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New Tax Rules to Rein in Foreign Firms in China
Summary:

Cover, issue no. 409, March 9, 2009
Translated by Liu Peng
Original article:
[Chinese]

China has been mulling over new rules to rein in tax evasion by foreign firms operating within its borders.

According to the latest draft of the new rules, firms set up under the jurisdiction of a foreign country but whose actual management organs are within China would be defined as resident businesses, and thus required to pay a 25% corporate income tax.

Regulators were soliciting opinions on the draft from other government agencies, the Economic Observer learned.

A source close to the State Administration of Taxation told EO that such regulation aimed to curb corporate tax evasion.

New Rules
The latest draft set three thresholds by which foreign firms would be identified as resident businesses and thus be required to pay corporate taxes. The thresholds were:

One, if a firm's board chairman or one-third or more board members lived more than 90 days out of the year in China;

Two, if over 50% of a firm's operational revenues came from China;

Three, if a firm's accounting files, official seals, and board and shareholder meeting minutes were recorded inside China.

If a foreign firm met any of the above three conditions, it would be required to pay a 25% corporate income tax on revenues from business both inside and outside China, according to China's tax law.

However, these foreign firms could still apply for preferential tax policy. For instance, if their stock dividends and bonuses were in accordance with other tax code they could be tax-free.

In past years, some Chinese firms managed to escape tax burdens by transferring their revenues from the mainland to off-shore headquarters registered in tax havens like the Virgin and Cayman Island, the Bahamas, and Bermuda.

These off-shore firms have been evading taxes on dividends from investment projects in China and revenues from trade with or services sold in China.

Influence
The EO learned the new regulation was a supplement to China's newly-revised Corporation Law, which came into effect on January 1, 2008.

The previous law did not clearly define "resident business".

A manager at an accounting firm who requested anonymity commented that the regulation would make a significant impact on foreign firms that operate in China.

Some firms needed to reconsider their shareholding structures in order to cater to the new regulation, the above source added.

Another accountant, also asking for anonymity, told EO that the regulation would affect foreign firms in two aspects:

First, if a domestic firm distributed dividends to its foreign shareholders, as long as those shareholders were identified as resident businesses, their dividends would be free of taxes.

However, if these foreign shareholders then planned to dish out these dividend gains to their own shareholders, and those shareholders were non-resident businesses, they had to pay a 10% tax on those dividends.

Second, if over 50% of a foreign firm's profits came from China, it would be identified as a resident business and required to pay 25% corporate income tax.

The EO learned that more and more foreign firms were consulting accounting firms to redesign their shareholder and income structure to avoid being marked as resident businesses.

Other industry players pointed out that the regulation was too harsh and too difficult to implement. They pointed out that the threshold of having over 50% of earnings come from China was unclear.

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