How to Send Profits from China
China maintains a system of foreign exchange controls, meaning funds flowing into and out of China are regulated. Therefore, sending profits from China has been a complicated and confused issue for foreign businesses with subsidiaries in the country.
There are different profits repatriation channels investors can choose from. In this article we want to explain these ways and help investors to understand and prepare a repatriation strategy that fits for your business.
Distributing profits as dividends
Sending profits as dividends to the overseas parent entity is the most straight forward and legitimate way to distribute profits. There are certain requirements a company needs to meet before it can distribute dividends.
A company can distribute dividends after its registered capital being fully injected. A company can only distribute dividends out of its accumulated profits, which means the accumulated losses from the previous year must be offset by the profits.
After that, a wholly foreign owned enterprises (WFOE) has to place 10 percent of its after-tax profits into a mandatory surplus reserve fund until it reaches 50 percent of the WFOE’s registered capital.
A company can distribute dividends once a year after the annual audit process. By its nature, dividend is after tax income, hence 25% will be paid as corporate income tax (CIT) and there is an additional 10% withholding tax before profits can be paid out to the foreign parent entity as dividends.
Intercompany services fee arrangement
When the foreign parent entity provides supporting services to the WFOE such as IT technology supports, management supports, marketing supports and human resources. The WOFE will need to pay service fees to the parent company, therefore an intercompany services contract needs to be in place.
It seems to be less prerequisites and more flexible when it comes to repatriating funds through intercompany service fee payments. A WFOE can make intercompany payments anytime in a year without completing the annual audit. So far as the
transactional documents are properly prepared, Chinese Foreign Exchange Control will process the intercompany payments rather quickly.
Although in general, intercompany payments are tax efficient, they are subject to VAT, surcharges, and possible withholding CIT. Since most of the intercompany services are performed by a foreign entity in China, they are being recognized as Permanent Establishment (PE) status. Chinese authorities will give a deemed profit rate between 15% to 50% , then the service fees will be subject to 25% CIT on the deemed profits, unless a CIT exemption applies under a DTA.
Investors need to setup the intercompany service agreement under arm’s length, providing sufficient business substance for such arrangements and making sure these services are charged at market prices. Chinese tax authorities sometimes put special scrutiny on intercompany service fees trying to avoid transfer pricing issue and shifting profits.
Royalty payments
Similar to the intercompany service fee arrangement, when a foreign entity gives a Chinese entity the right to use and license intellectual properties such as trademark, patent, and technical know-how. The Chinese entity ought to pay royalty fees back
to the foreign entity for using and commercializing these intellectual properties.
Companies pay royalty fees must to have royalty agreements in place, such royalty agreement should state clearly the value of the IP, and the contribution of the foreign company who is entitle to the royalty payments. Most of royalty fees are subject to a 10 percent withholding CIT and a 6 percent VAT, as well as surcharges.
Loan to a foreign entity
When a WFOE makes profit in China, it can lend to its foreign related entities. Setting up a foreign loan arrangement is complicated and also under strict scrutiny from the foreign exchange control.
Firstly, a WFOE needs to be established at least for 1 year before it can issue a foreign loan. The loan agreement needs to be setup at arms’ length with timeline and market interest rate. The WFOE and loan recipient need to follow the China foreign exchange regulations.
Secondly, a WFOE can only issue a loan to a related foreign entity which has equity relationship with the WFOE. A foreign loan mush not exceed 30% of the owner’s equity showing on the recent financial report.
Once the loan is approved by the Foreign Exchange Control, there is no tax implication to the WFOE when issuing the loan. The loan interest income is subject to 10% withholding tax and 6% VAT plus surcharges. Despite its complications, issuing a foreign loan can be a tax efficient way to send profits from China.
