GLOBAL CHALLENGING PRACTICAL VALUED RECOGNISED ADVANCED UP-TO-DATE STRUCTURED FLEXIBLE EMPOWERING RENOWNED SPECIALIST THOROUGH CURRENT INTERNATIONAL

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1 CHINA OPTION Contents What you ll cover and what you ll gain Recommended ways to prepare for your exam June 2017 exam questions June 2017 exam answers

2 GLOBAL CHALLENGING PRACTICAL VALUED RECOGNISED ADVANCED UP-TO-DATE STRUCTURED FLEXIBLE EMPOWERING RENOWNED SPECIALIST THOROUGH CURRENT INTERNATIONAL MODERN UNIQUE GLOBAL ADVANCED 2 ADIT

3 China option What you ll cover and what you ll gain The China module is one of fourteen elective modules available to ADIT students. A fixture within the ADIT credential since 2009, this module is designed to equip tax practitioners with a detailed structural understanding of the Chinese tax system, with particular emphasis on Individual Income Tax, Enterprise Income Tax, and inbound and outbound investment taxes. What you ll cover The China module gives candidates in depth knowledge of the mainland China tax regime in an international context. Key topics include: The structure of the Chinese tax system Individual Income Tax Enterprise Income Tax Legislative frameworks and jurisdictions to tax Inbound rules for foreign investment enterprises and corporations operating in China Outbound rules General Anti-Avoidance Rule What you ll gain A thorough grounding in current international tax issues in the context of China A robust understanding of theory coupled with practical application, giving you the confidence to apply these principles to your daily work Up to date knowledge of fast-changing developments in tax law, as exams are regularly updated to cover current tax laws and emerging trends ADIT 3

4 China option Syllabus I The structure of the Chinese tax system 5% II Individual Income Tax 15% III Enterprise Income Tax 80% I The structure of the Chinese tax system A Sources of Tax Law 1 B Structure of tax administration 1 II Individual Income Tax A Jurisdiction to tax 2 B Schedular system 2 C Wages and salaries 2 D Business income 2 E Services 2 F Income from property and investment 2 G Capital gains 2 H Effect of tax treaties 3 I Tax administration 1 III Enterprise Income Tax (EIT) A Legislative framework 1 B Jurisdiction of the tax 1 C Inbound rules: Foreign investment enterprises 1. Residence 2 2. Taxable income 2 3. Tax rate 2 4. Tax incentives 2 5. Reorganisations 3 6. Thin capitalisation rule 3 D Inbound rules: foreign corporations operating in China 1. Establishment, place of business and agent 3 2. Effectively connected income 3 3. Treaty considerations 3 E Inbound withholding taxes on investment income 1. Chinese source of income 2 2. Dividends 2 3. Interest 2 4. Rents and royalties 2 5. Capital gains 2 6. Treaty consideration 3 F Outbound rules 1. Foreign tax credit 3 2. Controlled Foreign Corporations 3 G Transfer pricing 3 H General Anti-Avoidance Rule 3 4 ADIT

5 China option Recommended ways to prepare for the exam Course Provision There are study options to suit everyone, from classroom learning to self-study. Whatever your preference, you ll find a method and providers that work for you. Find out more at Essential Reading Cao, F. Corporate Income Tax Law and Practice in the People s Republic of China (Oxford University Press, 2011) [ISBN: ] Available from Amazon: CCH. China Master Tax Guide (CCH, 2016) [ISBN: ] Candidates may take a copy of this text into the examination. Available from CCH: Li, J. Fundamental Enterprise Income Tax Reform in China: Motivations and Major Changes (2007) Available from Social Science Research Network: id= Li, J. Tax Transplants and Local Culture: A Comparative Study of the Chinese and Canadian GAAR (2010) Available from Social Science Research Network: id= State Administration of Taxation. China Advance Pricing Arrangement Annual Report 2013 (SAT, 2013) Available from State Administration of Taxation: part/ pdf State Administration of Taxation. Circular of the State Administration of Taxation on the Issue of the Implementation Measures of Special Tax Adjustments (Provisional). Circular Guoshuifa (2009, No. 2) Available from KPMG: Pricing-Services/Documents/Circular e.pdf United Nations. UN Practical Manual on Transfer Pricing for Developing Countries. 10.3: China Country Practices (New York: UN, 2013) Available from the UN: html Zhang, X. The Law and Practice of International Tax Treaties in China (Wildy, Simmonds and Hill Publishing, 2003) [ISBN: ] Candidates may take a copy of this text into the examination. Available from Amazon: UK/China Double Taxation Convention, together with 2013 Protocol Li, J. The Great Fiscal Wall of China: Tax Treaties and Their Role in Defining and Defending China s Tax Base (2012) Available from Social Science Research Network: id= Li, J. and Huang, H. Transformation of the Enterprise Income Tax in China: Internationalization and Chinese Innovations (2008) Available from Social Science Research Network: id= ADIT 5

6 China option June 2017 examination questions Transparent and accessible past papers Real questions and answers from previous exams are available to ADIT students to help with their study. Practice with previous exams helps students become familiar with the format of the exam, identify areas for further study and focus on exam technique. Other papers available PRINCIPLES OF INTERNATIONAL TAXATION AUSTRALIA IRELAND BRAZIL MALTA CHINA SINGAPORE CYPRUS TRANSFER PRICING EU DIRECT TAX UNITED KINGDOM EU VAT UNITED STATES HONG KONG UPSTREAM OIL & GAS INDIA 6 ADIT

7 THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2017 PAPER 2.02 CHINA OPTION ADVANCED INTERNATIONAL TAXATION (JURISDICTION) TIME ALLOWED 3¼ HOURS This paper has three parts: Part A, Part B and Part C. You need to answer five questions in total. You must answer: Both questions in Part A (25 marks each) The question in Part B (20 marks) Two questions from Part C (15 marks each) Further instructions All workings should be made to the nearest month and in Renminbi (RMB) yuan, unless otherwise stated. Start each answer on a new page and clearly indicate which question you are answering. If you are using the on-screen method to complete your exam, you must provide appropriate line breaks between each question, and clearly indicate the start of each new question using the formatting tools available. Marks may be allocated for presentation. The time you spend answering questions should correspond broadly to the number of marks available for that question. You should therefore aim to spend approximately half of your time answering Part A, and the other half answering Parts B and C. The first 15 minutes of the exam consists of reading time. You will be allowed to annotate the question paper during this time; however, you will not be permitted to start writing or typing your answer, or use a calculator. The Presiding Officer will inform you when you can start answering the questions. For your information this paper is accompanied by: Agreement between China and the United Kingdom for the Avoidance of Double Taxation (including Protocol)

8 Paper 2.02 China option (June 2017) PART A You are required to answer BOTH questions from this Part. 1. ACO is a company resident in the United Kingdom, which distributes medicines to customers in the UK. In 2016, ACO set up a wholly owned company, BCO, in China. Under the business plan, BCO produces medicinal products in China and supplies them to ACO at an arm s length price. ACO then resells the products to customers in mainland China. For the purpose of the business plan, BCO has been appointed as ACO s sole agent and authorised to accept orders on ACO s behalf. For each order taken, ACO sends a corresponding purchase order to BCO which then arranges production and delivery of the goods. ACO has licenced its patented medicinal products and rented a set of equipment to BCO, and has seconded its product manager, a UK resident, to work at BCO s office in order to monitor the quality of the products. The manager was in China for more than 304 days in 2016, and periodically reported to ACO s management. BCO paid a fee at cost plus 10% markup to ACO, in return for the services provided by the manager. It is expected that BCO will earn a profit in 2017, and will distribute the profit to ACO. What are the tax implications of the above activities in mainland China for ACO, BCO and the product manager? (25) 2. You are required to describe the GAAR under the Chinese Income Tax Law. Your description should address the following aspects of the GAAR: the legal framework; the content of basic rules (excluding procedural issues); the applied scope; any special tax adjustments which may potentially be made by tax authorities; and its relationship with other domestic anti-avoidance regimes and tax treaties. (25) Page 2 of 5

9 Paper 2.02 China option (June 2017) PART B You are required to answer THIS question. 3. CCO is a car manufacturer resident in the United Kingdom. In January 2015, CCO acted in joint partnership with a Chinese domestic company to establish a new car manufacturing company in China, DCO. For the purposes of management, CCO concluded an agreement with DCO under which three directors and two technical consultants were appointed by CCO to DCO for three years. The directors are members of DCO s governing board, but only visit China in order to attending board meetings. The technical consultants are based in China throughout the three year period, and are responsible for the design, production, installation and testing of equipment in which CCO has invested, as well as providing technical training services to staff in relation to the maintenance of equipment. Before the appointment, the three directors and two technical consultants were resident in the UK. Under the agreement, DCO is required to pay an annual management fee of RMB 10 million to CCO. You are required to explain the Chinese Income Tax implications of the arrangements described. (20) Page 3 of 5

10 Paper 2.02 China option (June 2017) PART C You are required to answer TWO questions from this Part. 4. You are required to provide a brief answer to the following questions, in relation to the Individual Income Tax: 1) How does the double taxation agreement (DTA) between China and the United Kingdom identify the individual taxpayer as a resident of a contracting state? (5) 2) Will a Chinese citizen who lives in the UK as a doctoral candidate at a UK university be taxed on his/her worldwide income? If so, explain how the tax will be applied. (5) 3) Bryn is a UK citizen who is employed by a Hong Kong-based company, for which he has worked since Bryn also purchased an apartment in Hong Kong. The company s activities required Bryn to work in Shenzhen, China, for five months in Which DTA will be applied in determining the taxation of Bryn s income from his work in mainland China, and why? (5) Total (15) 5. A United Kingdom company has carried on business activities in China through a representative office (RO) in Guangzhou, since The RO has two employees, one of whom is resident in China and the other resident in the UK. The annual salary of the Chinese resident employee totals RMB 500,000, and is paid by the RO. The UK resident employee s RMB 1 million annual salary is paid by the company s head office. In 2016, in support of the company s sales activities in China, expenses totalling RMB 2 million were spent by the RO; the expenditure included the provision of liaison and marketing services in China, but excluded the two employees salaries. However, the RO is unable to provide any evidence in support of its earnings. You are required to explain the Chinese Income Tax implications of these transactions in (15) Page 4 of 5

11 Paper 2.02 China option (June 2017) 6. Andrew is a United Kingdom citizen and was employed by a representative office (RO) in Guangzhou, China, in 2014; the RO was set up by a UK company (ECO) in London. In January 2016, the RO was restructured as a Chinese resident company, FCO, and Andrew was appointed as the legal representative of the new company. Andrew was not domiciled in China and returned to London in December During his time in China, Andrew was also employed by a UK company, GCO, based in London. GCO is an affiliated enterprise of ECO and FCO. Andrew visited the UK each year between 2014 and 2016, but for less than 30 days on each occasion. Andrew spent 181 days in China in 2014, 243 days in 2015, and 304 days in For his work at the RO, ECO paid Andrew RMB 600,000 in 2014 and RMB 800,000 in FCO paid Andrew a total of RMB 1 million in Andrew also received income from GCO, for work which he conducted for ECO during his time outside China, totalling RMB 600,000 in 2014, RMB 400,000 in 2015 and RMB 200,000 in You are required to explain the Chinese Income Tax implications of the transactions described, for Andrew. (15) 7. XCO is a Chinese controlled company registered in Xiamen, China, which produces medicinal supplies. XCO has a wholly owned subsidiary company, ZCO, in the United Kingdom. In 2015, XCO and ZCO set up a sale company (HKCO) in Hong Kong, which sells products supplied by XCO to customers in Hong Kong. 24% of HKCO s capital is owned by XCO, and the remainder by ZCO. HKCO is managed by a board of five directors, three of whom are domiciled in Hong Kong and the remaining two in mainland China. Board meetings are normally held via video conference. A senior manager is also domiciled in Hong Kong, and is responsible for HKCO s day-to-day management. In 2016, HKCO generated a large profit. For Chinese taxation purposes, HKCO applied to the tax authority s office in Xiamen for the identification of residence under Chinese Income Tax law. HKCO argued that its place of effective management is in mainland China. However, the tax authority argued that a substantial proportion of HKCO consists of a CFC of XCO, that HKCO is resident in Hong Kong and that it is controlled by XCO. You are required to: 1) Explain the tax benefits to which XCO and HKCO will be entitled if HKCO is determined to be resident in mainland China; (7) 2) Comment on the arguments presented by both parties regarding HKCO s tax residence. (8) Total (15) Page 5 of 5

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13 THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2017 PAPER 2.02 CHINA OPTION SUGGESTED SOLUTIONS

14 Paper 2.02 China option (June 2017) PART A Question 1 ACO has a PE in China according to Article 5 of China-UK Tax Treaty, because BCO is its sole sale agent, and profits from sale products earned by ACO through BCO and the payment received for its secondment of its employee (as a manager in BCO) from BCO will be attributed to the PE, therefore is liable for Chinese enterprise income tax according to Article 7 of China- UK Tax Treaty. Royalties received by ACO for licensing the patent to BCO shall be taxed in China at a limited tax rate no more than 10% of gross amount of the royalties according to Article 12 of China-UK Tax Treaty. Rent received by ACO for the rental of the equipment to BCO shall be taxed in China on 60% of gross amount of the rent at a limited tax rate no more than 10% of gross amount of the rent according to Article 12 of China-UK Tax Treaty. Dividends received by ACO shall be taxed in China at limited tax rate no more than 5% of gross amount of the dividends according to Article 10 of China-UK Tax Treaty, because ACO directly owns BCO s more than 25% capital which required by the Tax Treaty for application of limited tax rate. BCO shall receive the payments from ACO at arm s length price for its providing services as a sale agent. The manager shall pay individual income tax in China for his/her salary of work in China according to Article 15 of China-UK Tax Treaty, because his/her stay in China is more than 183 days in 2016, and his/her salary of work in China actually is borne by BCO, a Chinese company. Page 2 of 8

15 Paper 2.02 China option (June 2017) Question 2 The legal framework Article 47 of the Enterprise Income Tax Law, Article 120 of the Implementing Regulation on the Enterprise Income Tax Law, the provisions of Chapter 10 of Guoshuifa [2009] No. 2, and Order of SAT No. 32 (2014) The content of basic rules (not including procedural issues) Where an enterprise, which is within the personal scope of the Enterprise Income Tax Law, makes arrangement without any reasonable business purpose, resulting in the decrease of taxable income or other tax benefits, the tax authorities have rights to make a tax adjustment through a reasonable method. The main purpose of an arrangement is to reduce, exempt, or defer the payment of taxes shall be regarded as without any reasonable business purpose. Applied scope The following tax avoidance arrangements taken by an enterprise shall be under the investigation of tax authorities: the abuse of tax preferences, the abuse of tax treaty, the abuse of the legal form of corporation, tax avoidance arrangements related to the use of tax haven, and other tax avoidance arrangements without reasonable business purposes. All tax avoidance arrangements have characteristics as follows: (1) with sole or main purpose of obtaining tax benefits, and (2) obtaining tax benefits through methods that are line with provisions of tax law but inconsistent with economic substance thereof. The arrangements are not covered by the GAAR if they are irrelevant to cross-border transactions or payments, or are relevant to tax fraud. Tax adjustments made potentially by tax authorities Tax adjustments measures made potentially by tax authorities includes: (1) re-characterization of all or part of transactions under an arrangement; (2) disregard of the existence of targeted parties of transactions for tax purposes, or treating targeted parties and other parties of a same transaction as same entities; (3) re-characterizing or re-attributing among all parties of transactions items of income, deductions, tax preferences, and foreign tax credits; and (4) other reasonable adjustment measures. Relationship with other domestic anti-avoidance regimes and tax treaty Where an arrangement by an enterprise falls within the scope of the regime of transfer pricing, cost sharing, controlled foreign company, thin capitalization, or other special tax adjustments, the application of provisions relevant to those regimes shall be prior. Tax treaty does not prevent the application of the GAAR. However, where an arrangement by an enterprise is relevant to provisions on beneficial owner, limitation on tax benefits, or other issues related to the implementation of tax treaty, provisions on those issues related to the implementation of tax treaty shall be prior to be applied. Page 3 of 8

16 Paper 2.02 China option (June 2017) PART B Question 3 Chinese tax authority will treat the management agreement as a mixture agreement, under which the payment by DCO will be split as different items for the purposes Chinese income taxation. Director s fee will be split from the payment by DCO and be levied individual income tax in China under Article 16 of China-UK Tax Treaty. Two technical consultants will be treated as Chinese residents according to Chinese individual income tax law, and therefore need to pay individual income tax in China for their salary earned in China, which need to be split from the payment by DCO. The business income earned by CCO, which will also be split from the payment by DCO, is taxable income in China because 3-year-technical consultation services by 2 technical consultants in China will constitute a Service PE under Article 5 of the China-UK tax treaty. The payment by DCO to CCO needs to be in line with the arm s length principle because of affiliated relationship between CCO and DCO. Page 4 of 8

17 Paper 2.02 China option (June 2017) PART C Question 4 Part 1 Article 4 of China-UK Tax Treaty. Part 2 Not. If he/she has a domicile in the territory of China, he/she is regarded as a resident individual in China, and therefore his/her worldwide income shall be taxable in China. If he/she has no domicile in the territory of China, he/she is regarded as a non-resident individual in China, and therefore his/her income derived from the territory of China shall be taxable in China according to provisions of Chinese Individual Income Tax Law. Part 3 DTA between Chinese inland and HK will be applied. Bryn is regarded as a resident in HK, because he exercises his employment and has an apartment in HK. Page 5 of 8

18 Paper 2.02 China option (June 2017) Question 5 The RO in Shanghai is a PE of the company in China according to Art.5 of China-UK Tax Treaty and therefore is liable to pay enterprise income tax in China. According to Guohuifa [2010] No.18 and Gonggao [2016] No. 28 issued by the SAT, the amount of taxable income of the RO shall be calculated by the formula as follows: amount of taxable income = [cost (or expenses)/ (1- deemed profit rate)] deemed profit rate. Expenses in 2016 shall be two employees salary plus all other expenses, i.e., 0.5 million+1 million+2 million. The UK resident shall pay individual income tax in China because he/she has stayed and worked in China for 12 months, according to Art.15 of China-UK Tax Treaty. Chinese resident is also liable to pay individual income tax in China for his/her salary according to Chinese Individual Income Tax Law in this case. Page 6 of 8

19 Paper 2.02 China option (June 2017) Question 6 Andrew was not Chinese resident and stayed in China less than 183 days in 2014, thus his salary paid by ECO for his work for the RO is not liable for Chinese tax according to Article 15 of China-UK Tax Treaty and Guohuifa [1994] No.148. However, his salary of 2015 shall be taxed in China, because his stay in China was more than 183 days. In 2016, Andrew was employed as a legal representative of FCO, a China resident company, thus he is a senior personnel in FCO. According to Article 3 of the Implementing Regulation of Chinese Individual Income Tax Law, he shall be regarded to stay in China for 365 days in 2016, and thus be a Chinese resident. All salary paid by FCO in 2016 shall be taxed in China. All salary paid by GCO to Andrew for his work outside China is not liable for Chinese tax, according to Article 15 of China-UK Tax Treaty, Article 6 of the Implementing Regulation of Chinese Individual Income Tax Law, and Guohuifa [1994] No.148. Page 7 of 8

20 Paper 2.02 China option (June 2017) Question 7 Part 1 If HKCO was a resident in Chinese mainland, HKCO would be liable to pay Chinese enterprise income tax at 25% for its business profits, and there are no withholding taxes on distribution of dividends to XCO according to the Chinese Enterprise Income Tax Law. Otherwise, HKCO would be a HK resident and liable to pay profit taxes for its profits earned in HK at 16.5%, and withhold 10% of dividends distributed to XCO according to Article 10 of the Tax Arrangements between HK and Chinese Mainland. In addition, if HKCO did not distribute its profits to XCO without any reasonable business purpose, CFC rules under Chinese Enterprise Income Tax Law would be applied to XCO. Therefore, in latter circumstances, total tax burden assumed by XCO and HKCO together is bigger than that in former circumstances, even though XCO may claim HK income taxes credit when its dividends received from HKCO are taxed in China. Part 2 It is very difficult to consider the place of effective management of HKCO locates in Chinese mainland, because 3 directors of HKCO domicile in HK, they deal with management of HKCO in HK and make business decisions with other 2 directors via video conference, day-to-day management of HKCO is made by HK manager in HK, and main business of HKCO happens in HK. Therefore, the requirements on which a Chinese controlled company registered abroad may be identified as Chinese resident company under Guoshuifa [2009] No. 82 are not met in this case. By contrast, it is very evident that HKCO is controlled by XCO indirectly through ZCO. The shareholding of HKCO by XCO is line with the requirements on which a CFC may be identified under the Chinese income tax law. Based on the above, it seems that the arguments of HKCO are weaker than that of Xiamen tax authority. Page 8 of 8

21 GLOBAL CHALLENGING PRACTICAL VALUED RECOGNISED ADVANCED UP-TO-DATE STRUCTURED FLEXIBLE EMPOWERING RENOWNED SPECIALIST THOROUGH CURRENT INTERNATIONAL MODERN UNIQUE GLOBAL ADVANCED ADIT 1

22 China option Next steps Register today at Leadership An Academic Board of leading international tax academics is responsible for overseeing and evaluating the techincal content and rigour of the ADIT designation, to ensure the highest standard of assessment. Prof. Philip Baker Malcolm Gammie Dr Zhu Qing Prof. Luís Eduardo Schoueri Dr Partho Shome Prof. Dr Kees Van Raad Jefferson VanderWolk Prof. Richard Vann Please visit for more information. For further information or if you have a question you would like to discuss, please contact us: T: +44 (0) E: education@adit.org.uk W: ADIT is accredited by the Chartered Institute of Taxation. For more information about the CIOT, please visit Copyright 03/2018