Legal-Ease

Tax Calculation for Representative Offices

By ALBERTO VETTORETTI

All businesses are subject to tax registrations and filings of tax returns according to their actual activities in China, including Representative Offices (RO).

The following types of calculation methods normally apply:

1) Actual method

ROs that are engaged in business advisory, legal, tax and accounting or other types of consulting services will use the actual method to file tax returns, which basically means ROs should set up their own accounting system and record revenues and expenses to properly assess their taxable income.

2) Cost-plus method

ROs engaged in trading (including self-trade and agent trade), agency services, advertisement, tourism and other types of related service shall apply for the cost-plus method whereby revenues of the ROs are determined on a cost-plus basis and the expenses of running the ROs shall be used in the tax computation. Normally the tax burden would amount to roughly 8 percent to 10 percent of the officially declared overheads. Currently, this is the most common method for RO tax assessment in China.

3) Deemed-income method

ROs whose activities do not belong to the above two categories, shall pay taxes according to the actual revenues generated (including the fees received by the head office).

It is a widespread practice for ROs whose activities are taxed through actual and deemed-income methods, to receive offshore, part, if not the majority, of the service income (this practice is however illegal!) and avoid to declare huge amounts of revenues in China subject to the local enterprise income tax rate of up to 33 percent. The Chinese Government has the authority to track your ultimate shareholders and ask for explanations or penalties in the worse cases.

Many ROs would fall into the second category and it is thus immediately apparent that the less you spend (or better officially declare), the less you end up paying in taxes. From a purely mathematical point of view this is true, however, other factors can bring potential dangers to foreign organization (see table below).

These malpractices are common everywhere in the country. Chinese authorities are more and more aware of this and it may happen that local withdrawals above a certain amount need to be supported by declarations and signatures at the related bank.

If you do not officially declare all your expenses through the RO account or have separate funds to finance local activities, then firstly, you are not in compliance, and secondly, you run the risk of staff turning this against you when they are dismissed or leave the company (blackmailing and threats to disclose malpractices to local authorities are common in order to seek own financial gains). Local staff may even manipulate the company records to ensure it is not in compliance—in order to hold leverage against you in the event of any disciplinary action being taken against them at a later stage. This is relatively common.

No Government likes tax evasion and China is no exception to the rule. The penalties for late payments, non-payment and other transgressions can be severe and it is wise to seek professional guidance in this area.