Turnover taxes in the PRC

Value-Added Tax

The PRC Value-Added Tax (VAT) took effect on 1 January 1994. VAT applies to the sale and importation of goods in China, and also applies to processing and repair or replacement services carried out in China.

Sellers of taxable goods and services are required to collect VAT from purchasers at rates of 17 per cent for most goods, 13 per cent for certain staples, books and publications, and 17 per cent for processing and repair or replacement service. PRC Customs is required to collect VAT at the applicable rate at the time of importation of goods.
Goods exempted from VAT include:
Exports by certain FIEs which commenced their operations prior to 1994
Agricultural produce sold by original producers;
Contraceptives;
Second-hand articles; and
Such other items as may be specified by the State Council.

Exemptions from VAT also apply in respect of the importation of equipment for scientific research, supplies and equipment donated by international organisations and foreign governments, and such other items as may be specified by the State Council.

Goods exported by FIEs established in 1994 or later and by domestic enterprises are zero-rated (as opposed to exempt from VAT). Post-1993 FIEs are theoretically entitled to receive a partial refund of VAT paid by them in respect of purchases of raw materials from domestic suppliers when the finished goods made from the those raw materials are sold to customers outside China. However, post-1993 FIEs effectively suffer an effectively suffer an export VAT burden equivalent to 8 per cent of export sales value net of the value of imported raw materials which were orginally exempt, if applicable.

FIEs in operation before 1994 are not entitled to a VAT refund, but are entitled to a different refund, at least during the five-year period from 1994-1998 under grandfather rules, intended to ensure that such FIEs do not suffer any increase in tax burden under the new tax system. This refund is equal to the difference between (1) the total VAT and consumption tax burden borne by the FIE in the year and (2) the tax burden that would have been borne by the FIE under the pre- 994 system of turnover tax (Consolidated Industrial and Commercial Tax).

VAT payable on imports is calculated as follows:
Tax Payable = VAT Rate x (Dutiable Value of Goods + Applicable Customs Duty + Applicable Consumption Tax)

PRC Customs is required to collect VAT at the point of entry on behalf of the taxation authorities. Importers or their agents must pay tax within seven days of issuance of a duty-and-tax-payment certificate by Customs.

Sellers must charge purchasers VAT on the total renminbi purchase price of goods including all commissions, late payment interest, packaging and other fees, but excluding the applicable VAT itself, Consumption Tax and any transport department fees. Where a seller obviously understates a sales amount, the tax authorities may estimate a deemed sales amount. Taxpayers concurrently dealing in goods an services with different tax rates are required to separately calculate the relevant sales amount or pay tax at he highest applicable rate.

Sellers must remit VAT to the tax authorities according to the following formula: VAT Payable for Current Taxable Period = VAT Paid on sales During the Period – VAT Paid on Purchases of Domestic and Imported Goods During the Period

Different formulas apply to export sales by FIEs. VAT paid on purchases of fixed assets and on purchases of goods and taxable services used for non-taxable items, tax-exempt items collective welfare and individual consumption may not be deducted. Deductible amounts of VATs paid on purchases must be evidenced by special VAT receipts issued by sellers or, for imports, by duty-and-tax-paid certificates issued by Customs clearly specifying the amount of tax paid and other relevant particulars. Where there is an negative balance of VAT payable, the seller may carry the balance forward to the next taxable period.

VAT liability arises on the receipt by a seller of full payment or of a payment voucher for taxable goods or services, or on declaration to Customs by an importer of imported goods. Local tax authorities will arrange taxable periods for individual tax payers in cycles of one day, three days, five days, ten days, or one month depending on t he amounts of tax payable. A head office and each of its branches is required to pay applicable VAT to local tax authorities in the place where each is located. However, with the approval of the State General Administration of Taxation, a head office may pay on a consolidated basis for all of its branches.

Business Tax

Business Tax is payable at varying rates by enterprises which provide services, sell immovable property or assign intangible assets .
Business Tax applies at the following rates:
3 per cent of the price of services in the areas of transport, construction, posts and telecommunications, culture and sports;
5 per cent of the price for most other services, finance and insurance, the assignment of intangible assets and the sale of immovable property; and
5 per cent to 20 per cent, as set by local authorities, of the price for entertainment.
Foreign representative offices are subject to Business Tax on deemed income at a flat rate of 5 per cent.
Exemptions from Business Tax apply in respect of agricultural, medical, social welfare and educational services, cultural activities, and copyright licensing.

Business Tax is calculated at the applicable rate on the full price received by the seller or service provider, including all charges. Specific methods of the calculating the taxable amount apply to transportation enterprises, tourism enterprises, construction contractors that subcontract, enterprises trading foreign exchange, securities or futures enterprises, and financial institutions that on-lend. Where sellers or service providers concurrently engage in activities subject to different rates of Business Tax, they are required to calculate separately the different tax items, or pay at the highest applicable rate. Tax liability arises on receipt of full payment or a payment voucher for the taxable service or immovable or intangible assets.

Local tax authorities will set payment periods for individual taxpayers of five days, ten days, 15 days, one month, or per transaction, depending on the amount of tax payable.

Before a decision on investment in China is made, investors need to carry out research on various issues to help formulate their investment plan and strategies. Based upon experience, the following are some of the common major issues concerning investing in China.

Current investment policies

Specific industry policy set by the supervisory authorities of the relevant industry has to be thoroughly understood. It is also important to pay attention to Central Government policies discussed and announced by authorities such as the Politburo and the National People’s Congress. These policies will give an indication of the overall political and investment environment in China.

The government authority directly concerned with FDI is the Ministry of Commerce (MOCOM) and its local counterparts. MOCOM is responsible for the formulation of policies and regulations in attracting foreign investment. The ‘Catalogue for the Guidance of Foreign Investment Industries’ promulgated jointly by MOCOM and the State Planning Commission (now known as the State Development and Planning Commission) is essential reading. You will need to find out whether your intended project is classified under an ‘encouraged’, ‘restricted’ or ‘prohibited industry’ by the Chinese Government. There are different incentives and choices of investment vehicle for different classifications.

Last, but not least, it is vital to understand how local authorities interpret and implement the policies and what their attitude is towards the proposed investment, so that the necessary approvals can be more easily obtained

Which investment vehicle?

Investment vehicles commonly used in China are Sino-foreign equity joint ventures (EJV); co-operative (or contractual) joint ventures (CJV); wholly foreign-owned enterprises (WFOE); joint stock companies; holding companies; representative offices (RO); assembling and processing contracts (APC), and branches. Among these vehicles, RO’s, APCs and branches are not separate legal entities. Understanding the distinctions between the different vehicles will help you choose a suitable corporate structure for investment.

As a note of reference: there is a new type of entity available for setting up in China – a FICE (Foreign Invested Commercial Enterprise). This might be a worthwhile means of entry for a new investor in China but not just yet. As is ‘brand new’ (end of 2005/beginning of 2006), local bureaucratic administration is not quite sure how to ‘handle’ these entities and our advice would be to wait – at least until the end of 2006 – prior to proceeding with this type of entity.

Legal entity or not: Whether you decide to set up a legal entity or not will have a significant impact on your commitment to China, what you may wish to achieve and how you can meet these objectives. Each investment vehicle will have different characteristics in relation to capital commitment, corporate obligations, tax exposure, social security contributions and permitted scope of activities.

JV or WFOE: Having a local Chinese partner is often an effective way to assist you in manoeuvering through red-tape and bureaucracy. Such a partner can also help develop the local market, build up a good relationship with local authorities and manage local staff. However, for this type of relationship to be successful, the intended partner should share the same corporate vision and objectives as you do. Are they in accord with the management style and development strategies that your head office considers most appropriate? What will happen to your project and overall development strategy if your intended partners fail to deliver on today's commitment and obligations? How much will it cost you to exit if you have a partnership that doesn't work out?

Assembling and processing contract: Foreign investors previously have been able to set up their manufacturing bases in China by entering into an assembling and processing contract (APC) with a Chinese party. Under such an arrangement, the foreign party does not technically own any subsidiary or office in China. Rather, the foreign party provides technology, machinery, spare parts and raw materials, and the Chinese party provides manufacturing facilities and services for subcontracting fees. Finished products are exported by requirement. It is not surprising to find thousands of workers in a large-scale APC factory that is actually run by foreign investors. To set up an APC factory in China, foreign investors had to go through application procedures similar to those for foreign investments enterprises (FIEs)-approval of project proposal and subcontracting agreement by the supervisory authority of the Chinese party and the Ministry of Commerce (MOCOM). As it is the Chinese party that “owns” the factory, it will, in practice, handles all the application procedures for the foreign investors.
This type of contract is being more frequently challenged by tax authorities in the form of higher tax rates to the Chinese manufacturer and thus, is being replaced by other ‘economic incentives’ but it is still functioning throughout much of China Chinese holding company:
Foreign investors can apply to set up Chinese hold companies (CHC) pursuant to the PRC provisional Regulations for the Establishment of Investment Companies by foreign investors. Through the CHC, the foreign investor can make investment into FIEs and provide various kinds of co-ordinating services to them. The foreign investing party must fulfill the following conditions in order to apply for establishment of a CHC:
a) Either have total assets of not less than USD400m in the year prior to the application, set up FIEs in China of more than USD10m registered capital paid up by the applying party and have at least three project proposals accepted by the Chinese authorities, or
b) Have set up more than 10 FIEs engaging in production or infrastructure construction of not less than USD30m made by the applying party. A minimum registered capital of USD30m for the intended CHC. These amounts will be reduced under WTO accords.

Choosing a location

China is a huge country with 23 provinces and hundreds of cities. Factors such as government support, tax incentives, infrastructure, transportation, market size, labor quality and labor cost and distribution network should be carefully evaluated when looking for an appropriate location to set up a business.

The most popular destination, greater Guangdong in south China, has attracted over 36 per cent of total foreign investment and is faced with the threat that it may lose potential investors due to an increase in labor costs.

One may find investment incentives offered by local governments even more favorable than they should be according to Central Government policy. It remains uncertain when such extra incentives might be revoked by the Central Government. Similarly, it is also not uncommon for local governments to approve projects that go beyond their authority or are not in-line with Central Government policy. Such projects are exposed to the paramount risk of a subsequent reversal by the Central Government. Investors should seek legal advice and take a step back if they find that local practice conflicts with state legislation.

Set-up costs

There is no such thing as a shelf company in China. However, you can readily find sample JV contracts and articles of association. Some investors may just insert their own figures and company name in the sample document, whereas others may consider it necessary to have a professional draft an agreement from scratch. The latter may involve considerable professional work and fees. However, many investors would prefer to have professional assistance in preparing all these documents because this can save senior management resources and avoid pitfalls from the very beginning.

The total investment amount specified in the application usually includes registered capital and loans. The capital contribution made by a foreign party must be equal
to or exceed 25 per cent of the total registered capital for a JV. Local governments set different minimum capital requirements for different industries.

The capital injection is required to be made either in a single lump sum within six months of the issuance of the business license, or by installments within deadlines depending on the level of investment.

Repatriation of capital once injected is only allowed upon termination of the project. Loans denominated in foreign currency, including those made by foreign investors, are subject to registration with the State Administration of Foreign Exchange. Otherwise, repayments of interest and principal cannot be made from China.

Operating costs

There is a common impression among westerners that everything is cheap in China. In China's unique business environment, foreign ventures should pay careful attention to operating expenses that may not constitute substantial costs in other countries but do here, for example, costs to designated agents for their services because of the restrictive scope of permitted activities. Equally important, is to identify all the hidden costs relevant to the intended project, for instance, utility capacity fees, social security contributions and numerous local government charges.