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China: Case on Determination of Permanent Establishment of U.S. Company

(Dec. 1, 2010) A case in China's Jiangxi Province involving an American company's permanent establishment there has resulted in the company's being assessed by the tax authorities for payment of RMB12 million (about US$1.8 million). The company in the United States and its subsidiary in Shanghai were carrying out a construction project, with the parent responsible for the project's design and overseas management and the subsidiary engaged chiefly in the project construction and domestic management. Revenue of US$140 million was allocated to the American company and revenue of RMB900 million (about US$135.2 million) to the Shanghai subsidiary, based on these respective responsibilities. (Shiqi Ma, Permanent Establishment Case Published, TNS ONLINE (Nov. 26, 2010), International Bureau of Fiscal Documentation (IBFD) online subscription database,

To determine whether the parent company's activities constituted a permanent establishment (PE) in China, the tax authorities examined all the project-related contracts; gathered information on the foreign employees who worked onsite, including their employment contracts and passports; and looked into the parent-subsidiary relationship and their regular transactions. They also examined the company's method of calculating the project's revenue, did an on-the-spot investigation of the project personnel, and obtained information on the foreign employees' entries into and exits from China. (Id.)

The authorities concluded that the services the company provided did constitute a PE “and that the revenue derived from such services had to be taxed in China.” (Id.) In the end, the company reportedly agreed to pay the tax assessment of RMB12 million, after unsuccessfully arguing that only US$6 million (about RMB40.1 million) could be allocated to the Chinese PE. (Id.)

Instead of the term “permanent establishment,” China's Enterprise Income Tax Law (in force from January 1, 2008) uses “establishment” (jigou) or “site” (changsuo)

to include (i) management offices, business sites and representative offices, (ii) factories, farms and places of extraction of natural resources, (iii) sites where services are provided, (iv) contracted projects such as construction, installation, assembly, repair or exploration sites, or (v) establishments and sites for production or business operations.

The term “permanent establishment” is used in China's tax treaties, and generally follows the definition in the OECD and UN model conventions. (Shiqi Ma, China (People's Rep.) -Corporate Taxation: 6.1 International Aspects [under 6.2.1], IBFD,
(last visited Nov. 26, 2010).)

(See also Zhonghua Renmin Gongheguo Qiye suode shui fa, The National People's Congress of the People's Republic of China [NPCPRC] website (Mar. 19, 2007),
; Law of the People's Republic of China on Enterprise Income Tax [in English translation], NPCPRC website, (last visited Nov. 26, 2010).)