Introduction: Recent developments in the market
There have recently been a number of reports of owners based in various countries outside China, who have voyage chartered or time chartered vessels to Chinese charterers, whereby Chinese charterers have put owners on notice that they intend to "withhold" amounts from hire or freight payments (ranging between 4.25%-15% of the payment) on the basis that the owners in question are allegedly liable for Business Tax, or Enterprise Income Tax in China, even though the owners are based overseas and have no presence in China whatsoever. The question therefore arises: are Chinese charterers really entitled to withhold such amounts from hire or freight payments?
Section I: The Enterprise Income Tax
On a literal interpretation of Chinese law, freight or hire paid by Chinese charterers from a Chinese bank account to overseas owners is subject to the Enterprise Income Tax in China.
In China, the Enterprise Income Tax is defined as a tax levied on the income earned as a result of business operations by enterprises within the territory of China. The Enterprise Income Tax is analogous to corporation tax in other jurisdictions. Enterprise Income Tax is generally levied on profits earned by Chinese companies.
For the purpose of Enterprise Income Tax, there are two categories of tax payers under Chinese law: resident tax payers and non-resident tax payers. A company incorporated outside China is deemed as a non-resident tax payer if the company has not set up branches or premises in China or, if it earns income originating from China.
In the circumstances, owners incorporated or based outside China are technically still liable to pay Enterprise Income Tax in China, so long as they earn freight or hire from Chinese charterers that is paid from a bank account based in China.
Section II: The Business Tax
Another tax that we have recently seen cited as a basis for withholding tax from freight or hire payments is Business Tax. Business Tax is levied on the transactional amount earned from providing a taxable service within the territory of China, transferring intangible assets or selling real property. The Business Tax is distinct from Enterprise Income Tax in that the Business Tax is imposed on the transaction, regardless whether the tax payer makes a profit.
As the Business Tax is levied, amongst other things, on a taxable service provided within the territory of China, the question arises as to whether the chartering of vessels to Chinese Charterers should be classified as a taxable service in this context. Given that ships sail around the world, it is hard to say that the chartering service, or the "taxable service" is provided within the territory of China. However, the Chinese tax authorities are often inclined to interpret a service as being provided within the territory of China, so long as the service provider or the recipient of the service is located in China.
Therefore, it is certainly arguable that technically owners incorporated or based outside of China may still be regarded as Business Tax payers if they have ships chartered to Chinese charterers.
Section III: Withholding agent
As the Chinese tax authorities have no physical means of collecting either the Enterprise Income Tax or Business Tax from foreign entities, they have devised a mechanism whereby the payer of the taxable payment, i.e. the charterer, is deemed to be the "withholding agent". Chinese law places an obligation on the charterer as withholding agent to collect the taxes on behalf of the Chinese tax authorities.
If the withholding agent fails to withhold or collect taxes, the tax authorities should recover the tax amount from the tax payer and should impose a fine on the withholding agent. The potential fine ranges from 50% to 300% of the amount that the charterer should have withheld and collected. Given the Chinese tax authorities' recent hardened stance, it is fear of liability for a potentially substantial fine that is now driving Chinese charterers to fulfill their obligations under Chinese law as withholding agents and consequently look to make deductions from hire and freight payments to owners.
The relevant laws dealing with Enterprise Income Tax and Business Tax have actually been in force for some time in China, so it may seem strange that Chinese charterers are only now actually looking to withhold tax from hire or freight payments. To put this in context, sometimes in China certain rules and regulations are not always strictly enforced or adhered to, but the authorities may suddenly tighten up and look to enforce certain rules and regulations quite harshly. It is clear that the Chinese tax authorities have recently hardened up their stance on the chartering sector and are pushing local Chinese charterers to withhold tax from hire or freight payments effected from local bank accounts to an overseas owners.
Given that on a strict reading of Chinese law, owners are liable for tax in China with charterers acting as withholding agents, is there anything which can be done to resist such deductions?
The short answer is "yes", but the ultimate answer really depends on the specific circumstances of the individual case. Here are a few of points for consideration:
- Double taxation treaties - many jurisdictions have entered into double taxation treaties with China. Therefore, depending on the wording of the relevant treaty, it is often the case that owners may not be liable, even under Chinese law, on the basis that they cannot be taxed twice on the same profit (i.e. both in China and in the jurisdiction where taxes are paid)
- Charterparty terms - owners should consider protecting themselves with clearly worded clauses which make it clear that charterers are liable to pay all taxes originating from China, even if under Chinese law, owners are deemed to be the tax payer. It may well be that owners should consider more watertight clauses than those usually found in standard charterparty forms.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.