest. Both partners had the same parent company in Taiwan.
According to the China Taxation News report, the FIP distributed RMB1.12 million in profits to the limited liability partner in 2013. The limited liability partner claimed that the profits it received from the FIP should be characterized as dividends and enjoy the 5 percent preferential withholding rate provided by the China-Hong Kong Double Taxation Arrangement (“DTA”). The tax bureau, however, concluded that the profits the limited liability partner received should be characterized as business profits rather than dividends because the FIP was not a corporate entity but a tax pass-through entity.
Even though the profits were deemed to be business profits, the limited liability partner argued that these profits should still be exempt from EIT under the China-Hong Kong DTA because the limited liability partner did not have a PE in China. The limited liability partner argued that the partnership’s fixed place of business was exclusively owned by the FIP and the limited liability partner did not have a fixed place of business in China. However, the tax bureau took the view that the FIP was not an EIT taxpayer and the FIP’s fixed place of business should be deemed as the limited liability partner’s fixed place of business in China.
China does not yet have any law or comprehensive set of rules regarding the taxation of partnerships. Some general guidance is available under Circular 159, which establishes that partnership profits are first allocated to the partners, who are subject to individual income tax (“IIT”) or EIT depending on whether they are individuals or enterprises. However, China does not have any clear rules on how to tax a foreign partner in an FIP.
This decision clarifies that the FIP’s fixed place of business will be deemed as the foreign limited liability partner’s PE in China. Although this decision is not binding on future cases, it does provide some general guidance that might be considered persuasive by Chinese tax authorities in the future.