What are the restraints for a company’s entity in China to pay dividends directly to its foreign parent company?

There are several ways of repatriating cash from China, the most obvious being for a company’s entity in China to pay dividends directly to its foreign parent company. However, this is subject to certain prerequisites – only profits that have undergone annual audit can be repatriated using this channel, ensuring that the gross profit will be subjected to a 25 percent Corporate Income Tax (CIT). Further, a foreign-invested enterprise (FIE) can only distribute dividends out of its accumulated profits, which means that its prior accumulated losses must be more than offset by its profits in other years, including the current year.

An FIE also has to place 10 percent of its annual after-tax into a reserve fund until it reaches 50 percent of the FIE’s registered capital. The dividends are subject to a further 10 percent withholding CIT when distributed to foreign investors.

Based on the abovementioned constraints, many multinational corporations have adopted certain implicit policies, such as minimizing their profits in China in a legitimate manner via intercompany payments, i.e., charging their Chinese unit royalty or service fees. Although these transactions will be subject to turnover tax, and, possibly withholding income tax, the fees are deductible from the CIT taxable income and exempt from the 25-percent CIT, resulting in significant cost savings.