Dividend remittance from overseas branches
The circular provides a formula for calculating foreign tax attributable under circumstances where dividends received by a China resident company from overseas branches. Indirect FTC is permitted for a resident company that holds directly or indirectly no less than 20 percent of the subsidiary shares.

Over the weekend I was reviewing some of the analysis on China’s new foreign tax credit rules (“Circular 125″) hoping to come across some interesting, and perhaps controversial, comments on the new rules. Nothing really interesting came to light but I did notice the above comment from China Briefing. Can you see the anomaly? I am not posting this to simply point out the errors of others (I make enough mistakes myself), but rather to bring to light a little discussed, and understood, topic – branch offices.

Branch offices are a legal term of art. Importantly, a subsiduary company is not a branch office. For example, if you are carrying on business in Australia and you do not want to set up an Australian subsidiary of your parent company, you must set up a branch office of your organisation in Australia. Most countries have similar rules in relation to branch offices. China itself does not really allow foreign companies to set up branch offices (banks and insurance companies are an exception) but rather uses the representative office structure for the same purpose in limited circumstances (professional services firms such as law firms are an example). Otherwise, to do business in China legally requires one to establish an appropriate legal entity, a company (WFOE or JV) or, from March 2010, a partnership.

Importantly, a branch office cannot remit dividends, although it can remit profits. Circular 125 discusses the remittance of dividends by foreign subsidiaries not branch offices. This may seem like I am being rather anal but there is a significant difference in the taxation of subsidiaries and branch offices. For one, as Circular 125 confirms, Chinese tax resident enterprises will be taxable in China in respect of income relating to the activities of a branch office in a foreign jurisdiction. A branch office does not need to remit profits to the China head office for Chinese tax liability in respect of those profits to arise. In contrast, a Chinese tax resdident enterprise will only be taxable in respect of the income of a subsidiary company, subject to the controlled foreign company and anti-avoidance rules, where the subsidiary remits dividends to the Chinese enterprise.

There is a another important distinction between a branch office and subsidiary company established in the foreign jurisdiction. Under most, if not all, double taxation agreements, the country of source is not entitled to tax a company resident in the other country (the country of residence) in respect of business profits unless those business profits are attributable to a permanent establishment. A branch office would almost always amount to a permanent establishment, whereas a subsidiary company would generally not. Accordingly, the parent company could be taxed on the income of branch profits. In contrast, the subsidiary company itself would generally be the taxpayer where such a form is used.

Note this is a fairly general discussion of the taxation of branch offices. Some countries, in certain circumstances, treat branch offices as separate legal entities for tax purpose and impose tax on the branch office rather than the head office. For example, Australia treats branch offices of banks as a seperate taxable entity in various circumstances under Australia’s tax assessing acts. China’s tax treatment of ROs is another example of treating a non-legal entity as the equivalent of a legal entity for tax purposes

Now perhaps China Briefing was using the term “overseas branch” in the less strict sense. I guess that is possible but given that branch office in the strict legal sense is discussed in the Circular I would assume that wasnt the case. I am not a regular reader of China Briefing, I find a lot of their tax commentary does not explain the issues or the implications in a satisfactory manner, but the publication has been a long standing tax resource for non-Chinese speakers and should be applauded on that basis.

UPDATE: China Briefing has now corrected the article and published a notice of correction. The correction was inspired by this post according to an email I received. Kudos to China Briefing for accepting that they made an error and correcting it.