CHINA's taxes on cross-border technical services and licenses mainly include enterprise income tax (EIT) and business tax. A non resident enterprise is subject to China's EIT only on Chinese-source income. Chinese-source income derived by a non resident enterprise may be classified as ordinary income (i. e. , profits from business activities such as sales of goods and the provision of services) and passive income (such as dividends, royalties, interest, and capital gains). A nonresident enterprise that has created a permanent establishment (PE) in China regarding its business activities is generally subject to 25 percent EIT on business profits attributable to the PE. The passive income is generally taxed on a withholding basis at 10 percent or lower rates offered by applicable China's double taxation arrangements (DTAs) in China.

Unless otherwise reduced or exempted, an entity or individual who provides taxable services or transfers intangible assets or immovable property within China is subject to business tax in accordance with China's business tax regulations. For business tax purposes, services will be regarded as taking place in China if either the provider or the recipient of the services is situated in China. This article discusses some Chinese tax issues about technical services or licenses provided by foreign companies to Chinese entities and individuals.

Differentiation of Technical Services and Royalties

In the course of providing services, an enterprise often uses some technologies to complete the services. Also, an enterprise usually provides technical support services when transferring or licensing technology. In those cases, it is sometimes difficult to get an answer as to whether income from the provision of technical services is treated as business profits or royalties for EIT purposes. One basic principle that may be used to get the answer is that the PE article generally takes precedence over the royalty article when the provision of technical services meets both articles.

Usage of Technology for Services

In the course of rendering the services, if the provider of services uses knowledge and technology but does not sell or grant the technology, then those services will not meet the criteria for royalties, according China's tax rules. However, if the results arising from the services meet the definition of royalties in an applicable DTA and the provider and recipient of the services own the ownership and use right, respectively, of the results, then income arising from the services will fall under the royalties provisions in the applicable DTA.

Technical Services From Technology Transfers or Licences

In the course of the transfer or licensing of a right to use technical know-how, payments received by the transferor or licensor for the use of the technical know-how are regarded as royalties, regardless of whether they are received separately or constitute part of the total technical fees. However, if those service activities establish a PE, then the business profits attributable to the PE are subject to the provisions of business profits, and the related individuals performing the services are subject to the provisions of dependent personal services. The royalty provisions still apply to income from services in which no PE is created or in which the income is not attributed to a PE.

The royalty rules may apply temporarily if a deemed service PE cannot be determined in advance because of uncertainty about the duration of service (for example, if the fees, including technical service fees, are paid immediately after the technology transfer agreement is issued). The business profits rules will replace the royalty rules after the PE is created and the related income has been confirmed as being effectively connected with that PE. In that case, income tax treatment previously subject to the royalty clauses will be adjusted accordingly when subjecting the PE to EIT for the business profits, and the personnel to individual income tax.

Service Income Examples

The following are not royalties, but rather are income from service activities:

++ payments arising from post sale services in connection with sales of goods;

++ remuneration earned from services provided by a seller to a buyer within the product warranty period;

++ income derived by an institution or individual from the rendering of professional services (for example, engineering, management, or consultancy services); and

++ other similar remunerations designated by the State Administration of Taxation (SAT).

Income from these services is generally subject to the business profits provisions of an applicable DTA (except a few of China's DTAs).

Technical Services

Enterprise Income Tax

A PE is a fixed place of business through which the business of an enterprise is wholly or partly carried on, according to China's DTAs. The provision of services without using a fixed place of business is outside the aforementioned definition of a PE; however, it sometimes constitutes a PE. Under most of China's DTAs, the furnishing of services, including consultancy services, by an enterprise of a contracting state through employees or other engaged personnel in the other state will be considered a PE in that other state if those activities continue for the same project or a connected project for more than a prescribed period. The minimum prescribed period may vary depending on Chan's DTAs but is generally 6 months or 12 months. A PE will not be created if the life of the service activities is shorter than the minimum period.

Deemed Profit Methods

According to Guoshuifa [2010] 19 (Circular 19) , issued by the SAT on February 20, 2010, a nonresident enterprise is required to set up accounting books in accordance with China's Tax Collection and Administration Law and relevant laws and regulations; to proceed with accounting treatment using legitimate and valid vouchers; to accurately calculate its taxable income based on the matching principle of its functions and risks; and to report and pay EIT on an actual profit basis.

The SAT, however, reserves the right to use one of the three deemed profit methods to determine the taxable income of a nonresident enterprise if the SAT has difficulty performing a tax audit because the nonresident enterprise presents incomplete accounting books or documents, or if the nonresident enterprise cannot correctly calculate and report the EIT on an actual profit basis for any other reason.

++ A gross-income-based method is used to determine the taxable income of a nonresident enterprise that can accurately compute gross income or deduce gross income using reasonable methods but cannot accurately compute cost and expenses. The formula is as follows: taxable income = gross income x profit rate determined by the tax authorities.

++ A cost-plus method is used to determine the taxable income of a nonresident enterprise that can accurately compute its cost and expenses but cannot accurately calculate its gross income. The formula is as follows: taxable income = total cost and expenses ÷ (100 percent - profit rate determined by the tax authorities) x profit rate determined by the tax authorities.

++ The other cost-plus method is used to determine the taxable income of a nonresident enterprise that can accurately compute its operating expenses but cannot accurately calculate its gross income and cost and expenses. The formula is as follows: taxable income = total operating expenses ÷ (100 percent - profit rate determined by the tax authorities - business tax rate) x profit rate determined by the tax authorities.

Deemed Profit Rates

Circular 19 authorizes the tax authorities to determine a nonresident enterprise's deemed profit rate within the following framework:

++ 15 to 30 percent for construction projects and design and consulting services;

++ 30 to 50 percent for management services; and

++ 15 percent or more for other services or any business activities other than services.

If the tax authorities, based on evidence, believe that a nonresident enterprise's actual profit rate obviously exceeds the deemed profit rate established in Circular 19, a higher deemed profit rate can be used.

After-Sale Services

According to Circular 19, if a nonresident enterprise enters into a machinery, equipment, or merchandise sales agreement with a Chinese resident enterprise and renders installation, assembly, technical training, supervision, or other related services and the service fees are not indicated in the sales agreement or are unreasonable, the tax authorities can determine the gross income derived by the nonresident enterprise from the services on a case-by-case basis, by reference to the price of the same or similar services. If there is no such price for reference, the gross income will be determined as at least 10 percent of the total amount of the sales agreement.

Cross-Border Services

According to Circular 19, the EIT will apply to all income derived by a nonresident enterprise from the provision of services to customers in domestic China if all of the service activities take place in China. If those services arise both inside and outside China, the income will be separated into Chinese and foreign-source income based on the source principle, and the Chinese-source income will be subject to the EIT. If the tax authorities question a non-resident enterprise's allocation of income from domestic and overseas sources, the authorities can ask the nonresident enterprise to submit authentic, valid supporting documents and can reasonably determine the Chinese and foreign-source income based on the volume and time of work, cost and expenses, and other factors. If the nonresident enterprise cannot submit authentic, valid supporting documents, the tax authorities can regard all of the services as taking place in China for EIT purposes.

Business Tax

Business tax is imposed on all enterprises and individuals (including foreign enterprises and foreigners) that are engaged in the provision of taxable services, the assignment of intangible assets, or the sale of immovable property in China (unless otherwise reduced or exempted). Business tax is determined by multiplying turnover by an applicable tax rate. The turnover normally consists of the total consideration plus all other additional fees received from the contracting party for the provision of taxable services, the assignment of intangible assets, or the sale of immovable property in China. The business tax rate is 5 percent for the provision of services and for the assignment of intangible assets.

Royalties

Withholding Income Tax

A foreign enterprise that receives royalties from an entity in China is generally subject to China's withholding income tax at 10 percent of the gross amount of the royalties. In some of China's DTAs, the tax base used for computing the withholding tax may be reduced. For example, the China-France protocol stipulates that royalties paid for the use of or the right to use industrial, commercial or scientific equipment will be subject to tax on 60 percent of the gross amount of such royalties. Various taxes and surcharges (such as business tax) in connection with the transaction cannot be deducted from the tax base when computing the withholding income tax.

Business Tax

Unless otherwise reduced or exempted, a foreign enterprise is subject to a 5 percent business tax on royalties it receives from an enterprise situated in China.

China-India DTA

The China-India DTA provides a special tax treatment for fees from technical services. According to article 12 of the DTA, fees for technical services arising in a contracting country and paid to a resident of the other contracting country may be taxed in that other contracting country. However, such fees for technical services may also be taxed in the contracting country in which they arise, and according to the laws of that contracting country, but if the recipient is the beneficial owner of the fees for technical services, the tax charged will not exceed 10 percent of the gross amount of the fees for technical services. The term “fees for technical services” as used in article 12 is defined as any payment for the provision of services of managerial, technical, or consultancy nature by a resident of a contracting country in the other contracting country, but does not include payment for activities mentioned in paragraph 2 (k) of article 5 (permanent establishment) and article 15 (dependent personal services) of the DTA.

According to paragraph 2 (k) of article 5, the furnishing of services other than technical services as defined in article 12 (royalties and fees for technical services) by an enterprise of a contracting country through employees or other personnel in the other contracting country will constitute a PE in the other contracting country if activities of that nature continue within that other contracting country for a period or periods aggregating more than 183 days.

For the meaning of the technical services, the SAT issued a circular (Guoshuifa (1994) No. 257) on December 9, 1994, explaining that if the service activities last not more than 183 days, fees from the services will be taxed according to article 12 (on a withholding basis); conversely, if the duration of the services exceeds 183 days, then a PE will be created and such fees will be taxed according to article 7 (on the basis of business profits) of the DTA.