Rep Office Cost-Plus Taxation

A Representative Office (“RO”) is among the investment structures that an overseas entity can choose to enter the Chinese market.


Compared to other options such as the wholly foreign owned enterprise (“WFOE”) or the joint venture (“JV”) with a Chinese partner, a RO envisages a limited business scope: in China, a RO is generally not permitted to engage in any profit-seeking business and cannot issue invoices or collect remittances from clients. For such reason, the expenses incurred by the RO shall be covered by cash remittances from the overseas parent company. The activities of the RO shall be therefore limited to liaison and promotion office for its parent company’s products and services.


Despite the limitation in its permitted scope of activities, a RO shall keep a proper accounting and bookkeeping system and is taxed in China as a permanent establishment (“PE”) of the overseas entity. In the specific, the RO is subject to China Company Income Tax (“CIT”), China Value-added Tax (“VAT”), and the local additional surcharges (“LAS”) that are calculated on the VAT payable.


1. CIT liability

Based on the Circular of the State Administration of Taxation on Provisional Measures for the Administration on Taxation Collection of Resident Representative Offices of Foreign Enterprises (Guo Shui Fa [2010] no. 18, “Circular 18”), the tax liability of the RO shall be assessed based on the actual amount method (actual basis), by considering the revenue attributable to the RO and the expenses incurred by the entity.


From the practical perspective however, since an ordinary RO is not allowed to generate revenue from its activities, the accounting is limited to recording the expenditures incurred by the RO during the tax year and to file timely the CIT on a quarterly basis, and the VAT and LAS on a monthly / quarterly basis.


The tax liability of the RO will be then assessed based on the deemed amount method as stipulated by Circular 18, according to which the tax incurred by the RO is computed on the incurred expenses. Accordingly, Chinese tax authorities are empowered to compute the taxable income of the RO based on the cost-plus method.


The cost-plus method aims to compute the CIT based on the deemed amount of revenue derived from the total expenses incurred by the RO during the period and a deemed profit rate:


Deemed revenue = Total expenses / (1 – Deemed profit rate)


Deemed profit [1] = Deemed revenue – Total expenses

Or

Deemed profit [2] = Deemed revenue x Deemed profit rate


and


CIT payable = Deemed profit x CIT rate


After the tax registration, the RO shall confirm the deemed profit rate with the competent tax authority. Please note that the deemed profit rate shall be no less than 15%.


The expenses incurred by the RO that shall be considered in the application of the cost-plus method includes wages and salaries, bonus, allowances, welfare expenses, procurement expenses (i.e., fixed assets), communication expenses, travel expenses, rental, equipment leasing fee, transportation fee, business entertainment fees, and other expenses that are paid to employees within and outside China.


2. VAT liability

A RO conducting taxable activities according to the Value-Added Tax Interim Regulations of the People's Republic of China (“VATIR”) shall be subject to VAT.

There are two categories of VAT taxpayers:

  • Small scale taxpayers

  • General VAT taxpayers

General taxpayers are entities with a certain degree of organization and with a sound accounting system, that are able to compute accurately input VAT and output VAT from their transactions; those taxpayers are therefore entitled to the VAT credit system, according to which the output VAT arising from taxable transactions can be offset with deductible input VAT.


Small-scale taxpayers are those taxpayers without a sound accounting system, with annual taxable revenue less than CNY 5,000,000. Small-scale taxpayers shall follow a simplified VAT calculation, according to which the output VAT is computed according to a lower VAT rate, but the input VAT is not allowed to be credited or deducted.


Small-scale taxpayers that are able to adopt a sound accounting system can register themselves as a general taxpayer.


From the practical perspective, a RO can be treated as general VAT taxpayer: the output VAT is calculated based on the deemed revenue calculated according to the cost-plus method, and the 6% VAT rate applicable to the provision of services. RO that are characterized as general VAT taxpayers can deduct the input VAT from the amount of output VAT when determining the VAT payable.


A RO that is characterized as small-scale taxpayer shall compute the VAT payable based on the VAT rate of 3%, and no input VAT is allowed in deduction.


3. Local additional surcharges

A RO is subject to LAS that are computed on its VAT payable. LAS refer to three different types of surtaxes that are levied on VAT taxpayers, consumption tax, and previously business tax. These surtaxes consist of the urban maintenance and construction tax (“UMCT”), the education surcharge, and the local education surcharge.

UMCT is levied according to the location of the taxpayer (7% for taxpayers located in the city, 5% for county/town area, and 1% for other areas), while the education surcharge and the local education surcharge are levied at a flat tax rate of 3% and 2% respectively. The base for the surcharges is the total VAT, CT, and business tax payable by the taxpayer in a certain period.


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