CjhOn 26 July 2010, the State Administration of Taxation ("SAT") issued a departmental interpretation note, by way of Guoshuifa [2010] No.75 ("Circular 75"), for the double treaty agreement (“DTA”) concluded between China and Singapore which entered into force on 1 January 2008 ("China / Singapore DTA").  Circular 75 represents the SAT's effort for the first time to introduce a set of technical views, interpretation and practice guidelines for the implementation of a DTA in such a comprehensive manner.  More importantly, this set of interpretation is also applicable to other DTAs concluded by China if the provisions of the relevant articles in those DTAs are the same as those in the China-Singapore DTA.

We would like to highlight some rules in Circular 75.

1. Permanent establishment (“PE”)

1.1 To determine whether the secondment of an employee by a foreign parent company to its subsidiary in China creates a PE, Circular 75 states:

If a foreign parent company assigns an individual to work for its subsidiary in China and the subsidiary has the right to control the work of the individual and assumes the risks and responsibilities for the work, the foreign parent company will not be deemed to have a PE in the country of the subsidiary with respect to the work performed by the individual. In this case, remuneration paid to the individual will be deemed to be compensation paid to the subsidiary's own employee, regardless of whether the payment is made directly by the subsidiary or indirectly through the parent company's account. The payment will be deemed to constitute personal income subject to individual income tax under the tax law of country of the subsidiary and article 15 (dependent personal services) of the China-Singapore DTA. The payment also will be deemed to be an expense incurred by the subsidiary.

If a parent company assigns an individual to its subsidiary and one of the following conditions is satisfied, the individual may be deemed to be working for the parent company in the country of the subsidiary:

• The parent company has the right to direct the work of the individual and undertake responsibilities and risks relating to the work;
• The parent company decides on the number and qualifications of the assigned individuals;
• The salary of the individual is borne by the parent company; or
• The parent company earns profits from the subsidiary as a result of the assignment of the individual.
• If an individual is found to be working for the parent company in the country of the subsidiary, the PE issue will be resolved according to article 5 of the China-Singapore DTA.

1.2 Construction project PE

The China-Singapore DTA provides that a PE includes a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than six months ("construction PE"). A construction PE is more common in China and the tax authorities have more experience in dealing with this type of PE.

According to Circular 75, the duration of "supervisory activities in connection therewith" is determined by reference to the duration of the construction site or project for which the supervisory activities are carried out, rather than the duration of the supervisory activities themselves. For example, the duration of the supervisory activities carried out by a general contractor will be the same as the duration of the entire construction site or project

1.3 Service PE

The China-Singapore DTA includes a provision relating to the creation of a PE from the provision of services (“service PE”). The provision of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, will create a PE but only if such activities continue (for the same or a connected project) within a contracting state for a period or periods aggregating more than 183 days within any 12-month period.

"Connected project": Circular 75 sets forth following factors for determining whether several projects are connected:

• Whether the projects are covered by a single main contract;
• Where the projects are covered by different contracts, whether the contracts were concluded with the same person or with related persons, and whether the execution of one project is a prerequisite to the execution of another project;
• Whether the different projects are in the same character; and
• Whether the same individuals are performing the services under the different projects.

Nonresident enterprises may use the above guidance to manage PE exposure.

2. Dependent Personal Services

Circular 75 defines an "employer" as "the person who has rights on the results produced by the employee's work and bears the related responsibilities and risks." The circular also sets out the main factors to be used in determining the "employer" in a so-called "international hiring out of labor" arrangement (i.e. where the individual assigned to the Chinese company is formally employed by a hiring agent).

These factors include:

• The Chinese company has right to instruct the individual's work;
• The work is performed at a place that is under the control or responsibility of the Chinese company;
• The remuneration paid to the agent is calculated based on the work hours of the individual or has some connection with the individual's wages, e.g. a definite proportion of the individual's salary;
• Tools and materials used for the individual's work are mainly provided by the Chinese company; and 
• The number and qualifications of individuals are decided on by the Chinese company, not the agent.

The SAT also noted that these factors may be used in determining the "employer" in other employee assignment cases. Circular 75 also provides that the "substance over form" principle will be used to determine the real employer. According to Circular 75, where an overseas individual has a formal employment relationship with a Chinese enterprise, but in substance fulfils the obligation to the foreign enterprise, the foreign enterprise will be regarded as the real employer by reference to the above factors.

The SAT further noted that if an individual is the actual employee of the Chinese company, but also works for the foreign enterprise, whether a China PE arises from individual's work performed for the foreign enterprise should be analyzed under article 5 of the treaty.

Our comments and suggestions

With respect to construction project, a nonresident enterprise that provides services in China (whether to a resident or another nonresident company) should try to conclude separate service contracts for separate projects. If these projects are covered under a master contract, adverse consequence may result in determining "connected project."

As for the secondment and dependent personal service, Circular 75 adopts the “substance over form” principle to determine the real employer and looks at the economic employment relationship, thus, having a formal contractual employment relationship between the individual and the Chinese company would not be sufficient to establish that an individual is an employee of the Chinese company for tax purposes, regardless of whether he/she is legally regarded as an employee of the Chinese company. It is important that the assignment be structured so that the Chinese company satisfies all of the conditions mentioned in article 15 of Circular 75.

Nevertheless, because Circular 75 contains many new concepts and is somewhat complicated, it may take some time before the local tax authorities fully implement the Circular. Taxpayers should monitor developments closely and review their business practices to minimize any potential PE exposure in China.