Profit Repatriation Strategies for China

China has long maintained strict foreign exchange controls over funds entering and leaving the country, meaning foreign investors face a series of compliance challenges. With the current pace of regulatory changes, and with Chinese banks adopting different anti-money laundering procedures, such investors are naturally concerned about their ability to move funds and most importantly, repatriate profits. In this article, Valur Blomsterberg discusses the four primary ways for foreign-invested enterprises (FIEs) to achieve these goals, as well as applications of transfer pricing in China.

Profit repatriations (dividends)

Dividends to shareholders is the most common way FIEs in China repatriate profits, despite it being a fairly costly method. The expense is because, first, companies must pay corporate income tax (CIT) on profits. Of the gross income from dividends paid to overseas entities, a withholding tax of 10 per cent should be paid – unless a preferential rate is granted under a double tax agreement. Additionally, FIEs wishing to repatriate profits must place at least 10 per cent in a reserve account, up to a specified limit, which can later be reinvested in the business.

Profit repatriation is also a lengthy process. It can only begin after annual tax reports have been filed and CIT paid – usually by the end of June of the following fiscal year. It can then take up to two months to apply for a preferential tax rate, if applicable, and register it with the State Administration of Foreign Exchange (SAFE). And before a company can even become eligible to pay dividends, it must first fully top-up its registered capital and settle any accumulated losses carried forward from previous years.

Service fees

Another method FIEs have of repatriating profits is through service agreements. Certain functions—such as accounting, HR, information technology, and marketing—may be carried out at the firm’s group company-level or by a related party in exchange for a service fee charged by the group company to repatriate funds overseas. In general, VAT and other surtaxes on the service fees must be withheld by the FIE, in addition to a 25 per cent CIT on a deemed profit rate of between 15–50 per cent of the fee, before any remittance can be made. While CIT exceptions and other preferential treatment for intercompany service agreements exist in China, these are only available on a case-by-case basis and subject to pre-approval by the relevant tax authorities.

It’s important to note that service agreements signed with foreign entities must be registered with the tax authorities within 30 days. The authorities reserve the right to question the validity of these service agreements, and will scrutinise three areas in particular:

1. Were the services actually delivered?
2. Were the services rendered inside or outside China?
3. Were service fees calculated in accordance with the ‘arm’s length principle’?[1]

Given their potential for misuse, service agreements between related parties have become a focus for the tax authorities. Thus, it’s important to ensure such agreements are in compliance with the People’s Republic of China (PRC) law.

Royalties

Fees paid to an overseas entity in relation to the use of intellectual property are similar to service fees in that they are both tax efficient and relatively convenient for the business. Like with service agreements, a VAT of 6 per cent and a 25 per cent CIT on deemed profits—usually around 40 per cent—must be paid before remittances can be made. Royalty agreements must also be registered with the Trademark Office and the details provided, including the rationale for calculating royalty fees.

Foreign loan interest payments

The final method of repatriating profits overseas is through foreign loan interest payments. According to PRC law, an FIE’s total investments can exceed its registered working capital by between 30–70 per cent. The difference can be registered as a foreign loan on which the FIE pays interest to its parent company at a rate not exceeding the Bank of China’s official rate. FIEs are required to withhold a 6 per cent VAT and other surtaxes, as well as a 10 per cent CIT on all interest payments made on foreign loans.

How transfer pricing works

Transfer pricing is an accounting practice related to intercompany payments made in exchange for good or services. Transfer pricing allows companies to redistribute earnings amongst groups or related parties. However, due to the potential for misuse, the tax authorities will often examine such transactions, focusing in particular on:

• How each party benefited from the transaction;
• The necessity of the services in question;
• The rationale for determining price; and
• In the case of royalties, how much value the company derived from use of the intangible assets.

Additional considerations

When choosing methods of profit repatriation, a company should consider their particular business situation, keeping in mind that the Chinese tax authorities reserve the right to question the validity of many of methods. It’s also important that the business conducts thorough cashflow forecasts before repatriating profits to avoid needing to later increase its working capital.

It’s also worth mentioning that qualified non-resident foreign entities can defer withholding tax for profits derived from resident companies if they reinvest those profits in projects outlined in the Catalogue of Encouraged Industries for Foreign Investment. Thus, to take advantage of the full range of profit repatriation methods available and achieve an optimal tax liability, foreign investors are encouraged to plan ahead.

Valur Blomsterberg is a Business Development Manager at an accounting agency focused on foreign investment in China. Valur has previously worked for publicly listed multinationals and local firms in China. He is a regular content contributor to the media for topics related to SME financial management, tax and investment in China. LinkedIn: https://www.linkedin.com/in/valurblom/

[1] The ‘arm’s length principle’ states that the amount charged for goods or services exchanged between related parties must be calculated as if the parties were not related.