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China: Treatment of Royalties in Tax Treaty Provisions Clarified in Connection with Technology Transfers

(Feb. 19, 2010) On January 26, 2010, China's State Administration of Taxation [SAT] issued a circular to clarify the implementation of tax treaty provisions on royalties in connection with technology transfer. It amplifies an earlier circular on royalty provisions in September 2009.

Item 1 of the circular notes that technical services related to transfer of the right to use proprietary technology should be viewed as part of the technology transfer, and so the income derived from such services falls within the scope of royalties for tax treaty purposes. An exception to this rule are cases in which the royalties' beneficial owner conducts business through a permanent establishment in the country that gives rise to the royalties, the royalties received are effectively connected with the permanent establishment, and the technology transferer seconds personnel to the technology user for the provision of technical services which, according to the tax treaty, constitute a permanent establishment due to their duration. In such circumstances, article 7 (business profits) of the relevant treaty applies to that services-derived income, and the relevant tax treaty provisions on employment income (under article 15) applies to the personnel providing the services. If there is no permanent establishment and the services-derived income cannot be attributed to one, the income remains subject to tax treaty provisions on royalties (under article 12). (Shiqi Ma, Technology Transfer – Treaty Treatment Clarified, IBFD TAX NEWS SERVICE, Feb. 10, 2010, subscription newsletter from [email protected].) [Note: the bilateral tax treaties have a similar format, based on the Organisation for Economic Co-operation Development Model Tax Convention. See OECD Committee on Fiscal Affairs, MODEL TAX CONVENTION ON INCOME AND ON CAPITAL (Condensed Version), SourceOECD, July 17, 2008, available at none; text-underline: none”>.]vl=3512351/cl=30/nw=1/rpsv/hom
(online subscription database).]

Item 2 of the circular stipulates that if the technology recipient pays the fees (including those for technical services) immediately after the conclusion of the technology transfer contract and it is not possible to establish in advance whether the duration of the services will constitute a permanent establishment, article 12 provisions will apply. Should it subsequently be established that there is a permanent establishment and the received royalty income is effectively connected with it, the treatment of business profits and employment income should be adjusted accordingly, as noted above. (Id.)

Finally, item 3 of the circular states that its provisions and those of the 2009 ruling on royalty payments in tax treaties will apply to technology transfer and service contracts signed before October 1, 2009, and still being executed, provided that the tax treatment of income derived from the contract has not yet been determined. However, no adjustments will be made to the tax payment portion already collected before that date through the application of the royalty provisions to technology transfer and related services' income. (Id.; Circular on Questions Concerning Implementation of Tax Treaty Provisions, SAT Doc. (2010) No. 46 [in Chinese], SAT website, Jan. 26, 2010, available at
; Circular on Certain Issues Concerning Implementation of the Articles on Royalty Payments in Tax Treaties, SAT Doc. (2009) No. 507 [in Chinese], SAT website, Sept. 14, 2009, available at