Worldwide: Expansion Of People's Republic Of China ('PRC') Business Operations Into The United States

Last Updated: February 17 2016
Article by Mitchell R. Kops

Introduction

PRC businesses are increasingly looking at opportunities to expand their business operations into the United States. This article is a primer of the US tax considerations that a PRC business expanding into the United States should be aware of, as well as the relevant PRC tax implications1.

Overview of US taxation of non-US businesses

Generally, a non-US business has three alternatives for establishing or expanding its US operations: a partnership, a branch office of the non-US corporation, or a US corporation. Below is a brief overview of the US tax rules pertaining to these structures, followed by specific analysis of each alternative.

Partnerships typically take the form of a limited liability company ('LLC') or limited partnership ('LP'). Partnerships are entities with two or more members and are fiscally 'transparent' vehicles for US tax purposes, meaning that the partnership's tax items (gain, loss, deductions, and credits) 'pass through' to the individual partners and are not taxed at the partnership level.

As a general matter, non-US persons and non-US corporations that expand operations into the US through an LP or LLC are subject to US Federal income tax to the extent that their income is (i) effectively connected to a US trade or business (referred to as effectively-connected income ('ECI')); or (ii) not connected to a US trade or business but is US-sourced and is fixed, determinable, annual, or periodical ('FDAP').

Typically, income from a business' US operations will constitute ECI. ECI is taxed at the maximum US Federal rate applicable to the type of income generated. A non-US partner's allocable share of income from a partnership (including ECI) is generally subject to automatic US tax withholding at the following rates: ordinary income (generally, income from business operations) is taxed at a maximum rate of 39.6%; short-term capital gains (i.e., capital gains from assets held for a year or less) at the same rates as ordinary income; and long-term capital gains (i.e., capital gains from business assets held for more than one year)2  at a maximum rate of 20%. FDAP income typically consists of interest, dividends, royalties, rents, etc. and is taxed at a flat 30% rate, applied on a gross basis with no deductions allowable for expenses.

If a non-US business expands through an unincorporated US branch office3  of a non-US corporation, the non-US corporation generally is subject to the maximum corporate tax rate of 35%, regardless of the character of the income. Shareholders in a non-US corporation are not subject to tax on the non-US corporation's earnings. However, a 30% 'branch-profits tax' generally is imposed on the after-tax earnings of the US branch if such earnings are not reinvested in the non-US corporation's US business. Dividends distributed to non-US shareholders are not subject to US tax.

Similarly, non-US businesses expanding through a US corporation are not subject to tax at the shareholder (ie. parent company) level until a dividend is distributed. A US corporation is subject to tax at a maximum rate of 35% on its worldwide income regardless of source or character. Dividends from a US corporation to a non-US shareholder generally are subject to 30% FDAP tax withholding by the United States (essentially mirroring the branch-profits tax applicable to non-US corporations).

The above rules generally apply in the absence of an income tax treaty. The US has a network of income tax treaties that often mitigate the tax impacts of these structures. The US-PRC income tax treaty (the 'Treaty'), in force since 1984, is one such treaty; its impact on PRC investment into the United States is discussed further below.

Overview of PRC taxation of outbound investment

As in the US, the PRC taxes its tax residents (individuals or entities) on their worldwide income. The current corporate income tax (also called 'enterprise income tax') rate is 25%. As with US corporations, all income of an enterprise is taxed at the same rate (ie. 25%) regardless of the character of the income.

Similar to the tax regimes in many countries, PRC tax laws provide that foreign sourced income qualifies for a foreign tax credit. There are two notable points about the PRC foreign tax credit system. First, the PRC has a per-country system – ie. the foreign tax credit should be determined on a country-by-country basis and the foreign taxes paid in two countries cannot be blended. This limitation aims to prevent the potential for foreign tax credit abuse. Second, the PRC foreign tax credit is limited to three corporate tiers; any foreign tax paid by the fourth tier or lower tier subsidiary is not creditable in the PRC.

Although outbound investment by the PRC is still relatively new, PRC tax laws already contain comprehensive anti-avoidance rules. The most significant rules in this area are the anti-deferral controlled foreign corporation ('CFC') rules. A CFC in the PRC is defined almost the same as a CFC in the US4, except that purely PRC individually-owned foreign entities are not CFCs because the individual PRC income tax laws have not been amended timeously. The rest of the CFC rules are, however, quite different from the US CFC rules - in short, the PRC CFC rules mainly target undistributed earnings of CFCs. Such earnings are taxed in the hands of PRC shareholders if they are kept for non-distribution without reasonable business purposes (holding for future re-investment does not constitute a reasonable business purpose).

The other set of anti-avoidance rules on outbound investment deals with the deemed PRC tax residency of foreign subsidiaries of PRC enterprises. If such subsidiaries are considered effectively managed in the PRC, they are deemed to be PRC tax residents and subject to the full 25% enterprise income tax. The main criteria used for determining whether effective management is occurring in the PRC are that the decision-makers of the company mainly reside in the PRC and that the decisions are mainly made in the PRC.

Entity alternatives for US investment

Partnerships and LLCs

Chinese businesses expanding into the US through an LP or LLC are subject to US tax on their distributable share of partnership income to the extent that they have a permanent establishment ('PE') in the United States under the terms of the Treaty. A PE generally includes, among other things, a place of management, a branch, an office, or the furnishing of consultancy services through employees or other personnel. Typically, the activities of the partnership will constitute a PE of the PRC business in the United States, although in limited circumstances it may not5. For the purposes of this article, we will assume the expansion of operations into the US will create a PE in the United States. Assuming the LP or LLC has a PE, it is subject to US Federal income tax under the ECI/FDAP regime discussed above.

Branch of a PRC corporation

A PRC corporation that operates in the US through an unincorporated branch or a wholly-owned LLC, is subject to US Federal income tax at the entity level at the maximum corporate rate of 35%, regardless of income character. Importantly, the 'branch-profits' tax noted above is eliminated under the Treaty for qualified PRC corporations that are more than 50% owned by PRC residents.

US corporations

US corporations are also taxed at the entity level and shareholders are not subject to tax until a dividend is distributed. Income of a US corporation is taxed at 35% regardless of income character. Dividends to a Chinese shareholder are subject to 10% US withholding tax under the Treaty, resulting in an effective US tax rate of 41.5% to the Chinese shareholder.6

Conclusion

Given the 35% corporate tax rate and 10% withholding tax on dividends, a US corporation is generally not an optimal vehicle for a PRC business to expand operations into the US from an after-tax perspective (although there may be other non-tax reasons that a US corporation is otherwise desirable). The two remaining alternatives - a partnership or a branch of a PRC corporation - could each be attractive choices depending on the expected character of income to be earned from US operations.

If US operations are expected to yield significant long-term capital gains, an LP/LLC structure may be the best alternative, as the gains would be subject to a lower effective tax rate (20%) than if they were earned through a branch of a PRC corporation (35%).

However, if most income from operations will be ordinary income, a LP or LLC structure would result in a higher tax rate (39.6% versus 35%). The elimination of the branch-profits tax under the Treaty makes expanding through a branch of a PRC corporation attractive in these circumstances, since there will be no US tax on cash distributed by the branch to the PRC corporation (essentially equivalent to a tax-free dividend).

Lastly, because of the per-country limitation and three-tier limitation under the PRC foreign tax credit rules, and further due to the strict anti-avoidance rules, PRC investment into the US through a holding company in a third country may not generate any PRC tax benefit. Moreover, such a holding structure could be punitive from a US tax perspective. This would be particularly true for a Hong Kong holding company structure where a PRC enterprise invests in the US through a Hong Kong holding company (a structure preferred by a lot of PRC business executives). Since Hong Kong does not have a tax treaty with the US, the dividends paid to a US subsidiary would be subject to a 30% FDAP US withholding tax, versus 10% under the Treaty. In short, making PRC investment into the US directly would be preferred from a tax perspective in most cases.

Footnotes

1 US state and local tax consequences may also apply, but such taxes are beyond the scope of this article.

2 Capital gains in this context typically include gains from the sale of assets 'used' in the trade or business, but do not include gains from the sale of inventory or certain intellectual property.

3 Note that a wholly-owned LLC is treated the same as an unincorporated branch for US Federal income tax purposes.

4 For US purposes, a CFC is a foreign corporation of which more than 50% of the stock (by voting power or value) is held by a US shareholder holding at least 10% of the shares (by voting power or value) of the corporation.

5 For example, a PE does not include an office or branch which carries out solely 'preparatory or auxiliary' services. Therefore, expansion into the US to perform such marginal activities may not constitute a PE for purposes of the Treaty.

6 Effective tax rate is calculated by taking 35% of taxable income, then 10% of the remaining after-tax income. For example, on taxable income of $100, a US corporation would pay tax of $35; the remainder ($65) would be issued as a dividend, subject to 10% tax withholding ($6.50). The total tax payable on the $100 of income is thus $41.50, or 41.5%.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Mitchell R. Kops
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.