• Service: Tax, Global Indirect Tax, Global Transfer Pricing Services, Global Compliance Management Services, International Tax
  • Type: Business and industry issue, Regulatory update, Survey report
  • Date: 5/1/2012

Country perspectives on taxing the cloud – China 

Similar to other developing countries such as India, there are no specific rules in China addressing the taxation of new technologies such as cloud computing services. Hence, the taxability of such services would need to be analyzed in the context of the basic framework of the Chinese taxation system. In addition, there is generally no distinct tax treatment between public versus private cloud services.

Note: In the context of this page, the terms “China” and “the PRC” (People’s Republic of China), which are used interchangeably, exclude Hong Kong and Macau Special Administrative Regions.

Corporate income tax (CIT)

If the provider of the cloud computing service is a resident enterprise of the PRC, its worldwide net income from such transactions would be subject to CIT in China at applicable CIT rates (e.g. 25 percent if no preferential CIT rate is granted).

If the provider of the cloud computing service is a non-resident enterprise of the PRC, the CIT implication of such cloud computing service would depend on the following:

  • The characterization of the cloud computing income (e.g., royalty fee or service fee in nature).
  • Whether the provider has within China a permanent establishment (PE) or a place of business with which the cloud computing income is associated.

Characterization of transaction

Royalty fee

The term “royalty” is generally defined as payment of any kind received as a consideration for the use of, or the right to use the following:

  • any copyright of literary, artistic of scientific work including cinematograph films and films or tapes for broadcasting or television
  • any patent, trademark, design or model, plan, secret formula or process
  • any industrial, commercial or scientific equipment
  • any information concerning industrial, commercial or scientific experience.

For example, a customer pays the overseas cloud service provider a fee, and in exchange, the provider grants the customer access to a specified amount of storage space on its network infrastructure. The customer has the right and means to use the space to upload software and data. In such a case, since the customer pays to use the network infrastructure and also has control over it, the payment may be characterized as a royalty, being payment for the use of equipment.

Under the CIT law, the source of royalty is the place where the payer of such royalties is located or residing. If the users are PRC entities or residents, such payments would be considered to be sourced in China and therefore subject to PRC withholding tax (WHT).

Should the cloud computing income be classified as a royalty fee, it will be subject to WHT at 10 percent, assuming no preferential WHT rate is granted under the double tax agreement (DTA) entered into between China and the country of which the provider is a resident enterprise.

Royalty versus service fee

Although a very limited number of DTAs that China has entered into with other countries contain the technical service fee clause, the PRC tax regulations provide specific guidance on how to distinguish between a royalty and a service fee in the following situations:

  • In the case where a foreign service provider uses certain technology in providing services to its Chinese client, and such services do not result in the transfer or license of such technology, the service fees should not be regarded as a royalty. On the other hand, if the services provided result in certain intellectual property, and the service provider retains the ownership of the intellectual property of the service outcome (i.e., the Chinese client only has the right to use such outcome), the service fees should be treated as a royalty instead.
  • In contrast, where the foreign service provider enters into a mixed contract for technology transfer/license as well as provision of the relevant services to its Chinese client, the service fee, irrespective of whether collected separately, should be taxed as a royalty, for as long as the provision of such services has not resulted in a PE, or is not attributed to a PE. However, if the service performed has triggered a PE in China, the fees on the onshore services should be taxed as the business’s profits attributed to the PE, while the offshore portion should continue to be taxed as a royalty.

Therefore, when the fee charged by the overseas cloud service provider contains multiple items (e.g., use of licensed software available on the cloud, management of electronic data uploaded by the user onto the cloud, technical support services on the use of licensed software on the cloud), the classification of the income for PRC tax purposes would require further analysis.

Permanent establishment

Where the payment for services is not considered a royalty fee, it may still potentially be taxed in China on the basis that the payment is effectively connected to a PE constituted by the non-resident service provider in China.

We are not aware of any specific case in China where the foreign companies are deemed to have a PE in China by merely owning websites, contents, search engine and software hosted on a server located in China and owned by a Chinese entity. Nevertheless, the determination of PE is based on the facts of each individual case subject to the interpretation of the PRC tax authorities.

Should the following situations be triggered, the non-resident service provider may potentially be deemed to have a PE in China:

  • The Chinese vendor entity does not qualify as an independent agent (as interpreted under relevant DTAs entered into between China and the country of which the non-resident service provider is a resident enterprise).
  • Sales person(s) of the non-resident service provider has or habitually exercises the authority to conclude contracts on behalf of the non-resident service provider in China.
  • The non-resident service provider sends employees or other personnel to China to provide services (for the same or associated projects) for a period or periods aggregating more than the period stipulated in the relevant DTA entered into between China and the country of which the non-resident service provider is a resident enterprise.

CIT at 25 percent would be imposed on the profits attributable to the PE of the non-resident service provider; this CIT is usually calculated on a deemed basis.

If the payment is in the nature of a royalty fee but is associated with the PE of the non-resident service provider in China, the income may be treated as revenue derived by the PE and be taxed at CIT at 25 percent on the actual/deemed profit.

Related party transactions

Under the current Chinese tax regime, a business transaction between an enterprise and a related party should comply with the arm’s length principle. In the event of non-compliance, the tax authorities shall be empowered to make adjustments using reasonable methods.

Should any PRC resident enterprise contribute its effort jointly with other non-resident enterprises in rendering the cloud computing service, the computation and allocation of revenue/profit retained in the PRC resident enterprise should be carefully managed in order to meet the requirements of the arm’s-length principle.

If the revenue is derived by a PRC resident enterprise from providing a service (including a cloud computing service) to related parties, and the annual amount exceeds CNY 40 million, the PRC resident enterprise will be required to prepare and submit transfer pricing contemporaneous documentation to the tax authority on an annual basis.

Indirect tax

Business tax

There are two types of indirect taxes in China: Value Added Tax (VAT) and Business Tax (BT). VAT and BT are comparable to goods and services tax (GST) in other countries. However, while many other countries only have one type of GST applying to sales of goods and provision of services in China, VAT generally applies to sales of tangible goods, and BT generally applies to sales of services and the transfer of intangible assets (including the usage right of proprietary technology).

As no tangible goods would be transferred in the course of providing a cloud computing service, BT of 5 percent will generally be imposed on both the royalty fee and the service revenue. In the event that the provider of the cloud computing service is a non-resident enterprise of China, the payer of the royalty fee or the service fee would be obliged to withhold, report, and pay corresponding BT to the China tax authority on behalf of the non-resident service provider.

In addition, from 1 January 2012, the Chinese government launched a VAT reform pilot program in Shanghai. Some of the service industries are now subject to VAT instead of BT, and the affected industries impacted include Research and Development (R&D) and technical services, information technology (IT) services, cultural and creative services and certain others. Where the provider of cloud computing service is an enterprise registered in Shanghai, its service revenue and the royalty revenue may be subject to VAT at 6 percent.

Telecommunications industry barrier

Hosting a website through a server, with a view to generate profit, will be classified as a value-added telecommunications service and will be subject to PRC telecommunications sector regulations. According to relevant PRC regulations, a foreign-invested telecommunications enterprise must be established in the form of a joint venture (JV) and the equity interests of foreign investors in such JV cannot exceed 50 percent. Certain other requirements for the JV (such as minimum registered capital and prior experience in the telecommunications sector) need to be met before the government authorities grant the special license for providing telecommunications services.

Foreign exchange controls in China

Under the current foreign exchange controls in China, a PRC customer needs to obtain tax clearance from relevant tax authorities prior to remitting funds to an overseas vendor, where the fee is over USD30,000 for the transaction for services and any royalties. Even if the fee is less than USD30,000, such tax clearance is technically still required, in order to comply with PRC tax regulations. In the latter case, the tax clearance could be completed after the remittance.

During the tax clearance, the customers will need to provide various documents to the tax authorities and, on behalf of the overseas vendor, pay Withholding Tax (including BT) for software/storage usage fees and service fees, or claim CIT exemption for offshore service revenues. Such an exercise will be time-consuming for PRC customers. Furthermore, if customers do not follow the procedures, in the overseas vendor will underpay tax and the customers and the withholding agents will be held jointly responsible for these underpayments.

As such tax clearance procedure often causes significant delay to the customers’ payments to the overseas vendors, overseas cloud service providers should be aware of this as an inherent business risk.


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Sunny Leung

KPMG in China

+86 212 212 3488