Authored by: Ryan Yan and Daisy Gu

For a foreign corporate LP (Limited Partner) in a QFLP (Qualified Foreign

Limited Partner), is its income subject to a 10% withholding income tax or a 25% enterprise income tax? The answer depends on whether the QFLP constitutes a Permanent Establishment (PE) in China.

I. Standards for Determining a Permanent Establishment (PE)

(1) Fixed Place PE

According to the United Nations Model Double Taxation Convention Commentary, the OECD Model Tax Convention Commentary, and Guoshuifa [2010] No.75 interpreting the China-Singapore DTA, a fixed place of business established in China through which the business of an enterprise is carried on constitutes a permanent establishment, unless the activities are preparatory or auxiliary in nature.

(2) Agency PE

If a domestic agent has the authority and is able to exercise such authority on a regular basis to sign contracts in the territory of China in the name of a foreign enterprise, the agent shall be recognized as an agency-type permanent establishment of the foreign enterprise.

II. Scenarios where a QFLP is Considered a PE of a foreign enterprise in China

(1) Fixed Place PE

Pursuant to Paragraph 1 of Article 2 of the Partnership Enterprise Law of the People's Republic of China (Revised in 2006), which stipulates that "a partnership enterprise as mentioned in this Law refers to a general partnership enterprise or a limited partnership enterprise established within the territory of China by natural persons, legal persons, and other organizations in accordance with this Law", a QFLP is a business entity legally established within the territory of China with independent status. Therefore, companies, non-profit organizations, and partnership enterprises invested by foreign investors in China are generally not regarded as the natural extension of the foreign investors' own functions or entities within the territory, given that business entities are endowed with independence by law. Moreover, due to the passive nature of LPs, a QFLP is generally not treated as a fixed-place permanent establishment of the foreign LP in China.

(2) Agency PE

If a foreign LP has no right to manage the partnership affairs of the QFLP, and the LP cannot control the QFLP or the General Partner (GP) to conduct  business activities on behalf of the LP, in such cases, the QFLP or GP will generally not be recognized as an agency permanent establishment of the LP in China.

However, exceptions may apply. For example, if, in accordance with the partnership agreement or advanced arrangements, a LP holds veto rights over major matters such as the QFLP's investment targets, the disposal of the QFLP's assets, or the use of QFLP assets to provide guarantees; or if the LP influences the investment decisions made by the GP on behalf of the QFLP through governance bodies such as an investment decision-making committee or a joint committee, the tax authorities may hold the view that the foreign LP exercises de facto control over the domestic GP, and thus conclude that the foreign LP has a permanent establishment in China.

III. Application of Tax Rates

(1) Where a PE Is Constituted

In accordance with Article 26 of the Enterprise Income Tax Law of the People's Republic of China (Revised in 2018), "Dividends, bonuses, and other equity investment income derived by a non-resident enterprise that has established an institution or place in the People's Republic of China from a resident enterprise, where such income has an actual connection with the said institution or place" shall be excempt from enterprise income tax, However, this exemption does not apply to "investment income obtained from holding publicly issued and listed tradable shares of a resident enterprise for a continuous period of less than 12 months."

The dividend income obtained by a foreign LP from a resident enterprise through a QFLP may enjoy the tax exemption treatment for dividends, thereby being exempted from taxation in China, but specific procedural requirements must be met.

It must be noted that although the dividend income obtained by a foreign LP from the QFLP is tax-exempt, in accordance with the provisions of Paragraph 2 of Article 3 of the Enterprise Income Tax Law of the People's Republic of China (Revised in 2018) – "A non-resident enterprise that has established an institution or place in the People's Republic of China shall pay enterprise income tax on the income derived from sources within the People's Republic of China by such institution or place, as well as the income generated outside the People's Republic of China but having an actual connection with the institution or place established by it" – any other income obtained by a foreign LP from the QFLP and income having an actual connection with the QFLP shall be subject to enterprise income tax at a rate of 25% in accordance with Chinese laws.

(2) Where No PE Is Constituted

If a QFLP does not constitute a Permanent Establishment (PE) of a foreign LP within the territory of China, in accordance with Paragraph 1 of Article 91 of the Implementation Regulations of the Enterprise Income Tax Law of the People's Republic of China (Revised in 2019) [State Council Decree No. 714], which stipulates that "a non-resident enterprise shall pay enterprise income tax at a reduced rate of 10% on the income specified in Item (5) of Article 27 of the Enterprise Income Tax Law", a 10% withholding income tax rate shall apply.