Kristina Koehler-Coluccia, Head of Business Advisory, Woodburn Accountants & Advisors, discusses the main considerations for foreign businesses who need to repatriate profits from China
One of the main questions foreign investors have when deciding to establish a new business in China is: can I repatriate my profits out of the country?
The answer is simply yes. Just as in any other country in the world, you will be able to transfer your funds out of China, either as a company or as an individual. The most important thing is to ensure that your business operates in a transparent and legal way, within the country’s rule of law, and complies with all its fiscal obligations.
Nevertheless, the Chinese government wants to attract and maintain capital in the country so that it can be reinvested and used to push economic growth. As a result, the application process to repatriate funds or cross-border payments entails tedious paperwork and explanations.
Over the past six years in particular, Chinese tax authorities have become better educated regarding tax-optimised structures and investigate any request to approve profit repatriation. This is important to know for both foreign companies established in China and those dealing with Chinese companies from abroad. Every cross-border contract is scrutinised by the authorities to ensure it is legitimate.
However, there are a few practical things you can do to facilitate the process. As long as you are organised and you have the correct documentation, it’s not as complex as it may seem.
A good place to start is to talk to your bank and tax officer to discuss the paperwork involved. You can try to negotiate the documentation and tax rates that would be applied. It is in your best interest to pick your battles wisely and decide what is worth fighting for and what is a lost cause.
If your company cannot provide the documentation required for the transfer of capital, you won’t be allowed to do it. If you cannot produce valid papers to verify and justify a transfer that is going abroad, then you should not be doing the transfer in the first place.
The ultimate target of any company established in China is to become profitable and be able to pay back investors or reinvest its funds. It is crucial to establish a profit repatriation strategy early on in order to create a tax-optimised structure that helps you develop authentic agreements and contracts from the get-go.
Nobody else but you – and your company – decides what to do with the money. As long as you abide by the procedures, your capital can be maintained to grow and expand your business in China, or if it’s needed elsewhere, it can be transferred out of the country. Many entities feel pressure to repatriate funds, but when they face a period of further expansion or investment into new product lines, they find themselves without the resources to do it.
Similarly, organising payment in cross-border transactions between foreign and Chinese companies can be intricate. It helps to learn how to communicate and be patient with your Chinese counterparts to avoid any tax violation.
It is not easy for your Chinese counterpart to get contracts approved. The process involves extensive negotiations with tax officers, which means that any cross-border transaction, whether it is dividend repatriation strategies or just general service transactions, must have a valid and authentic agreement in China.
The State Administration of Foreign Exchange (SAFE) is the government bureau tasked with controlling capital flows into and out of China. Flows are strictly controlled, and foreign invested enterprises (FIEs) should be careful to avoid raising any red flags with the authorities. Any of the following may hinder a company’s ability to remit their profits abroad:
- profits that are not in line with industry standards;
- dealings with companies in tax havens;
- failure to complete all required documentation.
Tax implications and tax planning are important considerations for determining an optimal profit repatriation strategy. Since 1 January 2019, the corporate income tax (CIT) rate has been a standard 25%. However, there are special benefits for small to medium-sized companies and start-ups in China.
If a company reaches a revenue level of less than RMB 1 million, the tax rate will be 5%. If it is between RMB 1 and 3 million, the tax rate jumps to 10%. Once an FIE is profitable and before it can distribute after-tax profits, it is required to make up any losses carried forward from previous years, up to five years.
In addition to making up any losses, in order for a company to distribute and repatriate profits back to its investors, it must complete an external annual audit conducted by an accounting firm, settle its income tax liabilities, and set aside a minimum 10% of after-tax profits in a reserve fund until the accumulated reserve fund reaches 50% of the registered capital, which ensures that a portion of the profits are re-invested into the company.
The remaining amount is distributable profits. The withholding tax will be deducted before the dividend can be remitted back to the investors.
The most common profit repatriation strategy in China is a dividend payment, which can be done only once a year. It is relatively easy to repatriate profit by way of dividends, but the tax burden could be high from the China side (corporate income tax and withholding tax).
A number of documents will be required for this process (and these may vary depending on the bank and tax officer), but the most common to be presented are
- A resolution from the board of directors on the distribution of profits
- The latest audit report on the paid-in capital
- A certificate of filing at the tax bureau in case the amount is above $50,000
- A tax-payable receipt
- The business license.
China applies a 5-10% tax on dividends sent overseas, although the existence of double taxation agreements (DTAs) with some countries (including the UK) can reduce this by half.
Another strategy is the repatriation of service fees. The first thing is to have a valid and true business reason for implementing the service fee, which must be of economic substance.
For example, a company has a marketing service agreement with a Chinese entity and money is owed to cover travel costs of team members travelling regularly to China. The tax bureau could ask for proof of these marketing services, such as projects and advertisements, as well as to see the passport copies of all people who have travelled to China to render the services charged.
Foreign investors can provide services and thus get paid under service agreements with their FIEs in China. The service will be subject to China VAT if either the service provider or recipient is located in the country or the services are rendered in China.
For onshore services, whereby the servicing period is long enough (generally more than six months in any 12-month period) to constitute a permanent establishment (“PE”) in China, 25% corporate income tax (CIT) will be charged on the profits, which varies from 15% to 50% of the income arising from onshore service provision.
If a PE could not be established, CIT is theoretically not applicable. However, if certain conditions are met, e.g. the services are related to licenses, royalties, and know-how, tax authorities would treat the fees as royalties and levy a withholding tax. Service fees at ‘arm’s length’ are normally deductible for a FIE’s CIT purposes.
Royalties are fees paid in relation to the use of intellectual property, such as trademarks, patents, copyrights, and proprietary technology. Royalties are deductible for CIT purposes provided they are directly related to the FIE’s business operations and charged at normal market rates. Royalty remittances are subject to a 5-10% withholding CIT and 6% VAT.
The statutory CIT withholding tax rate of 10% can be reduced to a lower tax rate if a tax treaty is applicable. In order to receive a reduced withholding tax rate under a DTA, it is necessary to submit an application to the tax authority, which includes a Statement of Beneficial Owner.
There are many other ways of repatriating funds from China, such as reduction of registered capital, which is an exceedingly difficult process, and the company should have been extremely profitable. Other approaches include acquiring assets overseas, offering loans to overseas shareholders or sister companies, and offshore investments.
This article was originally published by Woodburn Global with the title ‘Developing profit repatriation strategies for your China business’
