Foreign companies transacting with Chinese clients need to have a good knowledge of the complicated Chinese tax systems. These rules also apply when an overseas parent company provides services to its own China subsidiary. Overseas companies that are not registered as legal entities or tax resident in China are liable to pay VAT tax even though all services are performed outside China. If you want an explanation, the Chinese side will argue that if they had registered a complaint, the payment you are likely to accept from them would be denied completely and you would not receive any sort of payment from their side. The rule is applicable to all sort of foreign service providers that offer services to Chinese entities such as:
IP registration services
Environmental consulting services
Architectural services, both structural and landscape
Software development services
Product and advertising design services
China’s VAT system is unique by international standards in applying VAT to most financial services (including interest income), and in applying VAT to real estate transactions involving not only business-to-business (B2B) and business- to-consumer (B2C) transactions, but consumer-to-consumer (C2C) as well. The deduction amount for tax varies based on the region and the bank.
The tax deduction ranges from 5% to 40%. The tax system in China is more or less linked to the business licensing / registration system and to foreign currency controls, so practically there can be real limitations on foreign entities wishing to do business in China without a local presence. It becomes really difficult to figure out the exact amount of deduction in advance. The amount of deduction is influenced by various factors.
Factor 1- Deduction vary from payment to payment
Factor 2- Depending on the attitude of the bank at the time
Factor 3- Identity of the bank officer
Factor 4- Character of the local tax office personnel involved in the transaction
That is the main reason why China lawyers say American and European service providers that they can help them to get their money out from their Chinese side but can’t give them exact deduction amount they have to pay to the Chinese authority.
There is one solution foreign service providers can take in order to reduce the risk of tax deduction. The solution is to shift all of the payment related risks onto your Chinese customers. Put a provision while signing service contract that all payments must be made net of taxes and fees. If the invoice amount is $50,000, the overseas service provider will receive exactly $50,000. On behalf of the overseas service provider, it is the Chinese customer who is going to pay all the fees and taxes. It is perhaps the best possible way to tackle the tax deduction issue.
According to the China lawyers, companies should deal with this issue in advance while signing up invoice for services and service contract. In case of the lack of properly furnished written documents, Chinese side may transfer the responsibility to you claiming that you are liable for paying VAT and income tax. They will not even make a move to prevent or minimize it. It is better to be prepared in advance.