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Tax: Time to review your RO

Tax and Finance

With the latest changes in the Chinese tax legislation, it is time for NZ investors with Representative Offices (ROs) in China to review their business plan.

 

ROs have been used by many foreign firms as the initial step to enter the Chinese market. An RO is a legal extension of the foreign head company and generally only provides liaison services and collects market information for the head office. Setting up an RO is one of the simplest and lowest cost options because there is no registered capital requirement, the application process is easy and the operating costs are relatively low.

 

The new regulations on Registration of Resident Representative Offices of Foreign Enterprises (“New Regulations”) took effect on 1 March 2011. The New Regulations tighten the rules on establishment and operation of ROs and strictly confine the role of ROs to “representation” rather than carrying on any profitable business activities.

 

We highlight some of the key aspects of the New Regulations below:

 

The New Regulations provide that ROs may not engage in any ‘for profit’ activities unless otherwise provided by international treaties or agreements concluded, or participated in by China.

 

If ROs engage in any ‘for profit’ activities, there can be sanctions including confiscating the illegal gain as well as any tools, equipment, materials, products or other property used to engage in for profit activities. In addition, penalty between RMB 50,000 and RMB 500,000 can be imposed by the Chinese authorities.

 

The old legislation was silent regarding the activities that were allowed to be carried out by ROs. The new regulations specify the activities that ROs may engage in. These activities include market investigation, display, publicity activities in connection with the products or services of foreign enterprises and liaison activities in connection with product sales, provision of services, domestic procurement or domestic investment by foreign enterprises.

 

Even if ROs do not carry out ‘for profit ‘activities, there can still be sanctions if ROs are engaged in activities other than the above specified activities. In such cases, the authorities can order ROs to make corrections. If corrections are not made, penalty between RMB 10,000 and RMB 100,000 can be imposed.

 

A more stringent application process is now in place for the registration of RO in comparison to the old rules. New compliance requirements are also imposed under the Regulations and a failure to file annual reports will trigger a potential penalty for ROs.

 

Under the New Regulations, the compliance burden of operating ROs in China has undoubtedly increased. Existing ROs operated by New Zealand businesses should ensure compliance with the new requirements in order to avoid any potential penalties. New Zealand businesses considering setting up operations in China should also consider the pros and cons of a RO with other options available such as a wholly owned foreign enterprise.

 

Foreign investors should also be aware of the recent changes to the Chinese tax legislation which aim to eliminate tax breaks for foreign investors: foreign investor exemption from the City Maintenance and Construction Tax (CMCT) and Education Surcharges (ES) was abolished effective 1 December 2010.

 

The exemption from the CMCT and ES has offered major advantages to foreign investors in the past two decades. The abolition of the exemption will now create extra burden for foreign investors in China, in particular those with substantial VAT, BT and CT liabilities.

 

The surcharges are calculated as a percentage to the Value Added Tax (VAT), Business Tax (BT) and Consumption Tax (CT). The ES is levied at a flat rate of 3% at the national level and 2% at the local level. The CMCT rate depends on the location of the taxpayer (7% for taxpayers located in a city, 5% for taxpayers located in a county and town area; and 1% for taxpayers located in other regions).

 

Foreign investors should review their business transactions and ensure they comply with any surcharges which may now be applicable to their business.

 

 

 

For any further details please contact Joanna Doolan, coordinating partner for the Ernst & Young NZ China Business Group joanna.doolan@nz.ey.com and Florence Wong Director of Ernst & Young's NZ China Business Group florence.wong@nz.ey.com.

 

Disclaimer: This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information.