Taxing time for foreign businesses

At the end of June, the State Administration of Taxation of China issued a notice for the ‘Provisional Measures on the Collection of Tax on Non-resident Taxpayers Engaged in International Transportation Business’, which came into effect on August 1, 2014. These provisional measures are aimed at the incomes (eg, charter hire, freight and surcharges, charges for loading and unloading, warehousing costs) received by non-resident enterprises conducting ‘international transportation business’ in China.

International transportation business refers to the transportation services of passengers, cargoes, mails, or others into or out of China via self-owned or leased ships, airplanes and shipment slots, and the relevant subsidiary business such as loading, unloading, and warehousing. The provisional measures explicitly provide that voyage charter and time charter are international transportation businesses and are therefore subject to the applicable tax rate for transportation services under the provisional measures.

This clarification ends the long debate of whether charter hire under time charter shall be deemed as income from transportation services, or property leasing. Incomes from property leasing are subject to different tax rates, and sometimes are not included into tax treaties for tax exemption.

Self declaration

According to the provisional measures, non-resident enterprises are required to declare and pay taxes themselves or through appointed agents. In addition to the self-declaration and payment, the tax authority can also designate a ‘tax withholding agent’ who is legally obliged to withhold part of payment – including charter hire, freight, and other incomes under international transportation business – to non-resident enterprises. Failure to declare, withhold, or pay taxes can result in compulsory payment of tax due, fines, and penalties.

Legally speaking, there has long been a requirement for non-resident enterprises to declare and pay tax for the income received from international transportation business, but these legal requirements were not strictly enforced by the tax authority and there was no specific regulation guiding or demanding foreign companies to declare or pay tax. The major mechanism for collecting taxes on international transportation business was tax collection at source through withholding agents.

In a circular from the State Administration of Taxation on ‘Issues concerning the Calculation and Collection of Enterprise Income Tax on Watercraft and Aviation Transportation Incomes of Non-resident Enterprises’ (Guo Shui Han [2008] No.952), the tax authority prescribed a unanimous withholding rate of 4.25%, made up of 3% Business Tax, and 1.25% Enterprise Income Tax, applicable to all revenue received from international transportation business. Previously, withholding agents, usually Chinese charterers, were required to withhold 4.25% of the charter hire owed to foreign owners. In fact, some withholding agents applied a higher withholding rate because they misunderstood and thought of time charter hire as income arisen from property leasing or royalties, instead of transportation services. In contrast, for those international transportation businesses with no Chinese charterers involved, neither business tax nor enterprise income tax is actually levied.

Now, the newly adopted provisional measures define international transportation business as any transportation into or from Chinese ports, and that this be subject to enterprise income tax. It seems that even shipments that do not involve a Chinese charterer could be considered as international transportation business, and therefore taxable in accordance with the provisional measures.

Wide remit

Such a distinct perspective gives rise to two uncertainties. Firstly, will the tax apply if a foreign owner charters a vessel to a Chinese charterer, but they are no calls to Chinese ports? In the past, this income would have been subject to business tax, but not enterprise income tax. Secondly, will the tax apply if a foreign owner charters a vessel to a foreign charterer, without the involvement of a Chinese charterer if the vessel calls at Chinese ports? So far, the State Administration of Taxation gives no clarification in this regard.

The provisional measures define total income under international transportation business and provide that actual, reasonable, and relevant expenses are deductible. In Article 7, the provisional measures define that a taxable income is the balance of total income minor deductible expenses. Deductable expenses refer to the actual, reasonable, and related expenses for international transportation business, such as running costs, crew salary, fixed asset depreciation, ports costs, and bunkers. In practice, the tax authority usually adopts a very strict review of deductible expenses, and requires all these expenses to be well supported by written evidence, and sometimes sets upper limit to certain expenses.

The applicable tax rates of 10%, 20%, and 25% are provided by the Law of the Enterprise Income Tax, and other related regulations. The tax to be paid is the result of multiplying the taxable Income with applicable tax rate. The provisional measures also provide detailed procedures for tax withholding, registration and declaration, account book setting, and tax treaty benefit application.

Non-resident taxpayers residing in countries that have tax treaties with China – such as Cyprus and Greece – can apply for a tax exemption in accordance with those treaties.

Overall, China has tightened up the tax regulation for international transportation business. Consequently, owners should be vigilant and always take various taxes into consideration before concluding charterparties with charterers.

Author information

Chen Xiangyong is senior partner and head of the Admiralty Group at China’s Wang Jing & Co. Mr Chen joined Wang Jing & Co in 1994 and is responsible for overseeing all significant maritime cases undertaken by the Firm’s branch offices around China. He is widely recognised as one of China’s foremost experts in admiralty law and has been selected as a leading lawyer in maritime and shipping by Chambers & Partners and Asia Law for many years. Wang Weisheng is a lawyer at Wang Jing & Co, specialising in maritime law. For more information go to www.wjnco.com.