New Value-added Tax Regime in China — Impact on Representative Offices

Representative offices (ROs) are normally set up in China under three circumstances:
1. A foreign company sets up an RO to promote its products and services overseas and establish networking relationships with Chinese businesses.
2. Law firms — An RO is the only business entity form in which a law firm is allowed to adopt in China
3. Non-profit organisations — An RO is the only business entity form in which a non-profit organisation is allowed to adopt in China

According to current laws, circulars and regulations for ROs, there are three methods to calculate tax liabilities (“RO Taxation Method”), depending on how capable the RO is in  maintaining its financial records as explained below:

Actual Basis Method
This method is adopted when the RO is capable of establishing accounting books in accordance with relevant laws and regulations, keeping those records based on legitimate and valid vouchers and accurately reporting its revenue, expenses and costs.

Taxable Income Made On Total Income Method
This method is applicable when the RO is able to accurately report its revenues but not its expenses and costs. Taxable income is calculated as follows:
Taxable Income = Actual Revenue x Deemed Profit Rate (No less than 15%)

Converting Appropriation Expenditures Into Income Method
It is applicable for ROs that are able to accurately report their expenditures but unable to accurately report their income. Taxable income is calculated as follows:
Step 1: Deemed Revenue = Current Appropriation Expenditure / (1 – Deemed Profit Rate)
Step 2: Taxable Income = Deemed Revenue x Deemed Profit Rate (No less than 15%)

According to the Caishui [2016] No. 36 circular, value-added tax (“VAT”) has replaced the business tax (“BT”) in all sectors — including real estate & construction, financial services & insurance, lifestyle and other services — with effect from 1 May 2016.

The table below compares the tax burdens under the previous BT and new VAT regimes. 

Assumptions:

  • Margin rate is 15%;
  • Business tax rate is 5%;
  • Surtax rate is 13%;
  • VAT rate for small-scale VAT taxpayer is 3%, while that for general VAT taxpayer is 6%;
  • Input VAT not deducted for general VAT taxpayer; and
  • Corporate income tax rate is 25%
RO Taxation Method  Actual Basis Method   Taxable Income Made On Total Income Method  Converting Appropriation Expenditures Into Income Method 
Tax Category      
Business Tax Formula Taxable Income = Actual Revenue – Actual Expenditures  Taxable Income = Actual Revenue x Deemed Profit Rate (No less than 15%)  Step 1:
Deemed Revenue = Current Appropriation Expenditure / (1 – Deemed Profit Rate – Business Tax Rate)

Step 2: 
Taxable Income = Deemed Revenue x Deemed Profit Rate (No less than 15%)
 Revenue  RMB125 RMB125 RMB125 
 Expenditures  RMB100 RMB100 RMB100
 Total tax burden based on expenditures  11.75% 11.75% 11.75%
VAT
(Small-
scale VAT Taxpayer)    
 Formula Taxable Income = Actual Revenue – Actual Expenditures Taxable Income = Actual Revenue x Deemed Profit Rate  Step 1:
Deemed Revenue =  Current Appropriation Expenditure / (1 – Deemed Profit Rate)

Step 2: 
Taxable Income = Deemed Revenue x Deemed Profit Rate (No less than 15%)
 
Revenue RMB117.65  RMB117.65 RMB117.65
Expenditures  RMB100 RMB100 RMB100
Total tax burden based on expenditures  8.4% 8.4% 8.4%
VAT (General VAT Taxpayer)    Formula Taxable Income = Actual Revenue – Actual Expenditures Taxable Income = Actual Revenue x Deemed Profit Rate Step 1:
Deemed Revenue =  Current Appropriation Expenditure / (1 – Deemed Profit Rate)

Step 2: 
Taxable Income = Deemed Revenue x Deemed Profit Rate (No less than 15%)
Revenue RMB117.65 RMB117.65 RMB117.65
Expenditures RMB100 RMB100 RMB100
Total tax burden  based on expenditures  ≤12.39% ≤12.39% ≤12.39%

From the table above, the effects of the change to the new VAT regime from the previous BT system are as follows:

1. If the RO generates an annual revenue of no more than RMB5 million, it is now considered a small-scale VAT taxpayer. For whatever taxation method is applied by the RO, the total tax burden based on expenditures is decreased from 11.75% under the previous BT system to 8.4% under the new VAT regime.

Under the new VAT regime, such an RO would therefore have a lower total tax burden based on expenditures.

2. If the RO generates an annual revenue of over RMB5 million, it is now considered a general VAT taxpayer, in which case, the tax calculation is much more complicated. For whatever taxation method is applied by the RO, the total tax burden based on expenditures (including VAT, surtax and corporate income tax) is not at a fixed rate but less than or equal to 12.39%. Compared with the tax burden of 11.75% under the previous BT regime, the tax burden now for such ROs under the new VAT system may be higher or lower. It depends a lot on the purchase price negotiated with the contractors and whether the RO is able to obtain a special input VAT invoice. Although other invoice types other than the special input VAT invoice are also accepted as original accounting vouchers, only the special input VAT invoice may be used to claim output VAT.