Getting Paid from China - Procedural and Tax Implications
posted Sep 25, 2012 by Paul Oliveira, CPA in the Global Tax Blog
Re-posted from Dezan Shira & Associates, by Chris Devonshire-Ellis, Founding Partner.
As increasing numbers of international businesses are now looking to sell products and services to the emerging China consumer market, in this article we examine the procedures for getting paid. It is not as simple as sending an invoice and expecting a wire transfer; China employs currency controls and this makes the procedural aspect a vital component when evaluating the administration aspect of payment.
Additionally, even though an international business may not be extant in China, there may well be China tax implications to consider that may be required to be deducted from your invoice before payment can be made. On top of this, mitigation against such taxes may be obtained in part through the use of applicable double tax treaties (DTAs). International businesses should be aware of all these issues prior to committing to selling goods and services to China and expecting payment.
The basic check-list to follow when understanding the payment procedures is as follows:
- What is the payment administration process in China?
- Are withholding taxes applicable to my invoice? If so, how much are these?
- If withholding tax deductions apply, what relief can I claim through the use of DTA?
We can answer these issues as follows:
Payment Administration Processes in China
As mentioned, China has currency controls in place and the RMB is not fully convertible. This means that upon receiving an invoice from an overseas supplier of goods and services, the Chinese company must go through several approval processes in order to effect payment to you. Because of this, delays can occur in getting payment made, however it is also useful to know exactly what the procedures are in order to minimize the receivables impact. In short, if your Chinese customer knows that you know the Chinese system – he’s more likely to remit on time.
Step One – Invoice Assessment
The simple matter here is distinguishing between goods and services. Non-resident enterprises sourcing goods from China do not need to be concerned with paying taxes in China. The various taxes (e.g. value-added tax, stamp duty, consumption tax and customs duty) that apply to the Chinese party importing the goods are borne and paid directly by the importer in China, which means that non-resident companies exporting the goods are not liable for these taxes.
On the other hand, non-resident companies providing services to clients in China are subject to various taxes (discussed in Step Two below).
Accordingly, if delivering both goods and services to a client in China, e.g. when selling equipment and at the same time providing after-sale services such as installation and supervision in China, it is important to clearly separate revenue received from each category. If the service fee is not specified in the sales contract or the fee is not deemed to be reasonable, Chinese tax authorities will refer to the pricing standard in same or similar service and adjust the fee. Where such a reference is not available, the tax authorities may deem the service income to be no less than 10 percent of the total contract amount.
Step Two –Tax Calculation
Provision of Services
Non-resident companies providing services to clients in China are subject to the following taxes:
- Business tax (BT) and other surcharges (e.g., urban construction and maintenance tax (UCMT) and education surcharges (ES)): Foreign contractors with or without operating organizations in China are subject to BT when they provide taxable services (e.g. communication, transport, construction, finance and insurance, telecoms, culture, entertainment and service industries) to entities in China. BT rate ranges from 3-20 percent (but predominantly 5 percent). Generally, UCMT, ES and LES will add an additional 12 percent to the base tax percentage. For example, if BT is 5 percent, UCMT and ES would usually increase the base tax percentage to 5.6 percent. Under the current VAT reform in China, if the service provided falls under VAT taxable services in the pilot cities, local tax bureaus may apply VAT and other surcharges to the services.
- Corporate income tax (CIT): The business profit of a non-resident company is subject to a 25 percent CIT in China if it has a permanent establishment (PE) in China and the business profit is derived from the PE.
- Individual Income Tax (IIT) (where the non-resident enterprise is deemed to have a PE in China): Once a PE is established, all employees sent to China to work for the PE from overseas will be liable to IIT in China, as they will automatically assumed to be receiving China-derived Income.
For non-resident enterprises receiving passive income (i.e., dividends, bonuses, other equity investment gains, interests, rentals, royalties, transfer of property) from China, they are subject to business tax (or VAT, depending on the nature of the income and the local tax authority’s determination) and surcharges, as well as withholding tax.
The withholding income tax rate for non-tax resident enterprises in China for passive income is 20 percent under the CIT law. This was reduced to 10 percent under the detailed implementation regulations of the CIT law applied to passive income. For countries that have signed tax treaties with China, such as Hong Kong, rates differ.
Step Three –Tax Payment
Your Chinese buyer needs to process your invoice by presenting it for tax assessment to the local tax bureau. They will assess whether any taxes are due and deductible from the invoice to be paid to you. Your Chinese buyer needs to pay any amount due on your behalf. When the tax portion is paid, the tax bureau will then issue either a tax paid certificate, or a tax cleared (if no taxes are due) certificate to your Chinese buyer.
Step Four – Currency Conversion and Transfer
Foreign exchange in China is under the supervision of the State Administration of Foreign Exchange (SAFE). SAFE has designed a policy on the requirements that should be fulfilled before conversion and remittance of foreign currency can take place. Banks are required to follow the rules laid out by SAFE and review all the required supporting documents such as contracts, invoices and tax clearance/exemption certificates, before converting RMB into the appropriate foreign currency for settlement of overseas invoices. For special types of payments, SAFE approval may be required. The conversion rate will be the average exchange rate or an exchange rate within the permissible range determined by the People’s Bank of China at that time.
In order for banks to approve overseas payments, the transferring party must present various documents to the bank. In the case of remitting service fees, the documents required include the service contract, fapiao (invoice) and tax receipt. When remitting dividends and bonuses, the documents required include an audit report issued by an accounting firm on the annual dividend and bonus situation, a board resolution on distribution of the dividends and bonuses. For amounts of US$30,000 and more, a tax clearance certificate showing clearances from the local and state tax bureaus need to be presented to the bank before the bank will process the transfer.
China’s banking system is somewhat tardy, and even then payment may not arrive for another five days, less applicable bank charges of course.
International businesses seeking to do business with China must understand these processes in full in order to both expedite payment and ensure the system is not used to fool you. Further information concerning credit checks on Chinese companies can be found by clicking here, and information concerning the double tax treaties China has with other countries may be found here.
Dezan Shira & Associates provides a range of services for companies looking to undertake foreign direct investment into Asia. These include corporate establishment, accounting, tax, payroll, audit and due diligence. To view this blog or learn more about the firm, please visit their website at www.dezshira.com.