The new B2V tax reform in China has meant that, as of May 2016, liability to Business Tax (“BT”) has been replaced by Value-Added-Tax (“VAT”). BT used to be managed and collected by the Local Tax Bureaux ("LTB") in China. However, the new VAT will now be managed by the State Tax Bureaux ("STB"). As a consequence, Individual Income Tax ("IIT") would now become the most important tax revenue of the LTB.
It is anticipated that as part of its revenue recovery scheme going forward, the LTB would strive to recuperate the consequential lost revenue from the BT sector by focusing more stringent tax collection procedures on the IIT sector in the coming months/years.
With the aim of increasing its revenue, the LTB have launched a large scale tax inspection of all companies in China. Their main targets are expatriate enterprises including Foreign Investment Enterprises ("FIEs"), Joint Ventures ("JVs") and Representative Office ("ROs"), etc. Together with the national tax inspection exercises since August 2016, the recent moves by the LTB serve two main purposes:
- To assess whether there is any non-compliance on the IIT filings of the expatriates in China; and
- To determine whether the criteria for Permanent Establishment ("PE") has been satisfied by the Foreign Enterprises ("FEs") through either secondment arrangements or frequent travel to China during the year.
Furthermore, various requests have also been sent out to target companies requiring these companies:
- To complete and submit the relevant IIT Questionnaires regarding their expatriates' IIT employment/filing status for the Year 2015.
- To meet with the local tax officers in person and to answer any additional enquiries as raised by them.
In China it is not uncommon that most of the companies have IIT non-compliance issues. Our research into the cause of such non-compliance, based on the comments from our clients and verbal confirmation from the local tax officers, shows the following two reasons:
- The companies with the most non-compliance tax issues are mainly those who have either engaged PRC tax agencies locally or that their expatriates' IIT filings are being handled by their local HR/Finance personnel internally.
In such cases, due to a lack of the necessary knowledge and experience required to handle such matters (e.g. tax equalization/protection policies, equity-based compensation arrangements, tax treaties application, etc) those PRC companies have or may face a certain level of non-compliance risk in the area of the expatriates' IIT filings in China.
- The criteria for PE are fairly complicated in China. The most common pitfalls FEs encounter when sending expatriates to China for work/assignment/secondment relate to the PE criteria. Unfortunately, thorough examination of this issue is commonly neglected by most FEs. Where a PE has been established by the FEs in China, the FEs will have a liability to corporate tax as well as IIT exposures.
We foresee that this is only the first step of the whole tax inspection exercise and it is anticipated that further action would be taken by the LTB in the coming months. As a precautionary measure, companies should consider taking the following immediate actions:
- To perform a review of their existing expatriates’ IIT filing arrangements so as to identify and rectify any non-compliance situation.
- To perform a review of the existing business operations and expatriates’ working arrangements in China so as to assess the potential PE risk.
- To communicate and monitor the PRC local colleagues carefully on the tax inspection issues.
- To obtain professional advice and assistance on the above matters, if necessary.
In China tax non-compliance and subsequent tax investigation is a very serious and sensitive issue. Any non-compliance may result in significant penalties (e.g. additional tax settlement, surcharge/penalty, negative impact on the business reputation, difficult to obtain financial support from the banks, etc). Therefore, all tax inspection issues in China must be handled with extreme care.
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