Business income or royalities?
The case of PanAmSat vs. Beijing State Tax Bureau
1 Case review
In May 1996, PanAmSat International System Inc. (PanAmSat), located in Delaware US, signed a contract with China Central Television (CCTV) for providing video distribution services. In January 1999, Beijing State Tax Bureau issued a notification (Jingguoshui No. 001) to the CCTV regarding the withholding tax of 7% on the payment made by the CCTV to foreign satellite companies, including PanAmSat. In March 1999, PanAmSat paid US$1,546,632 to the Beijing State Tax Bureau, but applied for a review of this tax treatment. In August, the review upheld the withholding tax of 7% on the income received by PanAmSat. Subsequently, PanAmSat sued the Beijing State Tax Bureau (Tax Bureau) at the Beijing Secondary Court of Appeal.
At the hearing in June 2000, the Tax Bureau withdrew the notification (Jingguoshui no 001). At the same time PanAmSat dropped their lawsuit. But four days after the withdrawal, the Tax Bureau issued another notification (Jingguoshui No. 319) for imposing the income tax of 7%. This was based on article 11 of China‐US Double Taxation Agreement, article 19 of the Foreign Investment Enterprise and Foreign Enterprise Income Tax Law in China (Foreign Tax Law), and the Decision on the Issue of Imposing Withholding tax on Foreign Satellite Companies issued by the State Administration of Taxation. PanAmSat applied for another review. In November 2000, the review upheld the No. 319 notification. Then, PanAmSat filed a lawsuit in Beijing’s First Court of Appeal seeking to reduce the unexpected tax burden.
During the court hearing the CCTV was required as a third party to testify. Again, in October 2001, the decision of the Court upheld the No. 319 notification. PanAmSat refused to accept the decision and appealed to the Beijing High Court. Finally, on 26 December 2002, the Beijing High Court overruled the appeal and upheld the decision of Beijing First Court of Appeal.
2 The arguments of PanAmSat and Beijing State Tax Bureau (Tax Bureau)
PanAmSat argued that the income derived from the contract between PanAmSat and the CCTV was business income from the service it provided to the CCTV. Under the China‐US DTA, PanAmSat had not set up its ‘Permanent Establishment’ in China; therefore, it is not liable to the tax on business profits in China. The service provided by PanAmSat was a business activity of the provider through the satellite they owned in space. The income should not be recognized as royalties under article 11 (3) of the DTA by classifying the payment as rent for the use of scientific equipment.
The Tax Bureau insisted that, according to article 11 of the DTA, the income shall be treated as royalties. Even though it was not the CCTV itself that operated the satellite and accessory equipment, the CCTV still has the right to use the scientific equipment. (Under domestic law, the income derived from the use of the scientific equipment was not defined as royalties, but rather as rent. However, under article 28 of the Foreign Tax Law, when there is a difference between the domestic law and the DTA, the DTA provisions prevail.)
REFERENCES:
Foreign Investment Enterprise and Foreign Enterprise Income Tax Law of the People’s Republic of China 1991
Article 19: Any foreign enterprise which has no organization or establishment in Chinabut has gained dividend, interest, rental, royalty and other income from sources in China, or though it has organizations or establishments in China, the said income is not actuallyconnected with any of its organizations or establishments, shall pay an income tax oftwenty percent on such income.
Article 28: Where the provisions of the tax agreement concluded between the government of the People’s Republic of China and foreign governments are different from the provisions of this Law, the provisions of the respective agreement shall apply.
Agreement between the Government of the People’s Republic of China and the Government of the United States of America for the avoidance of Double taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income 1984
Article 11(3):The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes used for radio or television broadcasting, any patent, technical know-how, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.
