Taxation Between the USA and China Navigating a Complex Landscape 2025
Introduction:
Among the global economic and trade relationships, the relationship between the US and China is one of the most significant bilateral relationships in the world.
These two countries are the largest economies in the world and are tied together through multitudes of trade ties, investment ties, and diplomatic ties.
An area often overlooked in the discussion of the two largest world’s economies are taxation issues. relating to cross border economic activity.
Understanding the various tax systems, double taxation issues, and tax rules through treaties
or international agreements is imperative for multinational corporations, individual investors, or even nations.
This paper examines the tax relationship between the US and China, the double taxation issues that go along with individuals or companies taking action across borders, and tax rules and attempts toward a fair and sustainable tax practice regulating cross border activity.
Overview of Tax Systems: USA vs. China
United States Tax System:
U.S. citizens and residents are subject to a worldwide taxation system where they are required to report their income from all around the world.
This includes corporations. In the U.S., taxpayers are taxed on their worldwide income, wherever it was earned.
The corporate tax rate has seen or is in the process of seeing reform to lower tax rates (the most significant being the Tax Cuts and Jobs Act – TCJA in December 2017), which lowered the federal corporate tax rate from 35% to 21%—a considerable reduction.
In addition to the taxes imposed by the federal government, individuals and businesses are generally subject to state and local taxes, which vary significantly.
Important Aspects of the Tax System:
Taxation of worldwide income Credits for foreign taxes paid Subpart Frules and GILTI rules as efforts to prevent profit shifting Complex reporting of foreign assets (e.g., FATCA)
Chinese Tax System:
Like many countries, China has a territorial tax regime which means taxes are levied on income earned within China’s borders.
The three main taxes impacting foreign businesses operating in China are: corporate income tax (CIT), value-added tax (VAT), and the individual income tax (IIT) levied on expatriate and resident individuals.
The corporate income tax rate in China is, on paper, 25%, but some high-tech enterprises and favored industries may be eligible to pay a lower rate.
The Chinese tax system has kept pace with global trends around modernization,
for example more effective enforcement of compliance, migrating from paper filings to digital filings, and greater overall transparency.
Overview of Some Key Characteristics of the Chinese Tax System:
Territorial tax regime VAT regime to impose taxes on goods and services Incentives of specific industry sectors Increased enforcement of anti-avoidance rules
The Issue of Double Taxation
what is douple taxation
Double taxation occurs when the same income is taxed by both the home country and the host country.
This may create an unacceptable financial and administrative burden on U.S. companies operating to in China or Chinese companies that invest in the U.S.Some examples of the various
types of double taxation include:
1. Jurisdictional Overlap:
A U.S. company generates income in China and is taxed by Chinese tax authorities, then a U.S. company is taxed again under U.S. law based on the global income tax rules.
2. Federal Withholding Taxes:
For example, a company may be subject to paying withholding taxes in the source country for a dividend, interest or royalty, thereby, incurring an additional tax burden in the home country.
3. Permanent Establishment:
If the source country determines that a company is “doing business” or has a “permanent establishment” (PE) in that country, or, the U.S.
company has employees in the source country, the company can be on the hook for local tax obligations even though the U.S. company does not have an official domestic subsidiary.
Real-World Example:
fImagine a technology company that is located in the United States earning royalties from a subsidiary based in China of $1 million.
On that $1 million in earnings, the Chinese government withheld 10% or $100,000 as tax on the royalties that are paid outbound.
So, the Chinese subsidiary has just earned $1 million and the U.S.-
based company is left with net $900,000 after taxes. When that income is repatriated back to the United States, the U.S.-
based company will have to report that income, and they may also have to pay additional taxes unless they can offset the taxes they paid in China as a foreign tax credit or treaty.
Tax Treaty between the U.S. and ChinaThe U.S. and China entered into a bilateral income tax treaty in 1984, with a protocol in 2009, in order to alleviate double taxation of income and facilitate borderless investments.
In addition to being the governing law in allocating tax treatment for the income types covered under the treaty, these treaties generally include clauses to seek to resolve disputes or issues in a bilateral manner.
Key Provisions of the Treaty:
Reduced Withholding Tax Rates: The treaty permits relatively low rates on dividends, interest, and royalties:
Dividends: 10%Interest: 10%Royalties: 10%These rates are lower than the statutory rates and will produce cost savings on cross-border payments.
Permanent Establishment Rules:
The treaty includes a threshold for whether or not a company is deemed to have permanent establishment in the other country; this will clarify the company’s tax obligations.
Home Country Relief from Double Taxation:
Each country agrees to provide tax credits for income that is taxed in the other country, which avoids double taxation.
Mutual Agreement Procedure (MAP):
This is a process where tax authorities of both respective countries may agree on resolving disputes that have arisen from the interpretation or application of the treaty.
Exchange of Information : It enables tax authorities of both respective countries to cooperate in tax evasion, compliance enforcement.
Tax Challenges Faced by Multinational Enterprises
Despite the tax treaty and the good faith efforts on both sides, American and Chinese companies doing business cross-border still have many headaches.
Transfer PricingTransfer pricing refers to the pricing for goods, services, and intangibles between related parties.
Both countries have rigorous transfer pricing rules that would generally prohibit profit shifting and tax base erosion. –
The U.S. Approach: Applies the arm’s length standard and imposes detailed recordkeeping obligations. –
China’s Approach: Similar standard but emphasizes location specific advantage (or lack thereof) and economic substance.
Disputes often occur with respect to the allocation of profits, particularly in high-margin areas (e.g., technology or pharmaceuticals) between U.S.
parent companies and their Chinese subsidiaries.
Tax Compliance and ReportingU.S.
entities operating in China, and any Chinese entity that has investment in the U.S.,
are subject to local tax compliance rules including VAT filings, audit requirements and documentation in Mandarin.
In addition, Chinese entities investing in the U.S.
must comply with various IRS rules with respect to FATCA and the like as well as reporting requirements.
Trade Tensions and Tax UncertaintyThe historical and ongoing trade tensions between the U.S.
and China have introduced uncertainty into the tax planning process.
Tariffs, sanctions and export controls may serve to indirectly impact tax planning, or the communications related to the tax planning process, for firms with
Methods to Mitigate Tax ExposureCorporations and investors must develop proactive measures to mitigate tax exposure and comply with tax laws in different jurisdictions.
Recent Changes and Key DevelopmentsOECD
Pillar Two and Global Minimum TaxAs part of its OECD
Global Minimum Tax (GMT) initiative launching under Pillar Two, China and the U.S. are both participants, establishing a minimum 15% tax on multinational profits.
While the implementation will vary, this will have a substantial impact on tax planning between China and the U.S.
Increased TransparencyBoth countries are heading towards increased transparency and enforcement:
China: There are widened e-invoicing and real-time tax reporting systems in place.
U.S.: Has expanded enforcement through IRS and increased penalties related to a taxpayer’s disclosures concerning foreign reporting rules.
Digitization/E-commerceDigital services are growing, and new questions arise regarding where value is created, and how it should be taxed.
Both countries are evaluating how to tax digital platforms and tax ecommerce going cross-border.
The Future of U.S.-China Tax Relations:
Tax will continue to be a critical component of the U.S.-China economic relationship.
The treaties and cooperative frameworks presented opportunities for greater cooperation, but the shifting global tax landscape will always test both jurisdictions.
There is an prospects to form greater alignment with regard to : Joint initiatives to combat tax avoidance.
More aligned bases of taxation of digital goods and services. Continued negotiations as countries undertake tax reform on an international stage.
At the same point in time, political posturing and economic rivalry will complicate matters of cooperation.
Companies and investors will have to remain informed and nimble enough to adapt to changes to rules about taxation, while navigating a world where geopolitical tensions are more acute.
Conclusion:
The tax relationship between the US and China is both significant and complex.
Due to the size of trade flows, the extent of investment flows and the ever-changing global tax
environment, it is important to consider how each country approaches taxation and how they engage with each other.
Taxpayers confront multilayered regulations and compliance obligations on everything from a basic bilateral tax treaty to transfer pricing and new digital taxes.
There are both difficulties and opportunities and taxpayer can find opportunities in areas such as tax planning and structuring, dispute resolution and other cross border opportunities for co-operation.
The global tax environment will continue to change and do so with the focus from a large number
of stakeholders including policy makers, multinationals and foreign investors of both countries.
