AUGUST/SEPTEMBER 2003 ASIA-PACIFIC TAX BULLETIN
CHINA
Withholding Tax Planning Techniques*
Daniel Chan and Carol Gaw
Baker & McKenzie, Hong Kong
1. WITHHOLDING TAX RATES ON PAYMENTS
TO A NON-RESIDENT WITH RESPECT TO
INTEREST, DIVIDENDS AND ROYALTIES
Under the Income Tax Law of the PRC for Foreign Invest-
ment Enterprises and Foreign Enterprises (Income Tax
Law), “profits (dividends), interest, rentals, royalties and
other income” obtained by a foreign enterprise without an
establishment in China from sources inside China were
originally subject to a 20% withholding tax. This category
of income is often referred to as “passive income”. On 18
November 2000, the State Council had issued a Notice
(Guo Fa [2000] No. 37) (Notice 37), which reduces the
withholding tax rate to 10% with effect from 1 January
2000.
At present, dividends received by a foreign investor from
a foreign investment enterprise is exempted from income
tax. As such, there is no withholding tax on dividends in
China.
2. WITHHOLDING TAX ON PAYMENTS TO A
NON-RESIDENT FOR SERVICES PROVIDED
(BY AN UNRELATED PARTY OR A RELATED
PARTY) OVERSEAS
If services are rendered outside of China, the fees obtained
from provision of such services will not be subject to with-
holding tax in China.
If services are rendered inside China, the tax position
depends on whether or not the service provider is from a
country which has concluded a double tax agreement
(DTA) with China.
Non-DTA country
Under the Income Tax Law, a foreign enterprise with an
“establishment” in China during a particular tax year is
liable to Chinese income tax (normally at a rate of 33%) on
its net income from production and business operations in
China and any income derived inside or outside China that
is actually related to that establishment.
Under the Income Tax Implementing Rules, the term
“establishments” is defined as “administrative organ-
izations, business organizations, representative offices,
factories, places where natural resources are exploited,
places where construction, installation, assembly, explo-
ration and other projects are undertaken, places where
labour services are provided, as well as business agents”.
© 2003 International Bureau of Fiscal Documentation
Exported / Printed on 17 Oct. 2022 by WU (Wirtschaftsuniversität Wien).
289
Establishments of foreign companies in the service indus-
try in China are usually taxed on a deemed profit basis.
In addition, business tax at a rate of 5% will be levied on
the gross amount of income.
DTA country
If the foreign service provider is from a country which has
a DTA with China, it would be subject to income tax only
if it has a “permanent establishment” (PE) in China. For
example, according to the United States–China DTA and
the Singapore–China DTA, a PE exists where services are
provided in excess of 6 months in any 12-month period.
The applicable tax rate is again 33%. Further, the DTA
provides that the foreign company may seek to pay tax on
a deemed profit basis in accordance with the laws of
China.
Since the DTAs do not cover business tax, the service
provider would still be subject to 5% business tax on the
service fee.
Under current practice, a Chinese payor must provide to
the bank either (a) a tax payment certificate or (b) a cer-
tificate of exemption from tax issued by the tax bureau, for
outward remittance of service fees. In theory, a tax exemp-
tion certificate is obtainable from the tax bureau on pro-
viding evidence that all the services have been rendered
outside of China. In practice, negotiation with the tax
bureau may be required.
3. WITHHOLDING TAX ON PAYMENTS TO A
RELATED NON-RESIDENT FOR AN
ALLOCABLE SHARE OF MANAGEMENT
EXPENSES/CORPORATE OVERHEAD
EXPENSES
In general, “management fees” per se and payment for
sharing the foreign affiliates’ costs of overhead paid to for-
eign affiliates are not deductible.
Under the present stance of Chinese tax law and practice,
whether service fees are deductible will depend largely on
(i) whether the tax authorities are satisfied that these fees
are paid for specific services rendered for the affiliate in
connection with the production of taxable income by that
affiliate and not a charge against the general overhead of
the parent; and (ii) whether they are conducted at arm’s
length.
* © Baker & McKenzie, 2002.
290 ASIA-PACIFIC TAX BULLETIN
Payment for sharing the cost for management services ren-
dered to the local entity should not be subject to any with-
holding tax in China if such management services are ren-
dered entirely outside of China.
However, as mentioned in 2., the “management fees” may
be subject to income tax if the foreign enterprise has cre-
ated an establishment (or PE in the case of DTA resident)
in China. The paying local entity will be required to with-
hold such tax payment. As will be discussed in 4., due to
foreign exchange control, any such payment overseas
would in any event require either a tax exemption or tax
payment certificate.
Further, it is possible that certain management fee pay-
ments be re-characterized as “royalties”. Royalties are tax
deductible but will be subject to withholding tax (see 1.).
4. LIMITS ON PAYMENTS A RESIDENT
TAXPAYER CAN MAKE TO A NON-RESIDENT
AFFILIATE WITH RESPECT TO ROYALTIES,
LICENSE FEES, SERVICES, OR ALLOCATION
OF MANAGEMENT EXPENSES/ CORPORATE
OVERHEAD EXPENSES.
In general, there are no regulations which specifically set
limits on these types of payments.
But under current practice, a Chinese payor must provide
to the bank either (i) a tax payment certificate or (ii) a cer-
tificate of exemption from tax issued by the tax bureau, for
outward remittance of service fees. In theory, a tax exemp-
tion certificate is obtainable from the tax bureau on pro-
viding evidence that all the services have been rendered
outside of China. In practice, negotiation with the tax
bureau may be required.
According to a tax notice issued by the State Administra-
tion of Taxation effective 1 June 2000 (Notice 82), where
consulting services are provided by a foreign consulting
enterprise to a Chinese company both inside and outside of
China, the tax authorities will deem that at least 60% of the
total income is for services provided inside China (unless
otherwise proven) and therefore be subject to the income
tax and business tax.
Further, according to the Notice on Issues Relevant to the
Submission of Tax Certificates for the Sale and Payment
of Foreign Exchange for Non-trade and Some Capital
Account Items effective 1 March 2000 (Notice 372), pur-
chase and outward remittance of foreign exchange for a
wide range of non-trade related payments to overseas par-
ties are permitted subject to the presentation to the relevant
bank of either a tax payment certificate or a tax exemption
certificate, among others.
In practice, the remittance of services fees abroad is scru-
tinized by the tax authority carefully. The tax authority
will issue a tax payment certificate/tax exemption certifi-
cate only if they think such payment is reasonable.
As far as royalty fee is concerned, where the licence
fee/royalty is paid by a commercial joint venture (e.g.
supermarkets, convenient stores, specialist stores and
exclusive stores) to its foreign parent or affiliated com-
© 2003 International Bureau of Fiscal Documentation
Exported / Printed on 17 Oct. 2022 by WU (Wirtschaftsuniversität Wien).
AUGUST/SEPTEMBER 2003
pany, such fees may not be more than 0.3% of the com-
mercial joint venture’s sales computed according to
domestic laws. Further, until recently, the tax authorities
used to adopt a practice which basically regards royalty
fees paid by a local entity to a foreign party as reasonable
if the royalty fees do not exceed 5% of the “net sales” of
the local entity.
In practice, trademark licence contracts and technology
transfer contracts are subject to registration and/or
approval requirements, the registration authority (usually
COFTEC or MOFTEC) would scrutinize the amount of
the licence fees/royalties. If the registration authorities are
of the view that the rates are unreasonable (whose views
tend to vary from one location to another), they may
request that the rates be adjusted.
5. DTAs THAT PROVIDE FAVOURABLE RATES
OF WITHHOLDING TAX WITH RESPECT TO
INTEREST, DIVIDENDS, AND ROYALTIES
China is a signatory to various DTAs and the favourable
withholding tax rates provided for under these DTAs are
largely the same.
Before the issuance of Notice 37, the withholding tax rates
on interest, capital gains and royalties could be reduced by
the DTAs. However, after the issuance of Notice 37, the
withholding rates on these types of income under the
domestic laws are, except for a few exceptions, largely the
same as the rates offered under various DTAs.
Mauritius is by far the most favourable treaty jurisdiction
for making investments in China. Under the China–Mauri-
tius DTA, the withholding tax rate on dividends (5%) is
the lowest among all the DTAs that China has entered into
(normally at a rate of 10%), although, as mentioned in 1.,
dividends paid to foreign enterprises are currently
exempted from tax. Furthermore, capital gains are
exempted from Chinese tax (with certain exceptions).
Finally, the China–Mauritius DTA allows an extended
period before an installation, construction or supervisory
project is deemed to be a PE.
6. FAVOURABLE JURISDICTIONS WITH
RESPECT TO THE TREATMENT OF SERVICE
PAYMENTS
Under the China–Mauritius DTA, a Mauritian company
will create a PE in China, if the service activities provided
by the Mauritian company continue within China for a
period or periods aggregating more than 12 months within
any 24-month period (for most treaty jurisdictions, such
minimum length of stay requirement is 6 months within
any 12-month period).
7. LIMITS ON “TREATY-SHOPPING”
Generally, there are no limits on treaty shopping although
there are other limits as described below.
AUGUST/SEPTEMBER 2003 ASIA-PACIFIC TAX BULLETIN
To be within the scope of a Chinese DTA, a foreign
investor in China must be a “resident” of the other con-
tracting state as defined in the DTA. China’s treaties pro-
vide that a person is a resident of a contracting state if the
person is subject to tax under the laws of that state by rea-
son of the person’s domicile, residence, place of general
management or any other criterion of a similar nature.
For instance, in Mauritius, a Mauritian company must be
registered as Category 1 global business licence company
in order to enjoy the DTA benefits. To qualify as a Cate-
gory 1 business licence company, a Mauritian company
must have at least two Mauritian resident directors, one
local qualified company secretary and one local qualified
corporate auditor. The company must hold its board meet-
ing in Mauritius and must have a bank account in Mauri-
tius through which the company channels fund for invest-
ment in other treaty country.
SOUTH KOREA
Withholding Tax Planning Techniques*
Dong Soo Kim
Woo, Yun, Kang, Jeong & Han, South Korea
1. WITHHOLDING TAX RATES
Under the Corporate Income Tax Act (CITA), interest pay-
ment, dividend distribution and royalty payment by a
South Korean corporation to a foreign entity having no
permanent establishment (PE) in South Korea are all sub-
ject to South Korean withholding tax at the rate of 27.5%
(including resident surtax). However, most double tax
agreements (DTA), to which South Korea is a party, pro-
vide reduced withholding tax rates on such payments or
exemptions from withholding taxes in South Korea.
Accordingly, a foreign investor may enjoy reduced rates or
exemptions from withholding taxes in South Korea on
such incomes from South Korea if the foreign investor is a
resident in a jurisdiction that has entered into a DTA with
South Korea.
2. WITHHOLDING TAX ON PAYMENTS TO A
NON-RESIDENT FOR SERVICES PROVIDED
OVERSEAS
The applicability of South Korean withholding tax on a
payment for the services provided overseas (“offshore ser-
vice fee”) depends on the character of the offshore service
fee. If the relevant DTA characterizes the offshore service
fee as personal service income, and provides that only the
country where the services are performed may tax per-
sonal service income, the offshore service fee may not be
taxed in South Korea. On the other hand, if the offshore
service fee is characterized as business income, the tax-
© 2003 International Bureau of Fiscal Documentation
Exported / Printed on 17 Oct. 2022 by WU (Wirtschaftsuniversität Wien).
291
Additional rules in the DTAs may limit the availability of
treaty benefits. A 1996 protocol to the 1984 United
States–China DTA denies treaty benefits to an entity
established in one of the DTA partner countries if residents
of the DTA partner country do not hold at least a 50%
interest in the entity.
It should be noted that the Chinese tax authorities have
issued a number of domestic documents regarding differ-
ent treaties on interpretation issues on a particular DTA
and on the procedural matters on ways to obtain treaty
benefits. These interpretation provisions may to a certain
extent limit the extent of DTA benefits to the scope of peo-
ple as clarified in these documents.
ation on the offshore service fee depends on whether or
not the relevant foreign service provider has a PE in South
Korea, i.e. the offshore service fee may be taxed in South
Korea only if the foreign service provider has a PE in
South Korea.
If there is no DTA between South Korea and the country of
residence of the provider of offshore services, the taxation
on the offshore service fee would be governed by the
CITA. Under the CITA, the offshore service fee would be
characterized as personal service income. The CITA pro-
vides that personal service income may be subject to tax in
South Korea if the service provider renders services in
South Korea or if services provided offshore are utilized in
South Korea. Therefore, under the CITA, if the services
provided offshore are utilized in South Korea, the payment
for such services may be subject to withholding tax at the
rate of 22% (including resident surtax).
It is, however, often difficult to distinguish personal ser-
vices income from royalties income. In fact, the tax
authorities have often re-characterized personal services
income as royalties where the personal services involve
the transfer of know-how, especially where the payments
for such services are considered excessive.
* © Baker & McKenzie, 2002