Among the cross-border contracts between Chinese and foreign enterprises, the most common are purchase and sale contracts for goods, service contracts, royalty contracts and so on. In this article, we take the royalty contracts as an example to provide some tips on how to formulate tax clauses therefore.
Assuming Company G is a taxpayer resident in Germany and licenses Company C, a client of Company G in the PRC, to use its registered trademark and collects trademark royalties accordingly. Before determining the contract price and formulating the tax clauses, the contracting parties need to assess the tax liabilities arising from the trademark license fees in the PRC and Germany, clarify the tax costs and, on this basis, negotiate the trademark license fees and formulate the tax clauses. Under the PRC tax laws, Company G, a non-PRC resident taxpayer, is required to pay value added tax ("VAT") at the rate of 6% and corporate income tax ("CIT", or called as withholding income tax) at the rate of 10% on the royalty fees received from Company C in China. In this cross-border business transaction, Company G is the taxpayer under the PRC tax laws, while Company C is the withholding agent and is thus required to withhold and pay CIT and VAT arising from the trademark royalties payable to Company G to PRC tax authorities. At the same time, as a taxpayer resident in Germany, Company G nay also required to file a tax return with the German tax authorities in respect of the trademark royalty income. Although Company G is the taxpayer of royalties under the PRC tax law, the parties may negotiate and agree on the bearing for different taxes in cross-border transactions.
Specifically, the two parties may reach the following agreement based on different negotiating positions and cost considerations:
Scenario 1: The royalty payment is an amount that includes all PRC taxes. In this case, the net amount payable by Company C to Company G is the invoice amount less all PRC taxes. That is to say, Company C's total payment is equal to the invoice amount (excluding the stamp duty). However, Company C's actual cost will be less than the invoiced amount because the VAT withheld is not included in the cost and can be deducted as its input VAT against its output VAT amount.
Scenario 2: The royalty payment is a net payment excluding all applicable PRC taxes. In this case, the net payment to Company G is the invoiced amount without any deductions. All PRC taxes incurred will be paid and borne by Company C. Therefore, the total cost to Company C will be the invoiced amount plus the income tax withheld and paid on behalf of Company C. The VAT withheld and borne by Company C would not be a cost factor as it can be deducted as input tax from its output amount.
Scenario 3: The royalty payment is the amount excluding Chinese VAT but including Chinese CIT. In this case, the net amount payable by Company C to Company G will be the invoiced amount less the Chinese income tax withheld by Company C. Unlike in Scenario I, the VAT withheld by Company C cannot be deducted from the royalty payment to Company G, but shall be borne by Company G. However, since the VAT withheld by Company C can be used to offset its output VAT, such a tax bearing arrangement would not increase Company C's costs.
For cross-border operations within a multinational enterprise group, from the perspective of group tax optimization perspective, it is worth considering which party should bear the VAT and withholding tax, based on the understanding of double taxation agreements signed between China and the host country of the overseas related parties, as well as the domestic tax laws of each party.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
