Developing profit repatriation strategies for your China Business
One of the main concerns foreign investors have when deciding to
establish a new business in China is if and when they will be able to
repatriate their profits out of the country. This question makes many
business professionals anxious before establishing an entity in China.
The answer is simply yes. Just as any other country in the world, you will be able to transfer your funds out. The most important aspect is to ensure that your business operates in a transparent and legal way, within the country’s rule of law, and complies with all its fiscal obligations.
As an individual, if you are planning to relocate out of China, you can also take your money out of the country. There are a few regulations and procedures that need to take place first, but in general there are no obstacles for repatriating capital.
During the 2008 financial crisis, many companies doing well in China had to send money to their other subsidiaries around the world. There was a significant outflow of capital from China, due to international circumstances, which did not make the Chinese authorities happy, but it was acceptable.
The goal of the Chinese government is to attract and maintain capital in the country, which can be reinvested and used to push economic growth. For this reason, the application process to repatriate funds or cross-border payments entails tedious paperwork and explanations.
However, there are a few practical things you can do to facilitate the process. As long as you are organized and you have the correct documentation, it's not as complex as it may seem.
A good place to start is to talk to your bank and tax officer to discuss the paperwork involved. You can try to negotiate the documentation and tax rates that would be applied. It is in your best interest to pick your battles wisely and decide what is worth fighting for and what is a lost cause.
If your company cannot provide the documentation required for the transfer of capital, you won’t be allowed to do it. If you cannot produce valid papers to verify and justify a transfer that is going abroad, then you should not be doing the transfer in the first place.
This process can be stressful because every government office and bank may request different documents. Following the appropriate steps and guidelines will give you clarity and help you stay organized.
The ultimate target of any company established in China is to become profitable and be able to pay back investors or reinvest its funds. It is crucial to establish a profit repatriation strategy early on, in order to create a tax optimized structure that helps you develop authentic agreements and contracts from the get-go.
Nobody else but you -and your company- decides what to do with the money. As long as you abide by the procedures, your capital can be maintained to grow and expand your business in China, or if it's needed elsewhere it can be transferred out of the country. Many entities feel pressure to repatriate funds, but when they face a period of further expansion or investment into new product lines, they find themselves without the resources to do it.
Similarly, organizing payment in cross-border transactions between foreign and Chinese companies can be intricate. It helps to learn how to communicate and be patient with your Chinese counterparts to avoid any tax violation.
A lot has changed in the past six years. Chinese tax authorities have become better educated regarding tax optimized structures and investigate any request to approve profit repatriation. This is important to know for both foreign companies established in China and those dealing with Chinese companies from abroad. Every cross-border contract is scrutinized by the authorities to ensure it is legitimate.
It is not easy for your Chinese counterpart to get those contracts approved. The process involves extent negotiations with tax officers, which means that any cross-border transaction whether it is dividend repatriation strategies or just general service transactions must have a valid and authentic agreement in China.
The State Administration of Foreign Exchange (SAFE) is the government bureau tasked with controlling capital flows into and out of China. Flows are strictly controlled and foreign invested enterprises (FIEs) should be careful to avoid raising any red flags with the authorities.
The following may hinder a company’s ability to remit their profits abroad: profits that are not in line with industry standards, dealings with companies in tax havens or failure to complete all required documentation.
Tax implications and tax planning are important considerations for determining the optimal profit repatriation strategy.
Starting January 1st, 2019, the Corporate Income Tax (CIT) has a standard rate of 25%. However, there are special benefits provided to small-medium sized companies and startups in China.
If you reach a revenue level of less than 1 million RMB, your tax rate will be 5%. If it is between 1 and 3 million RMB, the tax rate jumps to 10%. Once you are profitable and before you can distribute after tax profits, FIEs are required to make up any losses carried forward from previous years, up to five years.
Besides making up any losses, in order for a company to distribute and repatriate profits back to their investors it must complete the external Annual Audit conducted by an accounting firm, settle its income tax liabilities, and set aside a minimum 10% of after-tax profits in a reserve fund until the accumulated reserve fund reaches 50% of the registered capital, which ensures that a portion of the profits are re-invested into the company.
The remaining amount is distributable profits. The withholding tax will be deducted before the dividend can be remitted back to the investors.
The most common profit repatriation strategy is a dividend payment and it can be done only once a year. It is relatively easy to repatriate profit by way of dividends, but the tax burden could be high from the China side (corporate income tax and withholding tax). A Chinese bank will only process dividend payments with a completed audit report and tax receipt confirming the amount of profit distribution and tax payment.
A number of documents will be required and it may vary depending on the bank and tax officer, but the most common to be presented are a resolution of Board of Directors on the distribution of profits, the latest audit report on the paid-in capital, a certificate of filing at the tax bureau in case the amount is above $50,000, a Tax payable receipt and the business license.
China applies a 5-10% tax on dividends sent overseas, although the existence of Double Taxation Agreements (DTAs) with some countries can reduce this by half.
Another strategy is the repatriation of service fees.
First thing is to have a valid and true business reason for implementing the service fee, which must be of economic substance. For example, your company has a management service agreement with a Chinese entity and money is owed to you to cover travel costs of the team members traveling regularly to China.
The tax bureau may ask for proof of the management services, such as seeing the passport copies of all people who have traveled to China and the number of days spent to render the services charged.
Foreign investors could provide services and thus get paid under service agreements with their FIEs in China. The service will be subject to China VAT if either the service provider or recipient is located in the country or the services are rendered in China.
For onshore services, whereby the servicing period is long enough (generally more than 6 months in any 12-month period) to constitute a Permanent Establishment ("PE”) in China, 25% Corporate Income Tax (CIT) will be charged on the profits, which varies from 15% to 50% of the income arising from onshore service provision.
If a PE could not be established, CIT is theoretically not applicable. However, if certain conditions are met, e.g. the services are related to license, royalty and know-how, tax authorities would treat the fees as royalties and levy a withholding tax. Service fees at 'arm's length' are normally deductible for a FIE's CIT purposes.
Royalties are fees paid in relation to the use of intellectual property, such as trademarks, patents, copyrights, and proprietary technology.
Royalties are deductible for CIT purposes provided they are directly related to the FIE's business operations and charged at normal market rates. Royalty remittances are subject to a 5-10% withholding CIT and 6% VAT.
The statutory CIT withholding tax rate of 10% can be reduced to a lower tax rate if a tax treaty is applicable. In order to receive a reduced withholding tax rate under a DTA, it is necessary to submit an application to the tax authority, which includes a Statement of Beneficial Owner.
It is crucial to register your trademark before you even set foot in China. The royalty’s repatriation strategy is one of the simplest methods and it only requires a one-page contract together with the trademark licensing certificate that has been approved.
There are many other ways of repatriating funds out of China, such as reduction of registered capital, which is an exceedingly difficult process and the company should have been extremely profitable. Other approaches include acquiring assets overseas, offering loans to overseas shareholders or sister companies, and offshore investments.
Should you have questions about designing your profit repatriation strategy, complete the below inquiry form with your questions and comments.
DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.