China tax strategy

China tax strategy
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Double taxation has been dubbed “one of the most visible obstacles to cross border investment,” leaving room for a significant amount of money to be saved under the almost 3,000 double taxation avoidance agreements (DTAs or DTAAs) signed between nations across the globe. To combat such obstacles, DTAs aim to prevent the same income from being taxed by two or more states, while also eliminating tax evasion and encouraging cross-border trade efficiency.

DTAs are mostly of a bilateral nature and, while DTA-signing countries are not all members of the Organization for Economic Cooperation and Development (OECD), DTAs are generally based on model conventions developed by the OECD or (less commonly) the United Nations. And while about 75 percent of the actual words of any given DTA are identical with the words of any other DTA, the applicability and specific provisions of each treaty can vary substantially.

From an investor’s perspective, confusion about international taxation can arise when investors are subject to two different and potentially conflicting tax systems. For example, Hong Kong and Singapore adopt a “territorial source” principle of taxation, which means that only profits sourced locally are taxable. Meanwhile, other countries such as China and the United States are on the worldwide tax system, and resident enterprises can be required to pay tax on income sourced both inside and outside of the country. DTAs not only provide certainty to investors regarding their potential tax liabilities, but also act as a tool to create tax-efficient international investments.

DTAs apply to individuals and companies of the countries or jurisdictions who are parties to the agreement, with the aim to prevent double taxation by allowing the tax paid in one of the two countries to be offset against the taxes payable in the other country, and/or by providing exemptions or reduced tax rates for specific income types such as royalties, interest, and dividends.

Withholding Tax and Profit Repatriation

DTAs also affect the repatriation of profits and earnings, as the location of profit taking and distribution can be manipulated favorably under the correct circumstances. This means that profits may be permitted to be taken in a lower cost jurisdiction than would normally be the case and distributed from there back to the overseas headquarters. This makes complete sense when developing a business in Asia, as capital injections and investments can then be made from the lower tax jurisdiction.

The distribution of dividends back to the home domicile can also be arranged in a beneficial and less tax burdensome manner than would otherwise be possible. Many preferred holding compan  jurisdictions maintain DTAs that limit or eliminate the level of withholding taxes payable on dividends coming from subsidiary countries and going to parent companies. For example, Hong Kong has a DTA in place with China that lowers dividend withholding taxes from the general rate of 10 percent down to just 5 percent (provided certain capital holding requirements are met).

What this means for foreign businesses is that they have the option to create a corporate structure such that profits from a China subsidiary may be remitted to a Hong Kong holding company at a 5 percent withholding tax rate on dividends, before then being passed on to the overseas parent company with no additional tax obligations. In contrast, if the China subsidiary were to remit directly to the parent company in a country that does not hold a DTA with China, it may be taxed at a withholding tax rate of 10 percent. Such reductions can represent significant tax savings over a period of time, being realized instead as additional profits.

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