How to Transfer Money Out of China and Overcome Difficulties

Perhaps the most straightforward way to repatriate profits from an FIE is by way of paying dividends to its shareholder. However, the payment of dividends is subject to certain legal or practical restrictions, and the tax burden is relatively high by comparison with the other two options.

Pursuant to the PRC Company Law (中华人民共和国公司法), an FIE must satisfy the following conditions before paying any dividends to its overseas shareholder:

(i)   all tax payable by the FIE has been paid, especially the corporate income tax (CIT);

(ii)  all losses the FIE has accrued in previous financial years (if any) have been made up; and

(iii) the FIE has set aside no less than 10% of its after-tax profits as reserved funds, unless the accumulated reserved funds have reached 50% of its registered capital.

Also, in practice, Chinese banks usually require seeing the FIE's latest annual audit report showing the existence of distributable profits, as well as tax receipts confirming the completion of tax payment before processing the client's remittance instruction. Therefore, due to these accounting and tax requirements, the interim distribution of dividends is virtually impossible. Furthermore, since the annual audit report and tax return are usually only available around June or July of the subsequent fiscal year, most dividend payments take place in the second half of each calendar year.

As for the tax implications of this remittance method, FIEs normally need to pay 25% CIT on its gross profits, and an additional 10% withholding tax when remitting dividend to its overseas shareholders. Nevertheless, a more favorable withholding tax rate may apply if a double taxation agreement (DTA) is in place between the incorporation place of the FIE's foreign shareholder and China. For example, pursuant to the Arrangement between the Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (内地和香港关于避免双重征税和防止偷漏税的安排), if a Hong Kong resident directly holds no less than 25% shareholding in an FIE, then the Hong Kong resident is entitled to apply for a favorable 5% withholding tax rate while receiving dividends from the FIE.

Compared with remitting dividends directly, intercompany payments are subject to less regulatory requirements and are normally more tax efficient

2 .  Intercompany Payments as Service Fees and Royalties

Due to the tax inefficiency and the practical constraints of dividend payments alluded to previously, some foreign investors choose to repatriate funds from their FIEs via intercompany payments, such as fees charged for the provision of human resources, information technology, accounting or marketing services, as well as royalties charged for trademark, patent or know-how licensing.

Compared with remitting dividends directly, intercompany payments are subject to less regulatory requirements and are normally more tax efficient. However, foreign investors must ensure that such arrangements be based on true and fair underlying business transactions. Otherwise, they might face potential risk of being challenged by the tax or other government authorities.

An intercompany payment must be based on an arm's length transaction related to the FIE's business. Otherwise, the payment might not be recognized as expenses, and thus a 25% CIT would be levied. In practice, service fees and royalties paid by an FIE to its overseas affiliates are subject to strict scrutiny by the PRC tax authority. It is especially the case when the payment is a large amount and the underlying transaction lacks business substance, or when the recipient is located in a jurisdiction with a preferential taxation regime.

With respect to cross-border service fees, the PRC tax authority will pay close attention to the following: whether the service is beneficial in nature, and whether the price is determined in a rational way. As for intercompany royalties, it is generally the tax authority's opinion that profits derived from the licensed intangible assets should be distributed between the licensee and licensor based on their respective contribution to the value of such intangible assets. In other words, the PRC tax authority may raise challenges on whether the overseas licensor is qualified to receive royalties, or should only receive a limited amount of royalties.

In addition, certain registration or filing requirements may apply depending on the specific contents of the relevant service contracts or license agreements. For example, cross-border service contracts need to be filed with the tax authority for record after signing.

Intercompany payments in the form of service fees and royalties will be subject to various tax duties, which normally include a 6% value added tax (VAT), surcharges and a possible 5%-10% withholding tax, depending on whether any DTA is available. In general, since the aforesaid payments can be deducted from the CIT taxable income (subject to relevant accounting requirements), the overall tax burden for an intercompany payment is usually lower than dividends distribution. However, if the provision of service by an overseas entity is deemed to constitute a "permanent establishment" in China, or if the transaction is regarded as a transfer pricing tool to avoid tax by the tax authority, a CIT at 25% on the deemed profits portion would be levied unless any exemption under a DTA applies.

… extending intercompany loans … the advantage of this method is that, it is relatively tax efficient and the funds can be remitted back to China in the form of loan repayments in due course if needed

3 .  Outbound Intercompany Loans

Another way to remit funds from an FIE to its overseas affiliates is by extending intercompany loans. By comparison with the other two methods as discussed, the advantage of this method is that, it is relatively tax efficient and the funds can be remitted back to China in the form of loan repayments in due course if needed. However, the overseas lending provided by an FIE is subject to various pre-requisites and is under special supervision of the State Administration of Foreign Exchange (SAFE) and the People's Bank of China (PBOC).

First, an FIE must apply for a "quota registration" at the local SAFE bureau before providing an outbound intercompany loan pursuant to the SAFE, Circular on Foreign Exchange Control Issues Relevant to Overseas Loans Extended by Enterprises in China (国家外汇管理局关于境内企业境外放款外汇管理有关问题的通知（汇发[2009]24号）) (Hui Fa [2009] No.24 Circular) and PBOC, Circular on Further Clarifying Relevant Matters Concerning the Offshore Renminbi Lending Business of Domestic Enterprises (中国人民银行关于进一步明确境内企业人民币境外放款业务有关事项的通知（银发[2016]306号）) (Yin Fa [2016] No.306 Circular). Generally, there is a maximum threshold, which is equal to 30% of the FIE's owner's equity, on the total amount of outbound loans that an FIE is allowed to provide, which is subject to adjustments made by SAFE. The FIE may apply for adjustment or de-registration of such quota at the local SAFE bureau later if required.

After SAFE registration, the FIE must open a bank account with a SAFE-recognized bank as its designated bank account for outbound loans. All remittance of funds under its outbound loans must be made through the designated bank account, including the repayment of such loans. Within the quota registered in SAFE, the FIE may instruct the bank to make funds remittance. The bank will keep track of the lending and repayment of all outbound intercompany loans provided by the FIE to ensure that the loans do not exceed the provided quota.

According to Hui Fa [2009] No.24 Circular, Yin Fa [2016] No.306 Circular and other relevant regulations, there is a number of pre-requisites on intercompany loans made by an FIE (as lender) to its overseas affiliate (as borrower), including but not limited to:

(i)   the lender must have been established for at least one year;

(ii)  the overseas borrower must have an "equity relationship" with the PRC lender;

(iii) the interest rate of the loan must be commercially reasonable and must not be zero;

(iv) the term of the loan should be between six months to five years in principle, and any outbound loan with a term equivalent to or exceeding five years must be reported to local PBOC or SAFE bureau for record filing;

(v)  the principal amount of the loans must be commercially reasonable when taking the business scale of the overseas borrower into consideration; and

(vi) the loan transaction must be authentic, and the proceeds of the loan must be used for legal and commercially reasonable purpose.

Further, the remitting bank will keep a close eye on the provision and repayment of the outbound intercompany loan. If the overseas borrower fails to repay the intercompany loan in time and the onshore lender is unable to provide reasonable explanation for the borrower's non-payment, the bank may suspend any remittance of new outbound loans. Although the lender and borrower are permitted to extend the term of the outbound intercompany loan, in principle, such loans are only allowed to extend once. In addition, the bank would also pay attention to the frequency of the outbound loans and may ask for explanation if the PRC lender frequently provides outbound loans in a short period of time.

It is also worth mentioning the recent development of the "cash pooling" system available for multinational corporations (MNCs) operating a business in China. The "cash pooling" system was first launched in the Shanghai Free Trade Zone in 2014 and then expanded nationwide. It enables an MNC to designate one of its PRC subsidies as a "head sub" to integrate the cash flow generated throughout China with the global cash pool. There are two types of "cash pooling" systems in China: (1) the "RMB cash pooling" regulated by the PBOC in accordance with the Circular on Further Facilitating the Engagement in Cross-border Bi-directional Renminbi Cash Pool Business by Multinational Enterprise Groups (中国人民银行关于进一步便利跨国企业集团开展跨境双向人民币资金池业务的通知); or (2) the "RMB and foreign currency cash pooling" regulated by SAFE in accordance with the Provisions for the Centralized Operation and Management of Cross-border Funds by Multinational Corporations (跨国公司跨境资金集中运营管理规定). A case-by-case approval from or registration in the PBOC/SAFE (as applicable) is required for the establishment of either "cash pooling" system. Each type of "cash pooling" system has different pre-requisites and quota limitations on the inbound and out cash flow. Furthermore, some free trade zones provide preferential treatment on the regulation of "cash pooling" system programs established by MNCs whose "head sub" is located in the free trade zone. An example is the Shanghai Free Trade Zone where the Shanghai Headquarters of the PBOC issued the Circular on Supporting the China (Shanghai) Pilot Free Trade Zone in Expanding the Cross-border Use of Renminbi (中国人民银行上海总部关于支持中国（上海）自由贸易试验区扩大人民币跨境使用的通知) and the Circular on Further Expanding the Cross-border Financial Service Functions of the Pilot Free Trade Zone to Support Scientific and Technological Innovation and the Real Economy (中国人民银行上海总部关于进一步拓展自贸区跨境金融服务功能支持科技创新和实体经济的通知) to lower the barrier for MNCs to establish a PRC cash pooling system in the free trade zone.

For outbound intercompany loans, normally no tax duty is levied at the time of the provision of the loans. However, the interests received by an FIE from its overseas borrower will be subject to a 6% VAT and surcharges, and the interests' income will be included when calculating the FIE's taxable income.

Each option used by an FIE to repatriate its funds out of China above has its own pros and cons, and there is no one-size-fits-all model for an FIE. Foreign investors and FIEs should carefully assess the costs and benefits of each option and choose their own cash remittance method based on their specific situations (including taking into account factors such as business needs, financial situations, investment plans, etc.). It is also advisable to seek professional advice to develop a suitable cross-border funds management scheme for FIEs in China to achieve success in business.