growing mkts of east south asia
Post on 09-Apr-2018
215 Views
Preview:
TRANSCRIPT
-
8/8/2019 Growing Mkts of East South Asia
1/106
Growing Marketsin East and South Asia
Tax Planning International: Special Report
-
8/8/2019 Growing Mkts of East South Asia
2/106
-
8/8/2019 Growing Mkts of East South Asia
3/106
Growing Markets in East and South Asia
Six months ago the Asian economies were among the hardest hit in the world, as exports to the rich
countries plunged. However, the doughty resilience of these economies should not be
underestimated as they have already survived the Asian crisis of the late 1990s and are now
rebounding more strongly than expected thanks to the biggest fiscal stimulus of any region of theworld.
With the aversion of the economic crisis, whether temporary or permanent, certain Asia Pacific
countries have nevertheless been established as being increasingly important business locations,
generally offering low costs, incentives and long-term growth prospects.
In Growing Markets in East and South Asia, a number of KPMG experts and practitioners, attempt
to discern the tax and legal landscape of each of the eight countries discussed, and beyond the
obvious differences, whether there are certain features that are common to them all. The depth of
this understanding and comparison is facilitated by the unique layout of this Report in that each
section comprises four articles with much the same titles: The tax and legal framework; Taxtreatment of cross-border service activities; Holding and financing strategies for investment;
Investing in real property: Some tax aspects.
At the end of each section, readers will not only have a firm grasp of the corporate tax system and
company law unique to each country, but will also understand how legal changes affect investment
in real property; what the treatment of cross-border service activities means for foreign enterprises,
as well as what financial planning considerations are associated with foreign investment strategies.
Commissioning Editor: Bronwyn Spicer
Growing Markets in East and South Asia0 0 9 is publishedby BNA International Inc., a subsidiary of The Bureau of
National Affairs, Inc., Washington, D.C., U.S.A.
Administrative Headquarters: BNA International Inc., 1st Floor,
38 Threadneedle Street, London, EC2R 8AY, U.K.; tel. +44
(0)20 7847 5801; fax. +44 (0)20 7847 5840; e-mail:
marketing@bnai.com; website: www.bnai.com
Copyright 2009 The Bureau of National Affairs, Inc.Reproduction or distribution of this publication by any means,
including mechanical or electronic, without express
permission is prohibited. Subscribers who have registered
with the Copyright Clearance Center and who pay the $1.00
per page per copy fee may reproduce portions of this
publication, but not entire issues. The Copyright Clearance
Center is located at 222 Rosewood Drive, Danvers,
Massachusetts (USA) 01923; tel. (508) 750-8400.
Permission to reproduce BNA International Inc. material may
be requested by calling +44 (0)20 7559 4800; fax. +44 (0)20
7559 4880 or e-mail: customerservice@bnai.com
The information contained in this Report does not constitute
legal advice and should not be interpreted as such. All efforts
have been made to ensure that the information contained inthis Report is accurate at the time of publication.
Growing Markets in East and South Asia0 0 9 forms part ofBNAIs Tax Planning International: Special Reports, a series of
Reports focusing on key topics in international tax.
-
8/8/2019 Growing Mkts of East South Asia
4/106
The material contained in this Special Report is written by tax specialists who are experts in the laws of theirown jurisdiction. Tax and legal matters are frequently subject to differing opinions and points of view, thereforesigned articles within this report express the opinions of the authors and are not necessarily those of their firms,BNA International or the editor. While the authors and editor have tried to provide information current at thedate of publication, tax laws around the world are subject to change and therefore readers should consult theirtax adviser before taking any action related to the content of this Report.
-
8/8/2019 Growing Mkts of East South Asia
5/106
Contents
Growing Markets in East and South Asia
Indonesia
The tax and legal framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Graham Garven and Jim Nichols
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Michael Gordon and Jim Nichols
Holding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Graham Garven and Jim Nichols
Investing in real property: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17Michael Gordon and Jim Nichols
China
The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Mario Petriccione and William Zhang
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Mario Petriccione and William Zhang
Holding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Mario Petriccione and William ZhangInvesting in real property: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Lewis Lu and Mario Petriccione
Vietnam
The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Ninh Van Hien
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Ninh Van Hien
Holding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37Ninh Van Hien
Investing in real property: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Ninh Van Hien
Korea
The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Jae Won Lee and Na Rae Lee
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Jae Won Lee and Deok Hyun SeoHolding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Jae Won Lee and Deok Hyun Seo
Investing in real property: Key tax implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Jae Won Lee and Chung Wha Suh
-
8/8/2019 Growing Mkts of East South Asia
6/106
Contents
Malaysia
Outline of the corporate tax regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Leanne Koh Li Ann
Tax treatment of cross-border service by non-residents . . . . . . . . . . . . . . . . . . . . . . . . 55
Peggy Then
Holding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59Nicholas Crist
Tax planning for real estate investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Chew Theam Hock
The Philippines
The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Jim Nichols, in consultation with KPMG Manila
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Jim Nichols, in consultation with KPMG ManilaHolding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Jim Nichols, in consultation with KPMG Manila
Investing in real property: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Jim Nichols, in consultation with KPMG Manila
Pakistan
The tax and legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Shabbir Vejlaniand Asif Ali Khan
Tax treatment of cross-border service activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Shabbir Vejlaniand Asif Zia
Holding and financing strategies for investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
Shabbir Vejlaniand Asif Zia
Investing in real estate: Some key tax aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Shabbir Vejlani
India
The tax and legal system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
Amarjeet Singh
Taxation of cross-border services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
Amarjeet Singh
Holding companies and financing operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Amarjeet Singh
Real estate investment: Key regulatory and tax aspects . . . . . . . . . . . . . . . . . . . . . . . 101
Amarjeet Singh
-
8/8/2019 Growing Mkts of East South Asia
7/106
Indonesia
The tax and legal frameworkGraham Garven andJim Nichols
KPMG Hadibroto, Jakarta and KPMG LLP, London
During colonial times, Indonesia was the hub of a vast Dutch trading empire stretching from South Africa to the Pacific.
In more recent years, after four decades of authoritarian rule, in 1998 Indonesia transitioned to a democratic system ofgovernment.
Indonesia is the worlds largest archipelago and fourth most populous nation. This, combined with its strategic location,
rich natural resources and growing economy make it an increasingly important business location.
I. Applicable company law
Indonesia has a civil law system, based on Dutch law.
Indonesian company law is governed by Law 40/2007.
Law 40/2007 permits only one corporate form the limitedliability company (Perseroan Terbatas or PT). A PT is very
broadly analogous to the Dutch BV corporate form. It requires a
minimum of two shareholders and must have a minimum
authorised capital of IDR50 million, of which at least 25 percent
must be paid up.
II. The foreign direct investment framework
Although there is a general recognition that Indonesia needs
the development capital and the technical and management
skills of foreigners, there are a number of restrictions and
procedures that must be addressed. The desire to control
foreign investment is manifested in a variety of ways, for
example, in general:
All foreign investment is approved and monitored through
government bodies;
A domestic shareholding may be required in a foreign
invested company;
Companies can employ only a limited number of
expatriates and are required to demonstrate plans for
replacement of those expatriates by Indonesians;
Foreign companies are required to work jointly with
Indonesian companies in order to undertake government
contracts;
Certain fields of business are closed or may be restricted
to investment by foreigners;
Land holding and/or land rights are covered by a number
of restrictions.
The Investment Law No. 25 of 2007 was introduced mainly to
improve on the previous foreign investment legal framework
and regulates both foreign and domestic investment. With
regard to foreign investment, the law encourages foreign direct
investment by granting the right of entry for foreign business
through a government licensing procedure. The procedure iscontrolled principally by the Investment Coordinating Board
(BKPM) which is responsible for the evaluation and approval
of most foreign investment proposals and the coordination of
licensing requirements. Similar procedures apply for wholly
domestic investment, but with a broader range of permitted
activities.
Initial investment proposals to BKPM need to be in fields that
are not closed to foreigners, as do applications for expansion of
existing facilities. Periodically, the government publishes a
Negative Investment List which lists the business ventures
restricted or closed to foreign investment. Sectors that aregenerally closed to foreign investment include healthcare, small
scale retail and media.
In some cases where there are restrictions on participation by
foreign companies, such as in construction, oil and gas and in
government projects, participation may be possible in
conjunction with an Indonesian company. Indirect involvement
by means of technical assistance and management
agreements is also common, particularly in sectors where
direct investment has not been permitted. The Investment Law
specifies that foreign investment must be in the form of a
limited liability company, Perseroan Terbatas (PT),
incorporated in Indonesia with the approval of BKPM and/or,potentially, requiring various approvals from other government
ministries. In addition, for certain specified sectors such as
banking, oil and gas, mining and construction, the set up of a
registered branch by a foreign enterprise may also be
permitted. There is an anomaly in that the Indonesian Tax Office
-
8/8/2019 Growing Mkts of East South Asia
8/106
will often allow the registration of a branch for tax purposes in
the absence of a business license. This means that although
the branch is operating unlawfully, it is still able to fulfil its tax
obligations.
A PT company having an approved foreign shareholding is
known as a PMA company (Penanaman Modal Asing). The
legal form and operation of a PMA company is otherwise the
same as that provided for in respect of entirely domestically
owned companies. A foreign investor is usually a foreign
company. However, foreign individual investors are also
acceptable to BKPM. Foreign investors can initially hold in
many cases up to 100 percent equity, except for in the case
of restricted industry sectors. Under Indonesian company law,
a minimum of two shareholders is required for every company.
The Investment law grants the foreign investor the freedom to
manage a company including the right to appoint directors
and, if necessary, foreign technicians and managers where
skilled Indonesians are not available.
PMA manufacturing companies may not directly distributedomestically to end consumers. They may however establish
a separate company to distribute domestically (which can be
100 percent owned by the PMA company or another foreign
entity). In addition, PMA companies are permitted to sell their
products directly to:
Another PMA distribution company;
Manufacturers who use the products as raw materials or
for plant and equipment;
Construction companies who use the products in their
projects; or
Wholesale entities.
III. Exchange controls
BKPM, together with Bank Indonesia, the countrys central
bank, will monitor the source and disbursement of funds
approved for the establishment of a venture. For PMA
companies, sources external to Indonesia in foreign
currencies must be used to finance all loan capital and the
foreign parents equity capital. Certain external borrowing
requires official approval, but loans for wholly private sector
projects are not subject to this approval. PMA companies may
borrow from domestic non-state banks for working capital
requirements.
The import and export of Indonesian currency (IDR) is
subject to exchange controls and the lending of IDR to a
foreign enterprise by an Indonesian bank is generally
prohibited. However, it is possible to structure a loan to a
PMA company from a foreign parent so that it may make
remittances in foreign currency, such as USD, by reference to
the prevailing USD-IRD exchange rate. The loan agreement
would thus be economically in IDR, but will specify that the
settlement currency was USD.
One further alternative that achieves much the same result
would be to make a USD loan to the PMA company from itsforeign parent combined with a USD-IDR swap agreement
between the parties so as the loan plus the swap are
economically equivalent to an IDR loan. Either of these two
options should prevent taxable exchange differences from
arising in the PMA company in respect of the loan.
IV. The corporate tax system
The Indonesian corporate income tax system is based on two
main laws:
The Tax Administration Law (Law 28/2007);
The Income Tax Law (Law 36/2008).
These laws are the most recent amendments to tax laws
originally issued in 1983.In addition, there are tax laws covering VAT, taxation of Land
and Buildings (both a rates style annual tax and the taxation
of sale and acquisition), a stamp duty law (stamp duty applies
at a low nominal rate on most financial and legal documents)
and various local and regional taxes which may not have
significant impact. There is no separate capital gains tax, as
gains are taxed as income.
At the outset, it should be noted that in Indonesia there is a
fairly high degree of uncertainty regarding the interpretation
and application of laws. This is very evident in respect of the
tax laws and the conduct of the Indonesian Tax Office (ITO).
The ITO conducts tax audits with a comparatively unfettered
degree of power and the administrative provisions of the tax
laws are often seen to be geared to favour the ITO rather than
taxpayers.
A. Fundamental principles
Indonesian tax residents are taxable on worldwide income
under a system described as self assessment. This is largely
a misnomer as the ITO follows a rigorous and extensive tax
audit regime. Non-residents are taxable only on income
derived from or received from Indonesia.
Under domestic law, a company is considered resident inIndonesia if it is incorporated there. Having a place of
management in Indonesia can only result in creating an
Indonesian permanent establishment, rather than having any
wider implications for corporate residence under domestic
law.
To eliminate double taxation, Indonesia allows a credit against
income tax payable for taxes paid abroad subject to certain
limitations. This relief can be availed of only by resident
taxpayers in respect of the foreign tax paid or incurred. The
foreign tax credit is limited to the same proportion of the tax
against which such credit is taken.
B. Tax base
Taxable profits are based on accounting profits after
adjustment for tax depreciation and non-deductible expenses.
Expenses are generally deductible provided they are incurred
to earn, secure or collect profits. Tax depreciation for both
tangible and intangible assets connected with the enterprises
business operations is generally provided for as a tax
deduction, except in the case of internally generated goodwill.
Provisions are not generally deductible, except in certain
industries (notably banking and insurance). In addition the
costs of providing benefits to employees are generally not
deductible.
Losses may be carried forward to offset future profits. The
losses are offset against the first profit to arise, and they can
only be used in the five subsequent years after the year of
loss. In remote areas and certain fields, a longer loss carry
forward up to 10 years may be permitted.
Indonesia: The tax and legal framework
-
8/8/2019 Growing Mkts of East South Asia
9/106
C. Tax rates
The corporate tax rate applies at a single flat rate of 28 percent
in 2009 and will be reduced to 25 percent in 2010, in contrast
to the progressive rates which applied up to 2008, with a
maximum rate of 30 percent.
The corporate tax rate for a public company is subject to
a discount of five percent if 40 percent of its paid-up
capital is publicly owned by at least 300 parties (individualand/or corporation) and no single shareholder has more
than five percent;
Companies with a gross annual turnover less than IDR4.8
billion are eligible for a 50 percent rate cut, resulting in a
flat rate of 14 percent for fiscal year 2009 and 12.5
percent for fiscal year 2010 and thereafter. This applies to
Indonesian companies, even if they are part of a far larger
worldwide group;
Where gross annual turnover exceeds IDR4.8 billion but
is less than IDR50 billion, the 50 percent rate reduction
applies on the proportion of taxable income which results
when IDR4.8 billion is divided by the gross annual turnover; There is a branch profits tax levied at 20 percent on the
post tax profits accruing in an Indonesian permanent
establishment of a foreign enterprise.
D. Tax incentives
There are a limited range of tax incentives available in
Indonesia. The incentive system includes both activity based
and geographically based components. These incentives
include accelerated tax depreciation and an extension of the
maximum loss carry forward period to 10 years.
E. Withholding taxes
Except where preferential tax rates or exemptions are provided
for under a tax treaty, payments to non-resident corporations
without a registered Indonesian permanent establishment are
subject to final withholding tax at a rate of 20 percent. This
includes dividends, financing costs, royalties and payments for
services (whether or not rendered in Indonesia).
Tax treaties to which Indonesia is party may provide for lower
rates of withholding tax on dividends, interest and royalties of
between 0 percent and 15 percent.
A final withholding tax is the amount of income tax withheld by
a withholding agent which constitutes as a full and final
payment of the income tax due from the payee on said income.
The liability for payment of the tax rests primarily on the payor
as a withholding agent.
On the other hand, a creditable withholding tax is tax withheld
on certain income payments to domestic corporations or
permanent establishments. This is intended to equal or at least
approximate to the tax due of the payee on said income. The
income recipient is still required to file an income tax return to
report the income and/or pay the difference between the tax
withheld and the tax due on the income. If the tax withheld
turns out to be greater that the tax due on the income it is
possible to obtain a refund, but only after a tax audit has been
completed by the ITO.
As a general rule, withholding tax arises at the time when
income is paid or payable to the non-resident or when it is
accrued as an asset or an expense in the books, whichever
comes earlier.
F. Anti-avoidance
Whilst there are no explicit anti-avoidance provisions in the tax
law, the ITO makes extensive use of provisions allowing
adjustment to related party transactions, which are its main
anti-avoidance tool. Indeed, amendments to the related party
provisions, effective for the 2009 tax year, indicate a purpose to
attempt to use such provisions in a manner akin to a general
anti-avoidance provision. The approach to transfer pricingprinciples taken by the ITO is often markedly different and
counter to TP principles in any established tax jurisdiction.
Therefore, where there are related party (defined as where there
is a direct or indirect 25 percent shareholding) transactions,
particular care must be taken.
Generally, there are no specific provisions in respect of thin
capitalisation. However, interest on excessive related party debt
may be disallowed as a tax deductible expense under the rules
allowing for adjustments to be made where there are related
party transactions. Whilst there are no set limits for an
acceptable debt/equity ratio, a 3:1 ratio (as used as a guide by
BKPM) is often used by tax auditors as a benchmark.
Indonesia has rules on the taxation of controlled foreign
companies (CFCs). Broadly these rules apply to deem a
dividend to have been made from a company more that 50
percent directly owned by Indonesian resident shareholders.
Compliance requirements are rigorous and the penalties for
non-compliance harsh. In addition, the need for taxpayers to
settle an assessment prior to objecting or appealing has
historically led to many adjustments being made on the basis of
fiscal budgetary pressures rather than technical merit.
Assessments of underpaid tax are subject to penalty interest
and surcharges ranging from two percent per month to 100percent of the unpaid tax, depending on the perceived
transgression. Higher penalties apply if criminal acts have been
committed.
Tax strategies require careful consideration. In this regard a
strong focus should be placed on complete documentation
which has a detailed focus on the facts and circumstances of
the Indonesian operational circumstances. Rigorous adherence
to processes and procedures (on an annual basis) is also
required.
A clear understanding of the potential issues that could be
raised by the ITO and the detailed/practical operational aspects
of the business (and transactions) are all essentials to reduce
the risk of a lengthy and costly tussle with the ITO.
V. Conclusion
Whilst Indonesia has made some progress recently in the
fields of foreign investment and tax law to provide clarity and
encourage growth and investment, there remain a number of
bureaucratic hurdles to investment and the application of laws
and regulations is often inconsistent. In particular, transactions
with related parties remain an area where there is significant
uncertainty over tax outcomes.
Graham Garven is a Tax Partner with KPMGs Indonesian firm.
Jim Nichols is a Tax Manager in KPMG Londons InternationalCorporate Tax practice, specialising in Emerging Markets.
For further information, please contact the authors by email at:graham.garven@kpmg.co.id and james.nichols@KPMG.co.uk
Indonesia: The tax and legal framework
-
8/8/2019 Growing Mkts of East South Asia
10/106
-
8/8/2019 Growing Mkts of East South Asia
11/106
Tax treatment of cross-borderservice activities
Michael Gordon andJim NicholsKPMG Hadibroto, Jakarta and KPMG LLP, London
This article addresses the tax treatment of non-Indonesian enterprises carrying out service work in Indonesia. This could
be, for example, a consultancy business providing advice to clients in Indonesia and sending staff to work at the clients
premises, or a manufacturing business selling heavy machinery to Indonesia and sending personnel to supervise its
installation. In either case the question will arise whether any part of the income is taxable in Indonesia under
Indonesian domestic law, and whether any relevant double tax treaty provides protection.
I. Introduction
The licensing and regulatory rules in Indonesia can be quite
complex. The applicable regulations will often depend on the
type of project at issue. For example, there are specific
regulations governing the power and telecommunications
sectors. In addition to understanding the relevant rules,
investors must also consider the most appropriate business
structure for their role in the proposed project. Thus, it is
important to seek professional advice at the beginning of a
project in order to avoid unnecessary complications later.
II. Indonesian permanent establishment (PE)
A PE is defined in Indonesian domestic law as running a
business or carrying out activities in Indonesia. This definition
is further clarified by a non-exhaustive list of activities that
would result in a PE. Specifically, this includes the supply of
services in any form by an employee or other person for more
that 60 days in any 12-month period. A construction,
installation or assembly project is also included on the list,
without specifying any minimum time period before a PE is
created.
A registered branch of a foreign enterprise is included in the
definition of PE. However, Indonesian tax law also provides for
the registration of an unlicensed PE i.e. activities of a
foreign enterprise in Indonesia that are taking place without
obtaining regulatory approval to set up a branch.
Notwithstanding the fact that such activities are technically
not allowed under the foreign investment laws, such a PE can
register for income tax and VAT and file tax returns as for a
registered branch.
The above definition of PE is fairly wide. As such, where
cross-border services are being performed it is usually
preferable if the service provider is resident in a country with atax treaty with Indonesia that can provide some protection
(see below).
Profits of a PE would generally be taxed as for a resident
company and hence would be subject to 28 percent
corporate income tax. In addition a 20 percent branch profits
tax is also levied on net profits of any PE, after deduction of
corporate income tax or any final withholding taxes. The
branch profits tax may be reduced subject to any lower rate
specified in a relevant tax treaty.
III. Withholding tax on other Indonesiansource income
In the absence of having a PE in Indonesia, a foreign
enterprise may still be subject to Indonesian withholding tax
on other income considered to be Indonesian source, whichgenerally means that it is derived from property or activities in
Indonesia. Such income is subject to final withholding tax of
20 percent in Indonesia. This includes income from dividends,
interest, royalties, technical assistance and service fees
(whether the services are rendered in Indonesia or otherwise),
rental and leasing income.
Furthermore, withholding taxes may apply to payments made
to an Indonesian PE of a foreign enterprise or local subsidiary.
These include a creditable withholding tax (of 1.5 percent -
4.5 percent depending on the service) applicable to service
fees paid to such a PE or subsidiary. Technical/management
services and most other services including consulting and
advisory fees are subject to a creditable withholding tax at two
percent of gross income.
Apart from discussion of the technical and practical
requirements in respect of management and technical service
fees are the issues of:
Treatment of such expenses as royalty payments; and
Treatment of such payments as deemed dividends
where they are paid to connected parties and deemed to
be excessive and therefore non-deductible for the payor.
Royalties (which are widely defined under domestic law) aresubject to a creditable withholding tax of 15 percent if paid to
an Indonesian PE of a foreign enterprise or local subsidiary. A
20 percent final withholding tax applies to royalties paid to a
foreign resident without a PE. Treatment of service fees as
royalties may result if inadequate documentation is
-
8/8/2019 Growing Mkts of East South Asia
12/106
maintained. In Indonesia it is essential to have an agreement
in place which formalises the arrangement, sets out the types
of services to be provided, the basis of operation of the
arrangement and the allocation basis of costs.
Other specific considerations
1. Turnkey contract model
Any turnkey type contract must be structured carefully to
ensure that the offshore procurement activity and offshore
services, if any, are not subject to tax in Indonesia. The
Indonesian Tax Office (ITO) takes the position that turnkey
contracts are subject to withholding tax on the whole contract
value (including equipment and offshore services) unless there
are provisions to the contrary in a relevant tax treaty.
2. Purchase of goods
Purchases of goods and equipment from Indonesian suppliers
will be subject to VAT in almost all cases, but will not be
subject to any withholding taxes.
Some types of projects are granted import facilities for
equipment on a Masterlist. Purchases of non-masterlist
goods and equipment from overseas suppliers will be subject
to import taxes:
VAT at 10 percent;
Import duty and surcharges at variable rates;
Income tax prepayment at 2.5 percent.
Income tax prepayments on imports can be offset against the
importers income tax liability for the same financial year. It can
only be used for other purposes, or repaid, after tax audit
verification. Exemption from prepayment may be requested
annually during the period before the importer has
commenced trade.
IV. The position under double tax treaties
Most of the tax treaties entered into by Indonesia use
definitions of permanent establishment found in the OECD
Model Conventions (to which there are some modifications
drawn from the UN Model). Where such a treaty applies, this
can therefore add significant protection for the service
provider from creating a taxable presence in Indonesia or
being subject to Indonesian withholding tax on services
performed in Indonesia. In such a situation, a PE will generally
only be created in Indonesia where:
The foreign enterprise has a fixed place of business in
Indonesia through which the business of the enterprise is
wholly or partly carried on;
The foreign enterprise has an agent in Indonesia with the
power to conclude contracts in the name of the
enterprise; or
The foreign enterprise furnishes services in Indonesia for
a specified minimum period of time.
In common with many Asia Pacific jurisdictions, there is a
specific services PE concept in most of the tax treaties to
which Indonesia is party (which usually draws on the wordingin the UN Model in this respect). Where the relevant treaty
includes provisions based on the UN Model in relation to the
furnishing of services, this would generally mean that a PE
would be created in Indonesia if employees or other personnel
of the foreign enterprise furnished services in Indonesia for
more than the minimum period specified. This minimum
period generally varies from two months to six months (see
table at the end of this article).
In the case of construction, installation or assembly projects,
most of Indonesias tax treaties provide for a minimum period
of six months before a PE is created, although some provide
for only three months. The recently signed treaty with North
Korea is the only exception, with a 12 month period.
Where a treaty applies and the service activities performed fall
outside of the scope of the definition of a PE in the relevant
treaty, then service fees can be paid without deduction of
Indonesian withholding tax in accordance with the business
profits article of the relevant treaty. However, under certain
circumstances service fees may be characterised as royalties
under Indonesian law. This could occur, for example, when
the services included a transfer of knowledge or information
when the service provider has the relevant intellectual property
or know how.
There are cases where companies enter into combinedagreements, e.g. covering royalty or know-how matters as
well as service fees. Such combined type of agreements
present practical problems in Indonesia. The ITO is quick to
determine that all payments under the agreement should be
treated as payments for know-how and, accordingly, subject
to withholding tax as a royalty. This will result in the
imposition of a withholding tax assessment and penalties.
Where service fees fall to be treated as royalties, the
payments will be subject to a final withholding tax of 20
percent under domestic law or to a lower rate to the extent
permitted by the relevant treaty. Most tax treaties have a
maximum royalty withholding tax rate of 10 percent-15percent. However if procedures are not complied with in
terms of a Certificate of Tax Domicile (CoD) of the recipient
of the royalty, then the 20 percent domestic rate will apply. A
CoD must be renewed annually. It is essential that a
Certificate of Domicile of the supplier is on file with the
Indonesian entity at the time payment is made.
When considering the treatment of such fees, the
commentary to the OECD Model Convention provides
guidance on the distinction between service fees and royalties
that may be referred to in a treaty situation and may narrow
the scope of what the ITO can argue to constitute royalties.
The Indonesian Tax Office may have regard to the beneficial
ownership issues and the foreign lender would have to
demonstrate that it was beneficially entitled to the income in
order to benefit from the treaty. Unfortunately the
circumstances in which the beneficial ownership concept
would be applied are not well defined in Indonesian tax law
and therefore this may be subject to significant uncertainty.
V. Other points to be considered
There are likely to be other considerations, besides those
referred to above, in deciding how to structure the provision ofservices into Indonesia. For example, if the nature and extent
of the services is such that a PE will definitely be created, then
consideration may be given to setting up a local subsidiary to
provide the services. A local subsidiary would not suffer the
branch profits tax, but would be required to deduct dividend
Indonesia: Tax treatment of cross-border service activities
-
8/8/2019 Growing Mkts of East South Asia
13/106
withholding tax of up to the maximum rate prescribed by a
relevant tax treaty instead.
A PE generally offers more flexibility and fewer administrative
burdens in relation to its set up and operation. However, the
choice will depend on the specific circumstances of the
activities and where a PE is feasible care must be taken to
ensure that only those profits attributable to the PE are
subjected to Indonesian tax.
VI. Conclusion
Where services are being provided to an Indonesian taxpayer,
it is important to ensure that these are fully supported with
documentation evidencing active services and that activities
do not in themselves create a PE. Where the creation of a PE
is unavoidable, consideration should be given to the legality of
such an operation, given the complex licensing procedures,
and ultimately to the attribution of taxable profits of the PE. In
many cases it may be necessary to establish an Indonesian
subsidiary to remain within the licensing regulations.
Indonesia: Tax treatment of cross-border service activities
Table
Country/Territory
Technical serviceswithholding tax?
Constructionproject PE?
Services PE?
China No 6 months 6 months
France No 6 months 183 days
Germany Yes 7.5% 6 months No
Japan No 6 months 6 months
Luxembourg Yes 10% 5 months No
Pakistan Yes 15% 3 months NoSwitzerland Yes 5% 183 days No
UAE No 6 months 6 months
UK No 183 days 91 days
USA No 120 days 120 days
Michael Gordon was formerly a Tax Partner with KPMGsIndonesian firm.
Jim Nichols is a Tax Manager in KPMG Londons InternationalCorporate Tax practice, specialising in Emerging Markets.
For further information, please contact Graham Garven ofKPMG Indonesia and Jim Nichols by email at: graham.garven@
kpmg.co.id and james.nichols@KPMG.co.uk
-
8/8/2019 Growing Mkts of East South Asia
14/106
-
8/8/2019 Growing Mkts of East South Asia
15/106
Holding and financing strategiesfor investment
Graham Garven andJim NicholsKPMG Hadibroto, Jakarta and KPMG LLP, London
A foreign direct investment into any country requires planning on how to hold the investment, whether directly from the
investing parent, or through one or more tiers of intermediate holding companies, how to finance it, whether wholly by
equity or through a mixture of debt and equity, and in the latter case how to structure the debt.
We shall consider each of these aspects in turn below. As can be seen from the analysis of some of the other countries
in this report, some of these issues are common to other jurisdictions, whereas others are more peculiar to Indonesia.
I. Holding company strategies
In general, holding company strategies may be intended to
achieve any or all of the following objectives:
To reduce withholding tax on dividends in the source
country (Indonesia) or direct tax on dividends received in
the residence country;
To mitigate any tax on capital gains either in the source
country or the residence country on disposal of the
shares to a third party or within the group.
The following analysis deals with the source country issues
only, from the perspective of a foreign investor in Indonesia.
A. Indonesian domestic law position
Under the Indonesian Income Tax Law, dividends and interest
paid to non-resident shareholders are subject to 20 percent
withholding tax, whilst the sale of unlisted shares by
non-residents is subject to a five percent final withholding tax
on the gross sales proceeds or market value, if greater.
Foreign investors are subject to the same special tax rules on
sale of listed shares as Indonesian investors, such that a tax
of 0.1 percent applies on the gross value of the transaction.
Interest costs are generally deductible in Indonesia, subject toprovisions denying a deduction on related party debt deemed
to be excessive (see below).
B. Double tax treaties
Shareholders resident in a country with a double tax treaty
with Indonesia may benefit from a reduced rate of dividend
withholding tax of 10 percent or 15 percent (see table at the
end of this article). Thus, for foreign shareholders, total
Indonesian taxes on profits will range from 35.2 percent to
42.4 percent (28 percent income tax plus withholding tax on
dividends) in 2009.
Furthermore, most tax treaties provide for an exemption fromIndonesian tax on gains realised by a non-resident
shareholder on shares in an Indonesian company. However
some of these do not permit an exemption in cases where the
assets of the company whose shares are transferred consist
principally of Indonesian immovable property.
The tax treaties to which Indonesia is party typically provide
for a reduced rate of interest withholding tax of 10-15 percent.
The only major treaty with a provision for a rate lower than this
is the treaty recently negotiated with the Netherlands. This
provides for a 0 percent rate on interest on loans with a term
of more than two years. However, a circular letter
(SE-17/PJ/2005) issued by the Indonesian Director General of
Taxation on June 1, 2005 states that the Competent
Authorities of the Netherlands and Indonesia have not yet
discussed the law to implement this, as required by the treaty.
As such the Indonesian tax authorities have denied the use of
the 0 percent rate and instead require tax to be withheld at 10
percent until such time as a procedure is adopted.
The Indonesian Tax Office may have regard to beneficial
ownership issues and the foreign lender would have to
demonstrate that it was beneficially entitled to the income in
order to benefit from the treaty. Unfortunately the
circumstances in which the beneficial ownership concept
would be applied are not well defined in Indonesian tax law
and therefore this may be subject to significant uncertainty.
Export credit agencies or other foreign government provided
loans are usually exempt from withholding tax pursuant to tax
treaties.
In order to take advantage of reduced tax treaty rates or
exemptions, a certificate of domicile must be obtained from
the tax authority in the jurisdiction in which the foreign
shareholder is a tax resident.
II. Financing strategies
As discussed above, for foreign lenders in treaty countries, a
reduced interest withholding tax rate of 10 percent or 15
percent generally applies. As interest is generally a tax
deductible expense, debt financing is usually preferable to
equity financing from an Indonesian tax point of view, as it
achieves a saving of both corporate income tax and dividendwithholding tax, the combination of which would be greater
than the interest withholding tax burden. Related party debt
can also be used to finance an Indonesian PE of a foreign
enterprise in a similar way to an Indonesian subsidiary,
although it should be noted that loans from the head office or
-
8/8/2019 Growing Mkts of East South Asia
16/106
branches of the same enterprise will not generate tax
deductible interest, except in the case of PEs of banks.
There are no specific thin capitalisation rules in the tax law.
However, the loan to equity ratio is fixed by the BKPM
approval. 25 percent equity is normal, but higher gearing may
be permitted where this can be justified commercially. In
addition interest on excessive related party debt may be
disallowed as a tax deductible expense under the rules
allowing for adjustments to be made where there are related
party transactions. Whilst there are no set limits for an
acceptable debt/equity ratio, a 3:1 ratio is often used by tax
auditors as a starting point.
One further notable exception, where interest is not tax
deductible, is where the loan has been taken out for the
purpose of acquiring shares in an Indonesian company in
circumstances where the dividends that may arise from those
shares would be non-taxable in the hands of the shareholder.
This generally applies where an Indonesian company holds at
least 25 percent of the shares in another Indonesian company.
Interest expense is recognised on an accrual basis for tax andaccounting purposes. Rolling-up unpaid interest does not
alter the timing of deduction, or withholding tax obligations.
Foreign exchange differences on borrowings, whether realised
or not, are taxable/deductible in the period they arise.
However it is possible to structure a loan so that it is
economically denominated in IDR. This could be achieved for
example by having a loan agreement economically in IDR, but
specifying that the settlement currency was USD at the
prevailing USD-IDR exchange rate.
One further alternative, which achieves much the same result
would be to make a USD, combined with a USD-IDR swapagreement between the parties, so as the loan plus the swap
are economically equivalent to an IDR loan.
A. Bank financing
Interest and fees payable to an Indonesian bank and other
financial institutions are not subject to withholding tax.
Indonesian banks include banks established in Indonesia, as
well as branches of foreign banks which have been granted
operating licenses in Indonesia.
The overseas branches of Indonesian established banks
should similarly be exempt from withholding tax, however this
has not always been accepted by the Indonesian Tax Office.
In principle, a back to back arrangement could be entered
into with an international bank whereby an IDR loan to the
Indonesian subsidiary is granted by an Indonesian branch of
the bank, with a corresponding deposit made by the foreign
parent at a branch in its home country. This has the benefit of
eliminating interest withholding taxes. However, either the
bank or the foreign parent would need to bear the foreign
exchange risk. This could be managed by either making a
payment to the bank to bear this risk or entering into an
appropriate instrument to ensure that the overseas deposit is
economically in IDR. In either case there will be practical
issues to address and the additional expenses incurred maynot be justified by a potential interest withholding tax saving of
10 percent.
B. Deductibility of finance costs for an acquisition ofshares
As noted above, interest on loans taken out by an Indonesian
company to acquire a 25 percent or greater share in another
Indonesian company is generally not tax deductible and so
this strategy would not be effective in such circumstances.
Additionally there is no group taxation modus available in
Indonesia. Therefore, in order to be part of an effective taxplanning strategy any interest expense will need to arise in the
hands of a company which has sufficient taxable income
against which to utilise it.
One strategy could be for the foreign investor to acquire the
shares directly, with the Indonesian target subsequently
borrowing funds to effect a share buy-back. However, this
option is likely to run into difficulties in securing the necessary
regulatory approval from BKPM in relation to granting approval
for the foreign enterprise to invest into Indonesia.
As such leveraging a share acquisition of an Indonesian target
in a way that will give rise to deductible interest expense islikely to be difficult to achieve.
III. Conclusion
Indonesia has a fairly extensive double tax treaty network and
multinationals may find that they can obtain tax savings on an
investment depending on the vehicle used. Leveraging may
also be possible to increase tax deductions although there
may be restrictions on the level of debt at initial approval stage
and care must be taken to ensure that the debt is not seen as
being utilised for the financing of equity or interest costs may
be treated as non-deductible.
Below is a table setting out the key features of selected treaties.
Table
Country/Territory
Capital gainsprotection on
share disposal?
Maximumdividend
withholding taxa
InterestWithholding Tax
Australia No 15 10
China Yesb 10 10
Kuwait Yes 10 5
Netherlands Yes 10 10c
Portugal Yes 10 10
Switzerland Yes 10 10
UAE Yes 10 5
UK Yes 10 10
USA Yes 10 10
a Assuming a 25% or greater holding; UK shareholding requirement is only 15%.
b Except where assets of the Indonesian company comprise principally ofimmovable property located in Indonesia.
c 0% rate if on loan with a term of more than 2 years. However ITO denythis in practice.
Graham Garven is a Tax Partner with KPMGs Indonesian firm.
Jim Nichols is a Tax Manager in KPMG Londons International
Corporate Tax practice, specialising in Emerging Markets.For further information, please contact the authors by email at:
graham.garven@ kpmg.co.id and james.nichols@KPMG.co.uk
Indonesia: Holding and financing strategies for investment
-
8/8/2019 Growing Mkts of East South Asia
17/106
Investing in real property:Some key tax aspects
Michael Gordon andJim NicholsKPMG Hadibroto, Jakarta and KPMG LLP, London
The law relating to real property in Indonesia can be complex. This article gives an introduction to some of the aspects
that may be relevant to the tax structuring of Indonesian real property.
I. The legal framework
A foreign investor may invest in Indonesian real property
through a wholly foreign-owned company or in a joint venturecompany with a local partner. These are referred to as PMA
companies, which is a category of limited liability company
where some or all of the shares are owned by foreign
shareholders. A foreign investor can either establish a new
PMA company or it can acquire an existing PMA company;
similar rules apply to both methods.
A PMA company may obtain the right to lease, build on or use
land for between 70 and 95 years, depending on which right is
obtained and each of these is renewable simultaneously for
between 45 and 60 years with a further shorter renewal period
available on later application.
In some situations, where property is being developed, theproperty developer does not own the land and there is a
common practice of BOT (Build Operate Transfer)
arrangements. In such arrangements, a property developer
contracts with a landowner to construct a property on the
owners land at the developers cost. The developer will
manage the property and will receive the income generated by
the property for a predetermined period. The landowner will
receive a ground rent during the operating period and at the
end of the period, the building will revert to the landowner.
Where a foreign company operates as a branch, no investment
in real estate would be permissible.
II. Outline of ongoing tax position of anIndonesian real estate company
A. Income
Rental income on real estate is subject to final withholding tax
at an effective rate of 10 percent from gross rental. This is
normally withheld by the lessee. However, if the lessee has not
been appointed as a tax withholder, the tax should be self-paid
by the taxpayer who receives the income. There is then no
further tax on the rental income.
Other income of a real estate company, for example from
property management, may be subject to income tax at thegeneral corporate rates as follows:
2009 fiscal year 28%
2010 fiscal year and thereafter 25%
A reduction in rates may apply if revenues are less than IDR50
billion (approximately USD4.5m). (Refer to the article Indonesia:
The tax and legal framework)
There is a 20 percent withholding tax on interest, dividends,royalties and other fees payable outside the country, which is
generally reduced to 10-15 percent by tax treaties. The
non-resident must provide the PMA company with a certificate
of tax domicile from the competent tax authority in the country
of residence in order to take advantage of the tax treaty.
B. Deductions
In respect of income to which a final withholding tax applies,
expenses relating to rental income are not deductible, including
interest, depreciation and other costs. In respect of other
income, interest should be allowed as a deductible item, unless
such charges are from a related party and are in excess ofcommercial rates.
Land is not depreciable, except for plantation and certain other
industries. Depreciable assets other than building and
construction are specified by tax regulation to fall into one of
four asset categories according to the type of asset. Building
and construction are divided into permanent and
non-permanent structures. Buildings and other immovable
property are depreciated based on the straight line method at
five percent (permanent) or 10 percent (non-permanent).
Generally, tax losses in respect of income not subject to final
withholding tax can be carried forward for five years beginningthe first year after such loss occurs.
C. Other annual taxes
There is an annual tax on land and buildings. Tax is imposed at
an effective rate of 0.1 percent for properties with an appraised
value of less than IDR1 billion, and 0.2 percent for properties
with an appraised value over IDR1 billion, or for certain
businesses (e.g. plantations). The appraised value is fixed every
three years in most cases. Although the owner is normally
responsible for paying the tax due on rented property, the lease
agreement can specify who is liable for this tax.
III. Outline of tax consequences of a disposal
Broadly, there are three options for structuring a disposal of the
property, the tax consequences of each of which are outlined below.
A direct disposal of the property itself;
-
8/8/2019 Growing Mkts of East South Asia
18/106
A disposal of the shares in the Indonesian company by
the foreign shareholder;
A disposal of the shares in an offshore holding company
above the Indonesian company.
A. Disposal of the property
Proceeds from the sale of land and building by a company are
subject to a five percent withholding tax on the sale value,
which is a final tax.
Additionally, there is a five percent transfer tax on the sale of
land and buildings that is payable by the purchaser.
B. VAT
VAT at a rate of 10 percent applies to real estate transactions.
In addition to 10 percent VAT, there is a 20 percent sales tax on
apartments of more than 150 square meters or if the price is more
than IDR4 million/square meter. Care is therefore required in relation
to apartment properties in case the vendors have previously
engaged in dubious transactions aimed at avoiding this tax.
C. Conveyancing taxes/stamp duties
A nominal stamp duty of either IDR3,000 or IDR6,000 applies
to certain documents, such as receipts, agreements, and
notarial deeds.
D. Disposal of shares in an Indonesian real estatecompany
There is a five percent tax on the disposal of shares in an
unlisted Indonesian company. This is based on the sale price,
irrespective of any actual gain or loss. Many treaties provide for
an exemption from this tax, however some of Indonesias tax
treaties deny this exemption if the assets of the Indonesian
company are principally immovable property located inIndonesia. Therefore, the shareholders of the Indonesian
subsidiaries ideally should be resident in a country with an
advantageous treaty and an exemption from any gains realised
on the shares in their home jurisdiction.
E. Disposal of shares in an offshore holding company
Indonesia does not generally seek to assert extra-territorial
taxing rights in this situation. However, the income tax law now
contains a provision which may allow Indonesia to tax the sale
of shares in an offshore special purpose vehicle holding
company as if the sale was of the shares of the Indonesian
subsidiary.
IV. Structuring the investment
There are several factors to consider when selecting the
structure of the shareholding, in particular, the tax treaty
provisions relating to dividends and disposal of shares by
non-residents.
A. Profit repatriation
Foreign currency can be freely remitted into and out of
Indonesia. For a foreign investment project the Foreign
Investment Law further guarantees this position. There are
certain restrictions on remittances of local currency and thereare reporting requirements for foreign currency purchases
exceeding USD100,000 per month.
Dividends to foreign shareholders are subject to a withholding tax
of 20 percent. This is generally reduced to 10-15 percent under
various tax treaties, for example, the Netherlands (10 percent),
Australia (15 percent), Singapore and many others (15 percent, or
10 percent if 25 percent shareholding). If profits are retained in the
company rather than distributed as dividends, withholding taxes
are not imposed until the distributions are declared.
Although the company law permits a company to issue shares
of different classes, preference shares and redeemable shares
are extremely unusual. Investors have so far been reluctant to
undergo the delays and uncertainty of seeking approval for
such arrangements.
As a result, shareholder debt arrangements are a common
means to enhance the return to investors relative to a pure
equity holding.
Royalties and technical assistance/management fees can be
paid where a foreign shareholder or other entity provides
support services relating to the Indonesian project. An
Indonesian withholding tax is imposed at the applicable tax
treaty rate (generally 10-15 percent). Technical assistance fees
are subject to withholding tax unless they represent active
services under a relevant tax treaty. Passive services are treatedas a form of royalty. Fees for travelling to Indonesia to
undertake a specific property review for the Indonesian
company could be treated as an active service. Note, however,
that where a business is subject to final tax, such as property
rental, these charges (royalties, technical
assistance/management fees) are not tax deductible.
V. Leveraging the investment
The Investment Coordinating Board (BKPM) generally will
consider that initial debt funding should normally not exceed 75
percent of total investment. The local entity should report the
debt to Bank Indonesia.
There are no thin capitalisation restrictions for tax purposes.
Where there is a special relationship between taxpayers, the tax
office can re-determine the amount of income and/or
deductions, and reclassify debt as equity in determining taxable
income. Nevertheless, convertible debt and subordinated loans
are commonly encountered and these are treated as debt for
tax purposes.
However, where a final withholding tax applies to a particular
income stream, there is no deduction for interest against the
relevant income and therefore leveraging the investment may
not be tax efficient.
VI. Conclusion
The new investment law has relaxed previous restrictions on
real estate ownership and it would now seem that there is
greater flexibility for foreign investors to obtain land on a
long-term lease basis. Income earned from real estate
investment is subject to a final tax and therefore care must be
taken in structuring investments to avoid tax leakage from
non-deductible costs, including interest.
Michael Gordon was formerly a Tax Partner with KPMGsIndonesian firm.
Jim Nichols is a Tax Manager in KPMG Londons InternationalCorporate Tax practice, specialising in Emerging Markets.
For further information, please contact Graham Garven ofKPMG Indonesia and Jim Nichols by email at: graham.garven@kpmg.co.id and james.nichols@KPMG.co.uk
Indonesia: Investing in real property: Some key tax aspects
-
8/8/2019 Growing Mkts of East South Asia
19/106
China
The tax and legal frameworkMario Petriccione andWilliam Zhang
KPMG LLP, London and KPMG Huazhen, Shanghai
In this article on China we look at: applicable company law; the foreign direct investment framework; exchange
control; and the corporate tax system.
I. Applicable company law
Chinese company law is based on the Company Law of the
Peoples Republic of China (the CL), promulgated on October
27, 2005. Essentially the CL allows two types of companies,
namely the joint stock company (JSC, very broadly
equivalent to the European plc/ SA/ AG legal form) and the
limited liability company (LLC, broadly equivalent to the
French Sarl or the German GmbH). Only the JSC is allowed to
issue shares to the public.
In general, for both types of company, once share capital has
been issued it cannot be repaid or redeemed. Dividends may
be paid only out of after-tax profits, after making good past
years losses and subject to any compulsory transfers to
reserves. The general rule on such transfers is that 10 percent
of after-tax profit must be transferred to a statutory reserve,
until such reserve has reached 50 percent of the paid-in capital.
However, in the special case of an Equity Joint Venture (EJV:
see below), the specific legislation referred to below prescribes
that it is the Board of Directors that decides the proportion of
after-tax profit to be transferred to the various reserves. Hence,
the percentage stipulated in the CL is not applicable to EJVs.
II. The foreign direct investment framework
Foreign direct investment can take three main forms:
A Wholly Foreign Owned Enterprise (WFOE), governed
by the law of October 31, 2000 and the related rules and
regulations; this should generally take the legal form of an
LLC;
An Equity Joint Venture, governed by the law of March 15,
2001 and the related rules and regulations; this must take
the legal form of an LLC, and the Chinese shareholder
must be a company rather than an individual; or A Co-operative Joint Venture, governed by the law of
October 31, 2000 and the related rules and regulations;
this may take the form of an LLC or simply of a
contractual relationship (which in China does not have
separate legal personality), but it must prepare accounts.
Foreign companies in certain industries such as banking,
insurance and shipping may set up branches in China, which
are not separate legal entities in China.
In general, most foreign direct investment is subject to an
approval process, which, depending on the size of the
investment, is governed by the central or local authorities. The
rules which provide guidance for foreign investment in China
were overhauled in 2004 and distinguish four areas of the
economy:
The prohibited sector, including projects regarded asendangering state security or the public interest, projects
that cause pollution or endanger health, and projects that
use large areas of agricultural land;
The restricted sector, including areas where there is a
state monopoly and extraction of mineral resources;
The encouraged sector, for example certain high
technology activities, activities relating to re-use of
resources, activities relating to environmental protection,
and investment in the central and Western regions of
China; and
The permitted sector, which covers all other activities.
Investment in the restricted sector requires central government
approval if the investment exceeds USD50 million, whereas in
the permitted and encouraged sectors the local authorities can
approve investments up to USD100 million. All investments in
excess of USD100 million require approval of the National
Development and Reform Commission (NDRC) in the central
government.
III. Exchange control
China has a comprehensive exchange control system, which is
administered largely by the State Administration of Foreign
Exchange (SAFE). Some of the foreign investment into aWFOE or joint venture company can generally be made in the
form of debt from other group companies outside China. When
the company is first registered, the authorities will require a
certain proportion of the total investment to be made in the
form of equity rather than debt; the percentage of equity
-
8/8/2019 Growing Mkts of East South Asia
20/106
required depends on the amount of the investment, so for
investments above USD36 million up to two-thirds of the
investment can be made as debt, whereas for lower investment
amounts higher equity percentages are required. In addition,
more stringent requirements are imposed on the capitalisation
of real estate foreign-invested enterprises (FIEs). For instance,
under a notice issued by the SAFE in July 2007, foreign debts
to real estate FIEs established on/after June 1, 2007 are no
longer allowed.
IV. Corporate tax system
A. The tax reform
On March 16, 2007, the National Peoples Congress
promulgated the new Corporate Income Tax Law of the
Peoples Republic of China (CITL), which has taken effect
from January 1, 2008. The new law replaces the old dual tax
system, whereby domestic and foreign owned enterprises were
subject to different sets of tax rules, with a single tax system
applicable both to domestic enterprises and Foreign
Investment Enterprises (i.e. enterprises with a foreignparticipation of at least 25 percent). As is usual with Chinese
legislation, the actual law sets out only the broad framework of
the new system. The Implementation Rules which were issued
by the State Council in December 2007 provide more details,
however, the rules are still silent on some key areas (e.g. tax
treatment on various reorganisation transactions). Therefore,
the CITL and its Implementation Rules are likely to leave ample
discretion for the Ministry of Finance and/or the State
Administration of Taxation which have been issuing circulars
specifying further details on how the new rules are to be
applied. However, it is still expected that there is likely to be
continuing uncertainty on many of the detailed aspects of the new
rules although the CITL has taken effect for more than a year.
As will be seen below, underlying the new law is a shift from the
previous policy of subsidising the import of capital to a more
neutral approach where imported capital is taxed on a level
playing field with domestic capital.
B. Fundamental principles
The new law introduces a concept of residence based either on
incorporation or effective management (whereas the old law
effectively bases residence while not using that term solely
on incorporation). In common with the old law, the new law
also has a concept of PE (an establishment or place of
business in the PRC). Non-resident companies are taxable at
the normal corporate tax rate (see below) on the profits
attributable to such establishment. By contrast, the profits of
a non-resident enterprise that are not attributable to such
establishment will be subject only to the withholding tax
described further below under withholding taxes.
A Chinese resident company is taxed on its worldwide profits.
However, losses of foreign branches are not deductible in China.
Dividends paid by a Chinese resident company to another
qualifying Chinese resident company are exempt from
corporate taxation, whereas dividends received by Chinese
resident individuals are taxed at 20 percent.The corporate tax rate under the new law is 25 percent (down
from 30 percent plus three percent local tax). In principle this
applies across the country, in contrast to the old system where
a tax rate of 15 percent applies in Special Economic Zones and
reduced rates applying in other special economic areas (e.g. 24
percent for FIEs in Coastal Open Economic Zones, 15 percent
for manufacturing FIEs in Export Processing Zones, etc.).
The CITL and its Implementation Rules set out the following
general principles related to tax depreciation:
Tax depreciation is generally available on fixed assets
connected with the enterprises business operations,
provided, in the case of assets other than buildings and
structures, they are assets put into operational use;
Some more favourable tax depreciation treatments are
provided under the CITL and its Implementation Rules,
e.g. there is no restriction on the residual value of fixed
assets under the CITL in contrast to the old regulations
applicable to FIEs where the residual value of the fixed
assets should be at least 10 percent of their costs; the
minimum depreciation periods for transportation vehicles
other than aircraft, trains, vessels and electronic
equipment are reduced from five years (provided under
the old regulations), to four and three years respectively;
Tax depreciation is also available on intangibles
connected with the enterprises business operations, but
not on self-generated goodwill or on intangibles in relation
to which the development expenditure has been claimed
as tax deductible;
Tax depreciation on fixed assets and intangibles should
be calculated using the straight-line method.
Tax losses can be carried forward for a maximum period of five
years. No carry-back of losses is allowed.
Unless specifically allowed by the State Council, enterprises are
not allowed to file tax returns on a consolidated basis.
C. Tax incentives
By contrast with the old geographically based incentive system,under the new law, incentives are based on type of activity or
size of business. Specifically, high tech enterprises will qualify
for a 15 percent tax rate, and small-scale enterprises with
small profits will be taxed at 20 percent.
Enterprises are required to obtain recognition of being
high-tech enterprises in accordance with the new recognition
criteria and procedures in order to enjoy preferential tax
treatments.
Small-scale enterprises are defined as industrial enterprises of
which the taxable income for the year should not exceed
RMB300,000, total employees should not exceed 100, and
total assets should not exceed RMB30 million; or as otherenterprises of which taxable income for the year should not
exceed RMB300,000, total employees should not exceed 80,
and total assets should not exceed RMB10 million.
The State Council stipulates the grandfathering treatments for
enterprises with business licences dated prior to March 16,
2007 that are entitled to preferential tax treatments under the
old laws.
For CIT rates:
Transitional treatments for the reduced rate of 15 percent under
the old laws will be as follows:
Table
2007 2008 2009 2010 2011 2012
15% 18% 20% 22% 24% 25%
The 24 percent reduced rate under the old tax laws will transit
to the standard CIT rate of 25 percent immediately from 2008.
China: The tax and legal framework
-
8/8/2019 Growing Mkts of East South Asia
21/106
-
8/8/2019 Growing Mkts of East South Asia
22/106
-
8/8/2019 Growing Mkts of East South Asia
23/106
Tax treatment of cross-borderservice activities
Mario Petriccione andWilliam ZhangKPMG LLP, London and KPMG Huazhen, Shanghai
This article addresses the tax treatment of non-Chinese enterprises carrying out service work in China. This could be, for
example, a consultancy business providing advice to clients in China and sending staff to work at the clients premises,
or a manufacturing business selling heavy machinery to customers in China and sending personnel to supervise its
installation. In either case the question will arise whether any part of the income is taxable in China under Chinese
domestic law, and whether any relevant double tax treaty provides protection.
Under the new Corporate Income Tax Law (CITL) enacted
on March 16, 2007 and which has entered into force on
January 1, 2008, a foreign enterprise is taxable in China under
two alternative scenarios:
If the enterprise has an establishment or place of
business in China, then such enterprise is subject to the
normal 25 percent corporate income tax rate on the
Chinese-source income of the establishment and on
non-Chinese source income effectively connected with
such establishment;
In all other cases, Chinese source income of a
non-resident enterprise is subject to a 20 percent tax rate
under the CITL, normally by way of withholding tax,
which is reduced to 10 percent under the Implementation
Rules of the CITL issued by the State Council in
December 2007.
I. Establishment or place of business
The concept of establishment or place of business is
defined in the Implementation Rules of the CITL as an
establishment or a place of business that is engaged in the
production and business operations in the PRC, which is
along the concept under the old law. Examples are
management organisations, business organisations,
administrative organisations, and places for factories and the
exploitation of natural resources, places for construction,
installation, assembly, repair and exploration work, places for
the provision of labor services and business agents. It is
obvious that this is a very wide definition. First, there is no
requirement of permanence: an establishment or place of
business can be a very short-lived presence. Secondly, the
definition would seem automatically to catch any construction,
installation or assembly project, as well as any businessagent. Thirdly, the meaning of places for the provision of
labour services is also potentially very wide; it would seem to
cover many cases where the foreign enterprise sends
personnel to the premises of the customer in China to
execute or complete the work.
II. Withholding tax on other Chinese-sourceincome
In the absence of an establishment or place of business, a
foreign enterprise will be taxable in China on other income
regarded as having a Chinese source. Again, the Implementation
Rules of the CITL define this concept as follows:
Profits (dividends) earned by enterprises in China;
Interest derived within China (on deposits, loans, bonds,
advance payments made provisionally on another
persons behalf, or on deferred payments);
Rentals on property leased to and used by lessees in China;
Royalties such as those received from the provision of
patents, proprietary technology, trademarks and
copyrights for use in China;
Gains from the transfer of property, such as houses,
buildings, structures and attached facilities located in
China and from the assignment of land-use rights within
China;
Other income derived from China and stipulated by the
Ministry of Finance or the State Administration of Taxation
(SAT) to be subject to tax.So, generally, where there is no establishment or place of
business in China, fees for services are not subject to tax by
way of withholding tax either.
III. The position under double tax treaties
In view of the wide definition of establishment or place of
business in domestic law, it is usually desirable to ensure that
the enterprise providing the services is protected by an
appropriate double tax treaty. Most treaties, of course, have a
narrower definition of permanent establishment (PE) than
the above definition of establishment or place of business. Inparticular, as a general rule, treaties provide that a permanent
establishment exists only if either:
The foreign enterprise has in China a fixed place of
business through which the business of the enterprise is
wholly or partly carried on; or
-
8/8/2019 Growing Mkts of East South Asia
24/106
The foreign enterprise has in China an agent with power
to conclude contracts in the name of the enterprise.
In relation to services, many of Chinas treaties provide for an
additional category of PE, namely the services PE concept
in the UN Model Treaty. This provides, broadly, that there is a
PE of the foreign enterprise if the foreign enterprise furnishes
services through employees or other personnel engaged for
that purpose, if such activities continue for longer than a
specified period (six months in the UN Model) within any12-month period. As will be seen in the table, some of Chinas
treaties, namely the ones with Cyprus, Hungary and Mauritius,
extend this six-month period to 12 months, of course so
making it less likely that the service activities result in the
existence of a PE under the relevant treaty. The treaties with
the United Kingdom and Ireland are exceptions and do not
provide for such a services PE concept.
In this regard, an interesting point is that, following revision of
the commentary to the OECD Model in 2003, the OECD
interprets the fixed place of business concept as potentially
covering a situation where an enterprise carries out services
work at a customers premises (see paragraph 4 of the
commentary to Article 5, particularly the example in paragraph
4.5 of the painter who spends three days a week at a clients
premises over a two-year period). In this regard, it may be that
treaties that follow the UN Model and contain a clear rule on
when the provision of services gives rise to a PE provide
better protection than treaties based on the OECD Model,
where there is far more uncertainty on the circumstances
where a service activity conducted at a clients premises gives
rise to a PE.
Another important difference among the PE Articles of Chinas
treaties is in the duration that a construction, installation orassembly project needs to have before it is regarded as a PE.
Normally, this is six months, but, as shown in the table, the
treaties with Cyprus, Hungary and Mauritius allow 12 months.
In determining the number of months, one may make
reference to Guoshuihan 2007 No.403 (Circular 403) issued
by the SAT, with regards to the interpretation of month in the
double tax arrangement between Mainland China and Hong
Kong. According to Circular 403, the Mainland will take the
period from the month in which an employee of a Hong Kong
enterprise arrived in the Mainland for furnishing services, up
until the month in which the project was completed and the
employee left the Mainland, as the relevant period. Even if the
employee is present in the Mainland for one day in a particular
month, it will be treated as one month. If during this relevantperiod, no service was provided by the employee in the
Mainland for a period of 30 consecutive days, one month can
be deducted.
Although Circular 403 relates specifically to the double tax
arrangement between Mainland China and Hong Kong, it may
have an impact on the way the tax bureau interprets month
for other tax treaties. The tax bureau may potentially adopt the
restrictive interpretation of month as provided in Circular 403
for other tax treaties.
So, to what extent can a foreign enterprise choose whichtreaty to rely on for protection? The opportunity that many
multinational enterprises take up is to set up a company in the
jurisdiction chosen as having the appropriate protection in its
treaty with China, and conclude and perform the contract for
the services in question through that company. Careful
thought needs to be given to the degree of substance
required by the company; for example:
Does the company need to employ the staff performing
the contract or is it enough for the staff to be seconded
to it?
What level of substance does the company need in its
chosen home country?
Who should be the directors of the company?
The above are all difficult questions that will require advice in
each individual case. The Chinese tax authorities have not so
far taken a great amount of interest in cases of treaty abuse,
China: Tax treatment of cross-border service activities
Table
Country/ territory Technical services withholding tax? Service PE? Construction project PE?
Australia No Yes 6 months 6 months
Austria No Yes 6 months 6 months
Barbados No Yes 6 months 6 months
Canada No Yes 6 months 6 months
Cyprus No Yes 12 months 12 months
France No Yes 6 months 6 months
Germany No Yes 6 months 6 months
Hong Kong No Yes 183 daysa 6 months
Hungary No Yes 12 months 12 months
Ireland No No 6 months
Italy No Yes 6 months 6 months
Japan No Yes 6 months 6 months
Mauritius No Yes 12 months 12 months
Netherlands No Yes 6 months 6 months
Singapore No Yes 6 months 6 months
Spain No Yes 6 months 6 months
UK Yes 7%b No 6 months
US No Yes 6 months 6 months
a The Second Protocol to the China-Hong Kong Double Tax Arrangement which has taken effect from June 11, 2008 replaced the six months requirement with183 days in determining the service PE.
b But generally no withholding tax under domestic law.
-
8/8/2019 Growing Mkts of East South Asia
25/106
but this may well change as a result of the attention given to
this subject in many other countries and at OECD level.
IV. Other points to be considered
Of course, there will be considerations other than the above
that need to be taken into account in deciding how to carry
out business with China. First, and most obviously, in many
cases a PE will be unavoidable whatever the applicabledouble tax treaty. In such circumstances the choice will be
between taxation on a PE basis and setting up a local
subsidiary. A PE may give more flexibility (for example, profits
can be remitted to head office as they arise and the relevant
taxes have been settled rather than only after the financial
accounts for the year have been prepared and the transfers
to reserves required by law have been made), as well as
eliminating the charge to dividend withholding ta
top related