The Tax Analects of Li Fei Lao: Navigating Taxes, Business and Life In Asia: Including Taxation for US Expats

By Laurence E. Lipsher

This is a down-to-earth explanation (with the author's own cartoons) of how to do business and cope with the tax laws of 9 jurisdictions of Asia. Initially published in 2009, this critically acclaimed book explains how to start a business, how the business will be taxed, how the owners/participants will be taxed, mixed in with humorous foibles about life in Asia as an American expat.

• Language: English
• Publisher: eBookIt.com
• Release date: Apr 26, 2016
• ISBN: 9781456607104

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www.asiamedia.net

For Katherine Lipsher

…who, in the 16 years we have been with one another, has never quite understood how or why I have developed my business but who has backed me 200 percent all the time.

INTRODUCTION

The mainstream tax profession is just now learning, sometimes painfully, what business leaders have known for some time: our fledgling century does not belong to the West.

Money, power and influence still reside in places like New York and London — and will continue to do so for many decades to come. But there’s no denying that we’ve entered an era of intense economic globalization in which the titans of tomorrow might just as easily hail from China, South Asia, and the Pacific Rim.

Tax follows trade. So just as future MBA candidates rush to learn Mandarin, tax professionals around the world struggle to make sense of Asian tax systems. To their befuddlement, they are discovering exotic paradigms that share little conceptual similarity to the fiscal regimes back home.

Given the dearth of quality reference materials on point, the international tax community can breathe a collective sigh of relief that Laurence Lipsher has put pen to paper, creating a magnum opus that will benefit practitioners for generations to come.

For years, Lipsher has been the ‘go-to’ source for those seeking effective solutions to the thorniest of tax problems. He possesses a unique appreciation of not only the tax rules currently in force, but how these tax systems evolved over recent decades. That’s what sets Larry apart from the accountancy mills; he’s the guy who knows the right answer, and can concisely explain why it’s the right answer.

His knowledge base is genuine because he’s mastered the nuts and bolts of the Asian tax system from the inside — having now spent more than 23 years working in China and servicing clients across the region. This broad expertise is reflected in the range of jurisdictions addressed, including: China, Hong Kong, Macao, Taiwan, India, Singapore, Korea, Thailand, and Vietnam.

The practical benefits of this volume can be highlighted by informing readers of what they will not find in the pages that follow. You will not be exposed to the musings of an academic. Nor will you find the sanitized language of an industry spokesman. Lispher’s voice is one of real-world grit and authenticity. And no relevant topic is off limits; he tells it like it is. If that requires a frank discussion of corruption and its consequences for taxpayers, then so be it. He is at once an optimist and a realist.

Seldom has a book on taxation been so entertaining to read. The avatar for Lipsher’s storytelling is Li Fei Lao, who — with his sidekick Xiao Go Pi — keep the chapters flowing. His chapters are laced with smart anecdotes and humorous personal observations. Lipsher continually invents improbable subjects around which he weaves articles that attract a wide and varied readership. Who else can choose as an essay topic the kangaroo fart and meaningfully tie it into taxation in India or China? Where but from Lipsher’s computer keyboard would one find articles including tax haikus or blues riffs?"

Above all else, Lipsher appreciates cross-border taxation as contextual human drama. Governments tax economic activity because they must. Politicians offer tax breaks to their constituents because they must. And taxpayers will move heaven and earth to reduce their tax burden, again, because they must. Hindus would characterize the balance as reciprocal dharma, each factor tugging the other in equal but opposite directions.

No matter how dense the legislative and regulatory details, we never stray too far from the author’s awareness that our tax systems — and especially Asian tax systems at this moment in their evolution — reflect a complex balance of social, cultural and commercial endeavors.

Robert Goulder

Editor-in-Chief, Tax Analysts

Washington, DC

DOING BUSINESS IN CHINA

When it comes to doing business in China, begin with the essentials: how to legitimately conduct business in the People’s Republic of China. What follows are the basic, lawful (and, in the last case, not really legitimate but not illegal) ways that a non-Chinese individual or business can legally function in the PRC.

Joint Ventures — Same Bed, Same Dreams

When I first came to China in 1986, small companies had a choice of either an Equity Joint Venture (JV, as opposed to a Cooperative Joint Venture CJV) or a Representative Office. JVs with Chinese partners were encouraged, as from the government’s point of view, this was the easiest method of bailing out the state-owned enterprise system.

In the mid-1990s, as soon as the wholly-owned foreign entity became feasible, the JV went out of fashion because of all the nightmare stories about what Chinese JV partners would do to your business if you didn’t have a strong presence in the JV.

Today, JVs seem to be back in vogue. There are several reasons for this. In some restricted industrial areas, the JV is a foreigner’s only legal method of doing business. In other areas, with methods of due diligence now at a level of sophistication such that activities can be monitored and audit trails developed, JVs are proving an effective way for the non-Chinese businessperson to maneuver through red-tape and bureaucracy. A Chinese JV partner can also help develop the venture’s presence in the local market, build a good relationship with local authorities and manage local staff.

But while having a local Chinese partner is no longer the stuff of nightmares, certain criteria should be in place for this type of relationship to be successful: the intended partners should share the same corporate vision and objectives (same bed, same dreams!). When considering a local JV partner, it is useful to ask yourself the following:

Is the partnership in accord with the management style and development strategies that head office considers most appropriate?

What will happen to your project and overall development strategy if your intended partners fail to deliver on today’s commitment and obligations?

Should the partnership prove untenable, can you shoulder the exit costs?

Wholly Owned Foreign Entity (WOFE)

In the mid 1990s, the WOFE took off in China. The lure of ’complete control’ (or so the participating entities felt) as an alternative to putting up with a not-so-trustworthy JV partner became almost irresistible. While the WOFE is perhaps the most preferred choice, it is often a matter of economics as to whether or not it should be utilized.

The greatest drawback to a WOFE set-up is the registered capital requirements, which for many businesses are prohibitive. (Be aware, however: capital requirements (and other regulations) vary widely from one locality to another — there is absolutely no uniformity here. You’ve got to know the specifics of doing business in a given territory if you want to avail yourself of efficiency in the PRC!) A secondary drawback is the repatriation of profits. The laws on this matter are likely to change, but be aware that these restrictions are greatly reduced or eliminated through use of a Hong Kong company as owner of the Chinese WOFE.

Foreign Invested Commercial Enterprise

FICE is the new kid on the block in terms of acceptable methods of doing business in the PRC. Established for retail, wholesale, trading or franchising business, the FICE is the prime vehicle for the nonChinese firm to be able to sell in China. It has a lower — frequently much lower — registered capital requirement than a WOFE: RMB 400,000 for wholesale enterprises and RMB 300,000 for retail facilities in China. Adhering to WTO regulations, which aims to create a more level playing field for non-Chinese entities, the FICE is a boon to foreign operations in China. The trade-off for this lower registered capital requirement, however, is a more restrictive playing field insofar as what your FICE is permitted or proscribed to do. If your business plans fall within the parameters of a FICE….that’s nice!

The Registered Representative Office

This is how I’ve been doing business in China since 1990. It is the least expensive (cheap, actually) method of getting a start in China. If you need to be physically present in China but can conduct your business without invoices from China and do not have many employees, then this may be the only method that you should consider.

Remember, though, Representative Office owners must have a legitimate business, one that has been in operation for more than one year (but that’s not a problem: Hong Kong incorporators have easy solutions for this!). Rep Offices are permitted to conduct market research for their parent corporation as well as facilitate quality control, sales administration and marketing for the overseas parent corporation. If the Rep Office is reaching beyond these tasks, then there may be some potential problems in the future — but who knows how long it will take for that future to arrive? Looking at the present and the immediate future, you can get started in China for next to nothing. Effectively, there is no registered capital requirement.

Assembling and Processing Contracts

Foreign investors have previously been able to set up their manufacturing bases in China by entering into an Assembling and Processing Contract (APC) with a Chinese party. Most analysts consider this to be a thing of the past, especially with further limitations being imposed upon what a company can manufacture in order to maintain its eligibility.

I predict a rejuvenation of this concept outside the coastal areas, because economic incentives are needed to open up some parts of China. Under such an arrangement, the foreign party does not technically own any subsidiary or office in China. Rather, the foreign party provides technology, machinery, spare parts and raw materials, and the Chinese party provides manufacturing facilities and services for subcontracting fees. Finished products are required to be exported in order to maintain eligibility for the APC. It is not surprising to find thousands of workers in a large-scale APC factory that is actually run by foreign investors. To set up an APC factory in China, foreign investors must go through application procedures similar to those for Foreign Investment Enterprises (FIEs) — approval of a project proposal and a subcontracting agreement by the supervising authority of the Chinese Communist Party — because chances are that the local government and hence, the Party is your partner, as well as the Ministry of Commerce (MOCOM). As the Chinese government ‘owns’ the factory, it will, in practice, handle all the application procedures for the foreign investors.

This type of contract is dead in the special economic zones of the Pearl River and Yangtze Deltas, but it is still a form of operation that should be considered for the development of business within the new economic area along the Chengdu-Chongqing corridor. The APC will be offered in this region as an economic incentive, an alternative to higher taxes, combined with much lower wages and, alas, lax environmental regulations (in order to compete with Vietnam). Definitely keep this option open.

Other Methods

I know two ways by which non-Chinese have been able to operate businesses in China: either through a Chinese company (owned by someone’s brother-in-law), or by coming and going to China without establishing legal residence, ie. as a ‘business agent’ handling matters for a foreign entity that has not registered in China. Going forward, the new Unified Enterprise Income Tax will curtail use of the former, and the latter will be subject to investigation by the State Administration of Taxation more frequently, so be ware that these are not recommended methods of doing business in China.

How Your Business Will Be Taxed in China

Corporation Taxes

Unless you have the good fortune to be a business entity that was located in a tax incentive zone prior to the April 2007 introduction of the new Unified Enterprise Income Tax law, then you’re going to be confronting an enterprise income tax, effective since January 1, 2008, of 25 percent, with limited exceptions. The new Unified Enterprise Income Tax law is a big item to consider for the future. In approximately 11 translated pages, a brand-spanking-new tax law and code for business has been created in China — 60 articles, not including the commensurate regulations. That was not a typo: 11 pages! By comparison, would anyone care to guess how many thousands of pages would be the equivalent for such a measure enacted by the U.S. Internal Revenue Service?

If your legal business entity was up-and-running in one of China’s tax incentive zones prior to April 2007, then you have a five year period to ease on into the 25 percent unified corporation tax rate from your lower current tax rate. Perhaps more importantly, you still have the tax holidays that were granted to you when your business was established. The Special Economic Zones and Pudong each offered 15 percent tax rates, with tax incepted after tax holidays, and tax losses were offset. For those of us with businesses outside of an SEZ, with a 33 percent enterprise income tax rate, to say that we were envious would be a bit of an understatement.

Regardless of whether you are in a tax incentive zone, if you set up shop in the PRC after the April 2007 tax law introduction, forget about the five years of tax holidays and forget about easing on down the lane to a uniform unified tax you’ll be hit with the 25 percent tax at the outset. The exceptions: the Binhai New Area or the Chengdu-Chongqing New Area, where tax concessions and a 15 percent tax rate will still be available for many (but not all). To qualify, your business must be a truly high-technology endeavor or vital to agriculture, energy or animal husbandry …and it doesn’t have to be a manufacturing enterprise: a service company allied to the tech sector will also get the benefits, according to Yang Yuanwei, Deputy Director-General at the Policy and Regulation Division of the State Administration of Taxation (the guys who are writing the regulations to a new law). Representative offices will also be subject to this same 25 percent tax rate.

For tax purposes, a Foreign Investment Enterprise (FIE) is a PRC legal entity or unincorporated joint venture, or, as per the new law, an unregistered business agent representing a foreign entity in China, in which one or more foreign investors owns a stake of 5 percent or more. An FIE may be an Equity Joint Venture (EJV), a Cooperative Joint Venture (CJV), a Foreign Invested Commercial Enterprise (FICE), or a Wholly Foreign-Owned Entity (WFOE). Of these, EJVs, FICEs and WFOEs always take the form of PRC limited-liability companies, whereas a CJV may be either a PRC limited-liability company or an unincorporated business vehicle akin to a partnership.

What was formerly referred to as a Foreign Enterprise (FE) is now officially called a Non-resident Enterprise (N-RE). The N-RE is still essentially the same as an FE: a company or other business organization formed under the laws of a country other than China. For example, a Hong Kong company with a Representative Office in China is an FE, as is a US company that has no PRC presence but derives PRC-sourced income from licenses granted to Chinese licensees. A company that ‘unofficially’ has a representative business agent in China, under the new law, is also considered a Non-resident Enterprise.

Under the new Enterprise Income Tax Law, all FIEs and FEs/N-REs are subject to a 25 percent national tax on worldwide net income. There is also a section of this new law that provides for a 20 percent corporation income tax rate for certain qualifying small-scale/smallprofit enterprises. Trust me, you won’t qualify for this!

Employment Taxes

Effectively, you are going to have to pay 21-24 percent of employee wages for social insurance taxes. If you are operating a Rep Office, you’ll pay more -up to 40 percent -because you are not allowed to hire staff directly: staffing is a service provided by the local government Employee Service Corporation. You’ll also have to pay the prior month’s payroll taxes on or about the 10th of the subsequent month. This is all I’m going to say on employment/social insurance taxation. Simply be aware that you are going to have to pay it on a monthly basis.

Value Added Tax (VAT)

The PRC Value Added Tax (VAT) took effect on January 1, 1994. The VAT applies to the sale and importation of goods in China, and also applies to processing and repair or replacement services carried out in China. Sellers of taxable goods and services are required to collect VAT from purchasers at rates of 17 percent for most goods. Up until July 2007, there was an export VAT refund of 13 percent. This is a benefit of the past, as China attempts to figure out how to cure its trade imbalances.

PRC Customs is required to collect VAT at the point of entry for imported goods on behalf of the taxation authorities. Importers or their agents must pay the tax within seven days of issuance of a duty-and-tax-payment certificate by Customs.

Sellers must charge purchasers VAT on the total RMB purchase price of goods, including all commissions, late payment interest, packaging and other fees, but excluding the applicable VAT itself, Consumption Tax and any transport department fees. Where a seller obviously understates a sales amount, the tax authorities may estimate a deemed sales amount. Taxpayers concurrently dealing in goods and services with different tax rates are required to separately calculate the relevant sales amount or pay tax at the highest applicable rate.

Sellers must remit VAT to the tax authorities according to the following formula:

(VAT payable for current taxable period) = (VAT paid on sales during the period) — (VAT paid on purchases of domestic and imported goods during the period).

VAT liability arises on the receipt by a seller of full payment or of a payment voucher for taxable goods or services, or on a declaration to Customs by an importer of goods. Local tax authorities will arrange taxable periods for individual tax payers in cycles of one day, three days, five days, ten days, or one month depending on the amounts of tax payable. A head office and each of its branches is required to pay applicable VAT to local tax authorities; however, with the approval of the State General Administration of Taxation, a head office may pay on a consolidated basis for all of its branches.

On June 16, 2007, the Ministry of Finance and the State Administration of Taxation issued a circular that imposes new and lower value-added tax refund rates for a list of 2,831 commodities; effectively, this virtually eliminates the VAT export refund. With a little more than two weeks’ notice, exporters had to frantically ship prior to July 1 to avoid losing the VAT rebate. The VAT refund is now a thing of the past for the exporter, but I expect an export VAT rebate system to be re-introduced in specific areas of Western and Northeastern China, as the government seeks to develop those parts of the country. Any new VAT export rebate will be, at best, a temporary incentive solely for specific locations deemed as high priority for development. Companies should plan with its impermanence in mind.

While the subject of transfer pricing is more ‘fluff’ than the essential

‘stuff,’ it is nonetheless something that should be mentioned in the same breath as manufacturing and the VAT. If you want to be a tax efficient manufacturer in China, you should protect your investment by getting an advance pricing ruling from the government. Transfer pricing is the one area where the State Administration of Taxation has developed a degree of sophistication that is not to be taken lightly. After seven years, there are specialty transfer pricing audit teams under a division of the SAT that work wherever they are needed. If you are going to get hung for transfer pricing irregularities, you are almost certain to get it with a VAT additional tax, as well — the two frequently go hand in hand. Tax efficient investment strategy for the manufacturing operation in China: work upon an advance pricing agreement.

Business Tax

Not every company pays the VAT. That’s where the Business Tax comes into play. The Business Tax is a sales-tax-like payment based upon gross revenues for non-VAT/small entity commercial enterprises in China. It is also paid by all registered Representative Offices.

The Business Tax is payable by non-VAT payers. The Business Tax is payable at varying rates by enterprises that provide services, sell immovable property or assign intangible assets.

The Business Tax applies at the following rates:

3 percent of the price of services in the areas of transport, construction, posts and telecommunications, culture and sports;

5 percent of the price for most other services, finance and insurance, the assignment of intangible assets and the sale of immovable property;

5 percent to 20 percent, as set by local authorities, of the price for entertainment.

Registered Representative Offices are subject to the Business Tax on deemed income at a flat rate of 5 percent.

Business Tax is calculated at the applicable rate on the full price received by the seller or service provider, including all charges. Specific methods of calculating the taxable amount apply to transportation enterprises, tourism enterprises, construction subcontractors, enterprises trading foreign exchange, securities or futures enterprises, and financial institutions that lend. Where sellers or service providers concurrently engage in activities subject to different rates of Business Tax, they are required to calculate separately the different tax items, or pay at the highest applicable rate. Tax liability arises on receipt of full payment or a payment voucher for the taxable service or immovable or intangible assets.

Local tax authorities will set payment periods for individual taxpayers of five days, ten days, 15 days, one month, or per transaction, depending on the amount of tax payable.

Circulars 39 and 40

Remember (unless you are having a ‘senior moment,’ or this summary is so boring that you have already forgotten!) that no rules and regulations have been issued to go along with the inception of the new corporate income tax laws. On December 26, 2007, the State Council passed two circulars to clarify the grandfathering treatment provided under Article 57 of the new Corporate Income Tax Law.

Circular 39 stipulates the grandfathering treatment for existing enterprises — entities with business licenses issued prior to March 16,

2007. These lucky entities are still going to be entitled to the benefits.

Transitional treatment for taxation will be as follows:

Those entities in other tax entitlement areas that had previously had a reduced rate of 24 percent