China Tax Alert - April 3, 2008 - International Tax

By Vivian Jiang, Caesar Wong, Anthony Tam and Kevin Ng

Before 2008, foreign-invested enterprises with branches registered in China generally were required to file and pay Enterprise Income Tax (EIT) on a "combined" basis. Filing and payment were made with the tax bureau in-charge where the head office of the company was located and it was not necessary to make a separate filing or payment with the tax bureau where the branch was located. This process is changed for 2008, with a significant impact on foreign-invested enterprises with cross-district operations.

Under the new Enterprise Income Tax Law, effective 1 January 2008, resident enterprises with branch(es) registered in different regions in China must make a combined annual settlement and filing of EIT. In early 2008, the State Administration of Tax, the Ministry of Finance and the People's Bank of China issued a series of regulations and circulars to regulate the tax filing of enterprises with headquarters and branches in different districts. Following Circular Guoshuihan 2008 No. 44, which provides the new monthly (quarterly) provisional EIT returns and tax revenue allocation statement, more detailed guidance on the implementation of tax filing and payment was issued in Circular Caiyu 2008 No. 10 and Circular Guoshuifa 2008 No. 28 (Circular 28), released in mid-March.

Principles of the New Rules

Circular 28, Tentative Rules of Enterprise Income Tax Administration and Collection for Enterprises with Cross-District Operations (Rules), clarifies that, unless otherwise stipulated, affected enterprises are resident enterprises with branches (non-separate legal entities) registered in different districts (meaning provinces, autonomous regions, municipalities and cities specifically designated in the state plan) in China. The Rules, which apply as from 1 January 2008, are based on the following principles:

Combined calculation - The taxable profits and tax payable must be computed based on the total results of the head office and its branches.

Respective supervision - The head office and its branches are subject to the management and supervision of the tax authorities at the locations where they are registered.

Provisional local payment - The head office and its branches are required to make monthly/quarterly tax filings with the relevant tax authorities and pay provisional taxes locally in accordance with the Rules.

Centralized annual settlement - After the tax year end, the final tax liabilities and the amount of tax under or overpaid during the year must be calculated and final settlement made with the tax authorities in charge of the head office.

Tax revenue transfer - The Ministry of Finance will allocate and transfer the tax revenue deposited into the temporary account of the central government to the relevant local government accounts based on certain coefficient factors.

Features of the New Rules

Compared with the previous tax regime, the new requirements have the following features:

A headquarters and a second tier branch with manufacturing and business operations functions must make monthly/quarterly provisional payments to the local tax authorities. If a company has difficulties in making a timely provisional tax payment based on actual profits, it may be able to obtain approval from the tax authorities in charge of the head office to make provisional payments by the head office and its branches based on 1/12th (for monthly filing) or 1/4th (for quarterly filing) of total taxable profits of the previous tax year. In such a case, this method should then be adopted for the filings for that tax year.
The provisional tax payable for the period must be computed based on actual profits and it should be allocated among the head office and each of the branches (see Note 1 in the diagram below). Three factors should be used for allocation among the branches: operating revenue, employee remuneration and total assets of prior years (for the period January-June, figures from the year before last year and for the period July-December, figures from last year).
The year end final tax settlement only must be made by the head office.

Under the new Rules, the financial statements and accounting reports of the head office and individual statements and accounts of each of the branches will become critical, especially for the figures derived from the above three factors (again, operating revenue, employee remuneration and total assets of prior years).

New Filing and Payment Procedures

The following flow chart illustrates the procedures under the new Rules:

[Image omitted. Please view PDF attached at end of page for image.]

Diagram Note 1: The allocation percentage of advance tax payment for the entire company is 50% payable by the head office and 50% by all branches (collectively).

For the proportion of advance tax payment allocated to a single branch, the formula is: [0.35 x (amount of operating revenue of a branch/ amount of total operating revenue of all branches)] + [0.35 x (amount of employee remuneration of the branch/amount of total employee remuneration of all branches)] + [0.3 x (total assets of the branch/total assets of all branches. The advance tax payment of a branch formula is: the total amount of advance tax payment of all branches x proportion of advance tax payment allocated to that branch.

Comments

As noted above, the new Rules will have a significant impact on foreign-invested enterprises with cross-district operations. The deadline for the first quarterly provisional tax filing (i.e. 15 April 2008) is fast approaching and companies need to immediately begin planning for the filing deadline.

Special circumstances – The following circumstances are separately addressed under the Rules:

Companies that were assessed as a "small-and-low-profit enterprise" in the previous tax year are not required to make a tax filing or payment at the branch level for the current year;
Newly established branches do not need to make a local filing or payment during the year of establishment;
The head office of a de-registered branch must make the tax payment attributable to that branch for the remaining period of the year to the central treasury; and
Branches registered overseas are not required to make a tax payment.

Branches that are not required to make local tax payment - The Rules stipulate that second-tier and lower-tier branches that only perform auxiliary functions (e.g. after-sales services of products, internal research and development, warehousing), that do not carry out manufacturing or business operations and that are not required to pay VAT and Business Tax locally, do not have to make EIT payment locally. Affected companies should review their branch operations carefully (especially where both the head office and its branches are engaged in a service industry or where a branch may have "deemed sales activities") to prevent a situation where the operations will attract turnover tax liabilities locally, which may result in EIT local filing and payment exposure for the branch.

Operating revenue, employee remuneration and total assets - Although the Rules briefly define the three factors, further clarification and explanation are required. For example, it is unclear whether the common overhead, remuneration costs of executives working for both the head office and branches, and the assets controlled by both the headquarters and branches should be subject to allocation in determining the amount of the three factors. Companies that have not calculated the assets, expenses and revenue separately for each branch should do so as soon as possible.

Districts with different tax rates - Companies must calculate taxable profits (instead of tax payable) and divide them among the head office and branches based on the three factors. Different tax rates are then applied to the allocated profits of the head office and branches to compute the tax payable.

Different interpretations of tax authorities in different districts - Different local tax authorities may have different interpretations of the definitions and criteria in the New Rules (such as "small-and-low-profit enterprise"). Such differences in opinion may lead to re-review procedures.

High and New Technology Enterprise (HNTE) - Since the rules for application for HNTE status have not yet been issued, companies that likely will qualify still must pay provisional EIT at a rate of 25%. Should a company be granted HNTE status retroactively, it is unclear how adjustments to taxes paid in prior years would be made under the new Rules.

Local investment incentives - Some local governments provide investment incentives, the amount of the incentive sometimes being determined by reference to the local revenue raised from EIT payments. How the new financial revenue allocation method will impact current incentives granted to companies is currently unclear.

Branch losses - Based on the operation of the Rules, branches with a deficit or shortage of cash may still be required to make EIT payment locally. In addition, it is unclear whether there is any internal relief of tax losses among the head office and its branches.

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