The right approach to withholding taxes in China

Withholding taxes in China are levied on income received by non-resident enterprises from China, including:

• Passive income, such as dividends, interests, royalties, and other China-sourced passive income – taxed at a standard rate of 10%.
• Deemed profit obtained from business activities with an establishment or premises within China, such as management fees and service fees – taxed at a standard rate of 25%.

Passive income

Whereas the standard withholding tax rate for passive income is 10%, the applicable tax rate may be reduced if the non-resident enterprise is a tax resident of a country or territory that has a double tax treaty (DTA) with China that incorporates a lower withholding tax rate. Generally, the DTA will specify the applicable withholding tax rate on dividends, interests, and royalties. 

The reduced rate for dividends is generally only applicable if the beneficial owner is a company that holds, directly or indirectly, at least 25% of the capital of the company paying the dividends. The most common reduced rate is 5% but this differs per DTA.

Secondly, reduced rates for royalties are also applicable for a wide range of countries, ranging from 5% to 8%. Lastly, for interests, most DTAs do not specify a reduced rate, so the standard rate of 10% will prevail in most cases.

It is important to note that reduced withholding tax rates as specified by DTAs are not automatically applied. A company will need to apply with the tax authorities for the benefit, before completing its tax filing and sending out the funds.

Deemed profit

If a company receives income from business activities within China, withholding taxes are levied over the deemed profit of the activities. The deemed profit rate generally ranges from 15% to 50%. The most common case of deemed profit is for consulting services or management fees. Generally, a deemed profit rate of 30% to 40% is applied for such income.

As the deemed profit withholding tax rate is 25% of business profits, the effective tax rate would be 7.5% to 10%.

The right approach to withholding taxes in China

The two most common methods for companies to repatriate funds from China are dividends and management/service fees. 

While the withholding tax rate for dividends can be as low as 5% with a DTA, dividends can only be paid over net profits, which have already been taxed with a 5% to 25% companies income tax (CIT) rate. On the other hand, the payment of management or service fees will generally be taxed at 7.5% to 10%, which will lower the company’s taxable income, further reducing taxes paid. 

However, these fees must be deemed reasonable by the Chinese tax bureau and if the company does not have a valid basis for the fees, additional taxes may be levied. Furthermore, the use of such fees may impact the group’s transfer pricing.

For a company to determine which method is the most efficient to repatriate funds from China, a thorough review of the company’s full financial and fiscal position is required.

As a Partner at MSA, Brian leads the corporate services division. Providing guidance to enterprises navigating the Chinese market, Brian's expertise spans various areas of service, including facilitating market entry, company establishment, corporate structuring, and managing company liquidations.