Tax Related Matters between Head Office and Branch Office in China

In practice, taxpayers could meet with various tax compliance related issues between head office and branch offices within China. Indeed, there are lots of regulations and stipulations regarding financial accounting, Corporate Income Tax (“CIT”), Value Added Tax(“VAT”), Individual Income Tax(“IIT”) as well as social security. In practice, the treatments are even more diversified, but there are often connections between the treatment of various taxes and fees. This is a brief introduction of typical cases met in practice for enterprises’ reference.

First of all, branch offices without independent financial accounting are not necessarily exempted from local tax payment obligations. Independent financial accounting is related to accounting management. The business operating result of branch offices without independent financial accounting are uniformly accounted by the head office. Even so, branch offices with operations in different regions are independent VAT taxpayers in most cases. As long as VAT taxable income is derived from the branch office’s operating activities, the branch office would have VAT payment obligation.

In practice, some branch offices may undertake the function of local sales promotion substantially, while have the head office to conclude sales contracts, deliver goods and issue VAT invoices to the customers. In such case, the branch offices may claim that no sales income is derived locally and proceed nil VAT filings regularly. Nevertheless, particular attention should be paid to the corporate size and the substantial functions and risks undertaken by the branch offices under such circumstances, in order to avoid challenges from the local competent tax authority.

If the branch offices are carrying out critical operational activities locally, such as sales functions with local sales team instead of auxiliary supporting coordination work, the branch offices may be required to provide local employment contracts with the employees of the branch offices as well as their payroll slips, to elaborate on the local activities of the branch office. If the payroll structure of the local employees consists of base salary and sales commission fee, which is typical for sales personnel, it would be very likely to be affirmed by the local tax authority that the substantial sales negotiation is completed by the branch office, and the main decisions are not made by the head office. Besides, if the branch office keeps a local warehouse for regular inventory other than sample storage, its auxiliary function might also be challenged. Under such circumstances, regular nil VAT filings by the branch office are usually not accepted by the local tax authorities, and thus the functions performed by the branch offices should be reasonably compensated by the head office and the corresponding VAT should be declared.

In terms of CIT, it is stipulated in tax regulation that supporting branch office may not pay CIT locally if it is set up for after-sales services, internal research and development and warehousing functions, and does not have any independent production and operation function and does not pay VAT locally. Thus local tax authorities usually take reference of the VAT treatment to assess whether CIT should be allocated locally.

It is also noteworthy when employees of branch offices require to pay social securities locally. In the past, it could be practical to have a local HR agent hire the employees and dispatch them to work for the head office, so as to avoid direct employment by the branch office and the tax concerns in conjunction as mentioned above. However, labor dispatch is also restricted by compliance requirements. The number of dispatched laborers shall not exceed 10 percent of the total number of a company’s employees. Employers may use dispatched laborers only for temporary, auxiliary or substitutable positions. Such stipulation would push branch offices to hire local employees directly out of compliance considerations, so that the relevant tax consequences should be particularly noticed.

The tax related matters between head office and branch offices are usually connected between different tax categories and areas, so that have more flexible tax optimization opportunities. Enterprises should make upfront and comprehensive consideration for the relevant topics, from small issues such as invoice recipient for corporate expenses incurred to important selections between branch office and subsidiary setup. Enterprises should concern the related tax impacts along with the commercial considerations, and turn to external experts, when necessary, to avoid compliance risks in its future operation.