Circular on Issues Relevant to the Implementation of Articles on Royalties of Tax Agreements

1. Provided that the definition of royalty in a Tax Agreement expressly covers amounts received for the use of industrial, commercial or scientific equipment (namely relevant rental income in PRC tax laws), the article on royalties of the Tax Agreement shall apply to the relevant income. If the tax rate specified in the Tax Agreement is lower than the tax rate specified in tax laws, the tax rate specified in the Tax Agreement shall apply.

The foregoing provision shall not apply to income generated by the use of immovable property; rather, the article on immovable property of the Tax Agreement shall apply to income generated by the use of immovable property.

2. The information concerning industrial, commercial or scientific experience set forth in the definition provided in the article on royalties of a Tax Agreement shall be understood as proprietary technology, which, in general, means information or data of a proprietary technology nature that is required in the manufacturing or process production of a certain product and that has never been made public (Proprietary Technology).

3. In general, royalties related to Proprietary Technology involve the technology licensor agreeing to license its non-public technology to another party and permitting the other party to freely use the same, and the technology licensor usually does not itself participate in the specific exploitation of the licensed technology by the technology transferee or guarantee the results of the exploitation thereof. Usually, the licensed technology is already in existence, but also includes technology the use of which is licensed after the research and development thereof as needed by the technology transferee and which is subject to use restrictions, such as confidentiality as set forth in the contract.

4. If, in a service contract, the service provider uses certain specialised knowledge and technology in the course of providing the services, but does not transfer or license such technology, such services shall not fall within the scope of royalties. However, if the achievements derived from the services provided by the service provider fall within the definition of royalties of the Tax Agreement, the service provider retains ownership of such achievements and the service receiver only has the right to use such achievements, the article on royalties of the Tax Agreement shall apply to the income generated from such services.

5. If, in the course of the transfer or licensing of the right to use Proprietary Technology, the technology licensor assigns personnel to provide services such as support and guidance on the use of the technology and charges a service fee therefor, such service fee shall be deemed royalties, regardless of whether they are charged separately or included in the price for the technology, and the article on royalties of the Tax Agreement shall apply. However, if the services provided by the aforementioned personnel constitute an establishment, the article on business profits of the Tax Agreement shall apply to the income derived from the services. If the taxpayer is unable to accurately calculate the business profits vesting in the establishment, the tax authority may determine the same based on the principle of the vesting of profits in establishments of the Tax Agreement.

6. The following amounts or remuneration shall not be treated as royalties but rather as income derived from service activities:

(1) remuneration for after-sales services under a pure merchandise trading arrangement;

(2) remuneration derived by the seller from the provision of services to the buyer during the product warranty period;

(3) the amounts derived from the provision of relevant services by an organisation or individual dedicated to the provision of engineering, management, consulting and other such professional services; and

(4) other similar remuneration as specified by the State Administration of Taxation.

Usually, the article on business profits of the Tax Agreement shall apply to the aforementioned service derived income, unless otherwise specially provided in the particular Tax Agreement (e.g. the Chinese and English versions of the Tax Agreement specially setting forth articles on technology fees).

7. The article on royalties of a Tax Agreement shall apply solely to beneficial owners who are residents of the contracting party. Where royalties are obtained from the PRC by an establishment from a third party state established in the contracting party, the Tax Agreement between said third party state and the PRC shall apply to such royalties. The establishment of a PRC resident enterprise established in the contracting party is not a resident of the contracting party and the article on royalties of the Tax Agreement shall not apply to it as a resident of the contracting party. Where the office, place of business or establishment located in the PRC of a foreign enterprise bears and pays royalties to a resident of a contracting party with which the PRC has executed a Tax Agreement, the article on royalties of the Tax Agreement between the PRC and said contracting state shall apply to such royalties.

8. This Circular shall be effective as of October 1 2009. The implementation of articles on royalties of Tax Agreements shall be duly carried out in accordance herewith, and any problems encountered in the course of implementation shall be reported to the State Administration of Taxation in a timely manner.