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By Matthew, May 11, 2010 11:23 am

The Australian government recently announced its intention to impose a 40% tax on the “super profits” of mining companies. This is opposed to the general 30% (soon to be reduced to 28%) rate of tax for companies in Australia. This decision has come under some criticism – both from a policy and legal perspective. In respect of the latter, a Sydney lawyer has indicated that this may be in breach of Australia’s obligations under it Bilateral Investment Agreement with China (as an example). See here:

Alex Baykitch, a partner in the Sydney office of Holman Fenwick Willan, a law firm advising on international commerce, says legal action to try to get compensation for the tax hit could be taken under various bilateral investment treaties signed with numerous countries, including China.

There are no such treaties with the UK, Mr Baykitch says, but companies such as Chinalco, which own 9pc of Rio Tinto, may be able to launch legal action under one of these treaties.

Baykitch goes onto to say further:

The tax proposal “is a classic example of a potential breach of a host state’s obligations under a BIT”, according to Mr Baykitch. “Broadly speaking, BITs establish clear rules on the scope of investment protection and the treatment that states must provide to foreign investment in their territories. In addition, they establish a framework for the resolution of investment disputes through arbitration between the foreign investor and the host state.”

…

BITs generally protect foreign investors of a signatory state from actions of the other signatory state which affect the value of their investments. Typical BITs include clauses protecting foreign investors from discrimination, expropriation and nationalisation. BITs generally provide for such disputes to be arbitrated.

…

“BHP is 40pc foreign owned, Rio Tinto is more than 70pc foreign owned. That means these massively increased profits, built on Australian resources, are mostly in fact going overseas,” Mr Rudd told Australian radio. These comments about foreign ownership could add weight to the case that the mining tax breaches these rules, Mr Baykitch says.

To be honest, in my view, this argument doesnt really hold much water and I think mining companies would have a very difficult claim based on the present China-Australia BIT. Australian and Chinese laws (in particular) regularly place restriction on foreign invesments – Australia’s foreign investment review board requirements are an example. I hardly think an increased tax for ALL mining companies irrespective of the nationality of investors, despite possible nationalistic intentions, could fall foul of the BIT when other more direct restrictions to foreign investment apparently have not. Regardless, I think any arbitraiton would be prudent enough to take Mr Rudd’s comments for what they were – rhetoric to gain community support for the proposal.

Mr Baykitch might also want to advise all foreign companies operating in China’s highly restricted investment environment of their options under the BIT. Personally I wouldnt be paying for that advice because you have buckley’s chance of getting China to change even if the BIT did support such an argument. Now Mr Baykitch is a well regarded lawyer and obviously knows more about this area (it ii his specific area of expertise) than me but I just find it to be such a stretch.

Now going to the policy issue for the increased tax for mining companies, I have to say I can see the merit. Everyone should accept, regardless of political sensibilities, that the mining industry currently profits for a resource that has, in the overall scheme of things, a limited life span. Once the mining companies have exploited these resources, they will be lost to the community. A requirement that they pay a higher tax to take into account this loss is, in my view, not entirely unfair. I am, admittedly, not an environmentalist but I think that general economic principles can be used to support such an initiative.  Thats my two cents, for what its worth.

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By Matthew, April 22, 2010 11:12 pm

There are a lot of myths and misunderstandings about representative offices … probably the biggest is the idea that there is a 10% tax on the gross expenses of ROs. I pointed out previously (see my response to Alexandre in the comments section) why such a statement is strictly incorrect and is unhelpful in terms of comparing the relative tax merits of an RO as opposed to other investment forms.

The reason I bring this up is that yesterday I presented in Hwuason offices a seminar on the tax changes for ROs (a copy of the presentation can be found here). In preparing for the seminar I reviewed – as I often do – other professionals’ views  to see whether they had any insights or ideas that I had not considered. A recurring theme in quite a few of the materials I came across was that there is an inconsistency between the SAT’s treatment of ROs (in Circular 18) and the treatment of them by the State Administration for Industry and Commerce (SAIC). The SAIC reconfirmed in January – in the Notice on Further Administration of Registration of Foreign Companies’ Resident Representative Offices (see more here) – that ROs could not undertake direct business in China. The SAT’s alleged  inconsistency is that it indicates ROs may be taxable on actual income. The question is, according to some views, how can a RO have actual income if it cannot undertake direct business? Here are some of views I read:

From Mazars Hong Kong:

However, the tax filing on “actual basis” poses legal dilemma to ROs. In general, ROs are not allowed to conduct revenue generating activities in China. Circular 18 now requires ROs to ascertain their revenue by reference to their functions and risks, which seems to be contradictory to the capacity of ROs. There will be inconsistency in ascertaining the legal and tax position of ROs.

From Salans:

The inconsistency also theoretically exists between the tax rules and other rules issued by the Chinese government. According to Administration Rules on Permanent Representative Offices of Foreign Enterprises (“SAIC Rules”) issued by the State Administration of Industry and Commerce (“SAIC”) in 1983, a Rep office cannot directly engage in business operations

This may create a theoretical challenge if tax authorities are entitled to tax the income of a Rep Office from business operations, while such income may be illegal under SAIC Rules.

From Guo Lian Law Firm (I had actually never heard of this firm before – which is probably my ignorance – but am impressed with their analysis in this article):

Although the Provisional Measures permit all Rep Offices to apply the Actual Taxable Income Method in calculating the CIT, it shall carry no implications of lifting the long-standing ban on Rep Offices from engaging in direct income-generating business activities in China. We believe that Rep Offices shall remain away from any the activities.

Accordingly, at the seminar I posed two questions.

1. Was Circular 18 inconsistent with the SAIC’s Notice?
2. Does Circular 18 provide tacit approval for ROs to engage in direct business?

My answer to both these questions was NO.

The reason is that Article 3 of Circular 18 states as follows:

Representative office shall apply and pay the enterprise income tax on its attributable income.

The term “attributable income” has a very specific meaning in international tax – it is commonly used in terms of taxing companies in respect of “permanent establishments” they have in a foreign country. Income could be attributable to a source (such as an RO) without that source actually directly earning the income. In other words, the parent company of an RO will often earn income that could be attributable to the RO without the RO engaging in direct business. This is actually the classic model of an RO. In such circumstances, Circular 18 is saying that China will tax the RO on that income and in order for the foreign investor to avoid either of the two deemed methods, accurate accounting records need to be maintained to reflect what income is attributable to the RO.

Even if this view is incorrect, which it is not, I would still answer no to the second question. The SAT has no legal authority to indicate what business activities are lawful for an RO to operate. At the same time, the SAT will treat legal and illegal income equally – it will tax them. A drug dealer cannot resist tax on the basis that his/her income derives from the proceeds of a criminal act.  Such an argument that the “inconsistency” between Circular 18 and the SAIC Notice requires clarification is, with the absolute respect, bunk.

As an aside, I was very happy with how the seminar went and I am looking forward to doing the next seminar in May (probably on partnerships – stay tuned).

UPDATE 26/4/2010: I would have done this as a separate post but I promised no more posts on ROs. We are already beginning to see the interpretation of the new rules by the local tax authorities. In early April the Shajing Local Taxation Office in Shenzhen province re-assessed 15 ROs and increased the payable tax by almost RMB700,000. As part of the new tax environment for ROs, the Shajing Local Tax Office examined these ROs and discovered that the ROs had only paid their income tax to the state tax bureau but had not met their taxation obligations with the local tax bureau. The chief representatives of the RO were required, as part of these investigations to have discussions with the local tax officials in relation to the nature of their business.

The tax officials also examined and compared the materials provided by the ROs. As part of this process, the ROs indicated that there were some ambiguous aspects to the new policies. As transitional concessional arrangement, the local tax officials provide some guidance on the new policy to the ROs. However, it cannot be expected that the officials will take such a conciliatory approach in the future.

I will try and report any practice developments I come across.

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By Matthew,

In 2009 the State Administration of Taxation (SAT) undertook significant steps in relation to clamping down on anti-avoidance practices. However, taxpayers certainly should expect any lessening of the resolve of China’s tax authorities. I just came across an article published (in Chinese) on the SAT website that indicates (and confirms what Hwuason has been hearing) that the SAT considers that there is a significant way to go in relation to anti-avoidance practices – unsurprising really but it reinforces to extent to which the SAT considers this to be an issue.

The article quotes officials as stating that in 2010  China will step up efforts to counter tax evasion, with a particular focus on transfer pricing in the pharmaceutical and automotive industries, the use of intangible assets and share transfers, and cross-border related business transactions.

The SAT spent considerable resources in 2009 developing a sound system for its anti-avoidance investigation practices and it is expected that in 3020 this will continue to be fine-tuned. An official from the SAT’s International Tax Department recently commented that up until “present investigations focused more on anti-avoidance in respect of the purchase and sale of tangible assets, cost sharing by controlled foreign companies and thin capitalization”.

However, from this year, the SAT will look beyond these more simplistic anti-avoidance practices and will examine the issues on a more complex level, including exploring rational pricing of intangible assets and equity. In addition, outbound investment will receive special attention, particularly the transfer pricing practices employed by Chinese companies investing abroad and controlled foreign company management.

The SATs efforts to combat anti-avoidance in 2009 garnered significant results – the work of the national anti-avoidance team resulted in adjustments to taxable income totally 16.09 billion yuan and 2.09 billion yuan in back taxes.

Promisingly, the SAT official also indicated that the SAT will greater encourage bilateral Advance Pricing Agreements (APAs). Bilateral APAs allow multinational companies to achieve greater certainty in terms of their transfer pricing practices. There has been some doubt in the past about the difficulties in obtaining bilateral APAs and accordingly it is encouraging to see commitment to them by the SAT. Since 2005 China has entered into 12 bilateral APAs and it is expected that this number will rise as multinationals become more familiar with China’s approach and the attitude of officials towards them.