Circular on Issues Relevant to the Determination of Permanent Establishments and Other Matters for the Purpose of Tax Agreements

(Issued by the State Administration of Taxation on March 14 2006.)

Guo Shui Fa [2006] No.35

Tax offices of the State Administration of Taxation and local taxation bureaux of provinces, autonomous regions, municipalities directly under the central government and municipalities with independent development plans, and the Yangzhou Taxation Institute:

Item (1) of Article 5 (Permanent Establishments) of the tax agreements negotiated and entered into by China with foreign states specifies that "the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on" and Item (4) specifies that "the term 'permanent establishment' shall be deemed not to include the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any activity of a preparatory or auxiliary character." Based on the commentaries to the model tax convention of the United Nations, the commentaries to the model tax convention of the Organization for Economic Cooperation and Development and the practice of many countries worldwide, we give the following explanations on the meaning of the term 'business' and the expression "of a preparatory or auxiliary character" and on other issues relevant to permanent establishments.

1. The term "??" is the translation of the English word 'business' whose actual meaning does not solely cover production and operating activities, but also includes the general business activities carried on by non-profit organizations. Accordingly, the fixed base or place established in China to engage in business activities by a non-profit organization of the other contracting state to a tax agreement shall be deemed to constitute a permanent establishment in China unless such establishment carries on activities of a preparatory or auxiliary character.

2. When determining the "preparatory or auxiliary character" of activities, the following principles shall be considered:

(1) whether the fixed base or place provides services solely for the head office/parent company or whether it has business dealings with other parties;

(2) whether the nature of the business of the fixed base or place is consistent with the nature of the business of the head office/parent company; and

(3) whether the business activities of the fixed base or place constitute an important integral part of the business of the head office/parent company.

If the fixed base or place does not provide services solely to the head office/parent company but also has business dealings with other parties, or if the nature of the business of the fixed base or place is consistent with the nature of the business of the head office/parent company and its business constitutes an important integral part of the head office/parent company's business, the activities of the fixed base or place may not be deemed to be of a "preparatory or auxiliary character".

3. Individual income tax on the wage or salary income derived by a resident of the other contracting state for working for a permanent establishment shall be calculated and levied pursuant to the provisions on 'dependent personal services' (or 'employment remuneration') of the tax agreement and relevant domestic tax laws. If the services are provided to the government of the other contracting state, the levy of or, exemption from taxes, shall be determined based on the provisions on 'government service' of the tax agreement.

4. If a taxpayer is of the opinion that its establishment or place in China provides services of a preparatory or auxiliary character solely for its head office/parent company and does not constitute a permanent establishment, it shall provide the relevant supporting documentation to the tax authorities who shall reach a determination thereon.