Getting Caught in Permanent Establishment Status in China?

By Richard Hoffmann, ECOVIS Beijing China

The Company:

An individual entrepreneur, who has been engaged by a German manufacturing company, carries out services in China for a client of this German manufacturing company.

The Issue:

The individual entrepreneur works on several projects, which are all connected to one another. For this purpose he is going to stay in China for longer than 183 days per calendar year. The question arises whether the individual entrepreneur’s service will trigger permanent establishment (PE) status of his business in China and whether this induces any tax obligations.

The Solution:

Thanks to our experience in dealing with German clients, ECOVIS Beijing China was able to provide the individual entrepreneur, as well as the German manufacturing company originally engaging him, with an answer on their tax obligations.

Generally speaking such an activity enforces a PE. However, not the work of the individual entrepreneur will be regarded as a PE but the activity of the German manufacturing company engaging him constitutes a PE. Although the service itself is carried out by the individual entrepreneur, it is the German manufacturing company having contractual obligations to its Chinese clients. In conclusion, a part of their revenue derives from China. Additionally, the projects, as mentioned above, will take longer than six months in total, which leads automatically to a PE in China of the German manufacturing company. In this case, the German manufacturing company will have to pay Corporate Income Tax and Value-Added Tax or Business Tax on their Chinese-derived income. This means, that the German manufacturing company also has to register at the local Tax Authority in order to avoid fines or any other penalties.

The individual entrepreneur’s activity, although he works in China for longer than six months per year, will not give rise to a (PE) of his own company. This is the case because the individual entrepreneur is working on behalf of the German manufacturing company and not for a Chinese company. There are no contractual obligations between the German individual entrepreneur and the Chinese client. The service contract signed is between the German individual entrepreneur and the German manufacturing company. Thus, the entrepreneur’s payment is German-derived income and not Chinese-derived income, which excludes him from the permanent establishment status. He does not have to pay any Value-Added Tax, Business Tax or Corporate Income Tax. Nevertheless, due to his stay in China for such a long time of more than 183 days, the individual entrepreneur will be subject to Chinese Individual Income Tax.

The company’s benefit:

Thanks to the competent advice of ECOVIS Beijing China, the individual entrepreneur could be certain of being in compliance to Chinese regulations. The German manufacturing company was also alerted and now knew about its permanent establishment status and the corresponding tax obligations.

You have similar problems, are interested in our services or have any questions? Please don’t hesitate to contact us: richard.hoffmann@ecovis.com