Tax Issues in the Chinese Film Business

By Jesse Weiner

The tax issues faced in one’s own home country, especially in the movie business, are usually enough to give one a headache. Dealing with those same issues in a country with a relatively young tax system, not freely convertible currency, and rather opaque rule-making regime can seem like a daunting task. Hopefully the following overview of rules and practice will give those in the business a general guide to the tax and repatriation issues they may face when working in or with China.

Originally primarily concerned with domestic enterprises, China’s tax system went through a major overhaul in the 1980s in order to regulate foreign and foreign-invested enterprises and individuals. There is no single tax law or code governing the taxation in China, but there is a basic law setting out the broad principles of each tax with details generally provided in implementing regulations and specific rules in the form of circulars issued by the State Administration of Taxation (SAT) or the Ministry of Finance (MOF). China’s tax administration is characterized by the important discretionary power given to local authorities, which often leads to disparities in the practices of different tax bureau – local specific tax advice does sometimes need to be sought.

Box Office Bases

Since 2004, when the National Film Industry Development Special Fund Office (NFIDSFO) set up computer software that tracks the box office numbers, supposedly 95% of Chinese cinemas now in fact have installed that (or upgraded) software, the statistical results of which are published periodically. It is this data that forms the basis of understanding the true China box-office situation.

Presently, in addition to collecting and analyzing this digitized data provided by the theaters and theater chains, the larger and more developed distribution companies in China also employ people to make on-site inspections, the main function being to take random samplings of the actual number of tickets being sold for any particular film and ascertain the ticket price. The results of the random on-site monitoring are synthesized and used to produce an estimate of what the software-generated results should be.

The difference between these two sets of results have become smaller over the last few years but seem now to continually remain at a small but stable degree. Of course, with cinemas being built at just an astonishing pace in China (roughly 10 per day), there are going to be some theaters that attempt to skirt the rules. To wit, it was reported in late February that fifteen Chinese movie theaters (all in second- and third-tier cities) were to be penalized by the State Administration of Press Publications Radio Film and Television (SAPPRFT) for underreporting box office receipts. SAPPRFT also announced that it has issued new rules to curb fraud, including requiring theaters to upgrade ticketing software by May 1, 2014.

Even with accurate box office results, though, in practice it is often the case that distribution companies make public statements regarding the box office for a particular movie as substantially higher or lower than either of those results. Therefore, a producer, co-producer, or other such party should ensure that in their executed contracts with distributors there exist clauses defining the rights to monitor box office sales and rights to auditing. It is in those parties’ best interests to ensure their rights to obtain access to the original statistical data because in the event that a dispute arises regarding such under/over reporting, such parties can appoint expert third-party auditors or others to investigate and report on the situation.

Box-office Makeup

Regarding the taxes and fees from the overall box office ticket sales, a nationally-imposed value added tax (VAT) of 3.36% is first applied. After that, the NFIDSFO of SAPPRFT applies a “Special Film Fund” tax of 5% on remaining box office, which is used to support the making of special-themed films and to support the renovation of movie theaters. After deduction of the two aforementioned items, the remaining box office amounts will be allocated according to agreements between the theater or theater chain and the production/distribution companies.

While the determination of that allocation of the remaining box office is mainly driven by market conditions, the film industry has formed a relatively fixed system and practice. In March 2012, SAPPRFT (although at that time, SARFT)  announced a guiding opinion regarding the sharing of box office, which instructed that the production/distribution party may receive no less than 43% of the box office, while the theater operators receive no greater than 50%. As an aside, the SAPPRFT opinion also set up a situation in which cinema operators were offered a bonus (i.e., a partial-to-full refund of the 5% Special Film Fund tax) when a higher percentage of box office is collected for domestic films.

But even under these guidelines there is much leeway in the proportional allocation of the box among the parties, and factors such as the film’s origin can make a difference. That is, for a purely domestic film or a flat-fee imported film (FFI) the production/distribution parties may collect 43% of the box office, with the cinema chain company collecting7% and the theater operator collecting no more than 50%. For an import that is of the revenue share variety (RSI), the foreign production company ordinarily receives 25% of box office (after the deal struck between the US and China in 2012 which raised US producers’ share from about 13%), while the distribution company gets 25%, and cinemas operators and theater chain together receive about 50%. Based on different market expectations for particular movies, revenue share of the box office can (and does) often fluctuate.

As another aside, in August 2013, a dispute arose between the sole importer of foreign films (China Film Group) and US studios when CFG attempted to foist the obligation of payment of the Value Added Tax (VAT) onto the US studios. Since it had been supposedly agreed in 2012 that the increased 25% share of revenue to US studios was a net figure (with P&A costs and all local taxes accounted for by CFG), the US studios remained steadfast in their position and eventually prevailed.

Return on Investment of Box Office

At this stage of the China film market, domestic films still rely almost exclusively on box office sales for recoupment of costs and profit-making. In general when the ratio of a film’s total cost of production to gross box office takings reaches 1:2.5, the film can break even (i.e., recoup costs).

In Hollywood, on the other hand, the box office on average accounts for approximately only 20-30% of a film’s total revenue, the majority of the revenue coming from transfer or licensing of various exclusive rights in the film’s copyright, and the development of related consumer products and merchandising. Clearly there is ample room for China’s film market to grow in the areas of derivative film products and merchandising. Furthermore, in relying so heavily on only one main revenue stream for their movies, producers in China take on a greater risk than elsewhere.

Taxes on Revenue Share of the Box Office

There are 24 taxes in China, which can be classified into seven categories: turnover, income, resource, property and behavior, prescribed items, agriculture, and customs taxes. Of all those various taxes, on a national level, the domestic film production party will be liable for the VAT of 6% and Enterprise Income Tax (EIT) of 25%. Other taxes and fees may be assessed according to local authorities’ rules and regulations.

The tax filling for foreign co-production entity should be handled by the Chinese party and declared to Chinese tax authorities, which means the Chinese party undertakes the tax withholding and collection obligation. Such relevant tax clearance certificate should be submitted to the State Administration of Foreign Exchange (SAFE) for recordal and inspection. After SAFE’s approval the revenue remittance to the foreign co-producer can be undertaken.

Those taxes that the Chinese side of a co-production make on behalf of the foreign co-producer should not be taxed again (i.e., double taxation) from the foreign co-producer’s home country. China has signed tax treaties with a number of countries, including the US (in 1984), which follow the OECD model treaty; in general, the treaty provisions provide that if a taxpayer of one country pays income tax in the other country, then the amount of the tax paid is available as a credit to offset the income taxes imposed by the taxpayer’s country of residence. But it should also be noted that while this is a simple and straightforward concept, the actual implementation of this goal can often be complicated and requires advance planning. The 99 countries with which China has signed tax treaties can be found on the SAT website: http://www.chinatax.gov.cn/n6669073/n6669103/11810819.html

For those investing in films (or a slate of films) in a foreign country, as many Chinese companies are becoming wont to do, the bi-lateral tax treaties also come to the rescue: while investment income earned by non-residents in the US is taxed at a flat rate of 30% of the gross amount without any deductions or allowances for costs, the US-China tax treaty limits the withholding of interest on passive forms of income to 10%.

Taxes on Income of Talent

Under Chinese law, cast and crew including directors and all major talent must pay individual income tax (IIT). And with regard to the IIT obligation, China tax law strictly distinguishes between those participating in the production of film and television projects as individuals or as employees of talent agencies.

In accordance with China IIT law and relevant regulations along with bilateral agreements to which China has become a party, foreign talent (including those from Hong Kong, Macau, and Taiwan) should first declare IIT to the Chinese government for income obtained in China. After filing said tax in China, they may then obtain a tax certificate issued by the Chinese tax authorities, which can be used as tax credit or deduction at the individuals’ home tax jurisdiction.

In general, talent will conclude a labor service contract with a production company for participating in a project. After production of the film, the production side will pay (one hopes) the appropriate remuneration to talent, but withhold the talent’s individual tax, which is an obligation that falls to the producer. As an aside, it has also become customary in the last few years that for actors with a certain cache and degree of notoriety to have their contracts set the remuneration at a pure net rate, leaving to the producer not just the physical obligation to withhold IIT, but the actual financial obligation, as well.

IIT is calculated per service item/project. If the service fee for a particular project is less than or equal to Rmb4000, the taxpayer may first deduct Rmb800 before the tax is applied; if the income exceeds Rmb4000, then a 20% deduction on gross income can first be made before tax is applied. The tax that is applied on remaining amounts follows a progressive rate. The applicable tax rates are:

• 20% for income that does not exceed Rmb20,000,
• 30% for income from Rmb20,001-50,000,
• 40% for income greater than Rmb50,000.

It should also be noted that for scriptwriters (and other writers and artists of artistic or literary works), the 20% tax rate applies regardless of the one-time amount paid. Although surely not advised, there have been reports of unscrupulous producers attempting to pay their directors as supposed scriptwriters in order to save on tax payments. Moreover, on-going royalties paid to the scriptwriters for TV and film productions are always taxed at the 20% rate.

According to the PRC Individual Income Tax Implementing Regulations, income from a single-project-based labor-service contract will be considered a one-time event and taxed after the individual receives payment. If continuous income arises from a single project, then the total gained in any single month will be considered the one-time taxable amount for that month.

In those situations where talent is represented though an agency, the production party will generally execute an agreement with the talent agency, specifying the terms of the specific talent to participate in a certain movie or TV project. As for remuneration, the producer will pay fees directly to the talent agency, whereupon talent agency should (according to their own agreement) pay talent.

However, there is yet another distinction in the IIT rues here. That is, if talent is not generally employed by talent agency, but for the purpose of participating in a single project or event, the agency and talent sign a short-term labor agreement (so-called “Individual Personal Services” found in the US-China (as well as other) tax treaty), the remuneration from such case shall be considered personal service (taxed on the one-time principle as outlined above), and the talent agency shall be tasked with obligation of withholding the correct IIT.

On the other hand, where talent is employed on a long-term basis by a talent agency (so-called “Dependent Personal services”), taxable income will accrue on all the work engaged throughout the year and not calculated on the basis of a single project. Again, though, it’s the talent agency that will be required to undertake to withhold IIT liability.

There is a 7-level progressive tax rate for salaries and wages – i.e., for those actors with a long-term contract with a talent agency (revised September 2011)
Payable tax amount for full month	Tax rate	quick calculation deduction (RMB)
No more than RMB1500	3%	0
more than 1500, less than 4500	10%	105
more than 4500, less than 9000	20%	555
more than 9000, less than 35000	25%	1005
more than 35000, less than 55000	30%	2755
more than 55000, less than 80000	35%	5505
more than 80000	45%	13505

Tax Treatment of Other Industry-Related Services

The Foreign Investment Guidance Catalogue (the Catalogue), revised in 2011, essentially divides China’s economy for foreign investment purposes into three categories: prohibited, restricted and encouraged. Projects in these categories are subject to different examination, approval and registration requirements. Projects categorized as “encouraged” face relatively less scrutiny while those categorized as “restricted” are subject to stringent requirements and examination. Generally speaking, the encouraged field for foreign investment is more focused on the industries where Chinese lack advanced technologies. The restricted and prohibited fields for foreign investment are more focused on those areas that are lagging technologically, resource-heavy or environmentally unfriendly, harmful to state security, etc.

Projects in the encouraged category usually are eligible for preferential treatment. The principal incentives include a 15% preferential tax rate applicable to new high-technology enterprises and a 50% super deduction for qualifying R&D expenditure. There also is a geographically based incentive (valid until the end of 2020 mainly for China’s western regions) focused on new high-technology enterprises established in or after 2008; in addition to the 15% rate that applies to all new high-tech enterprises is a two-year tax holiday followed by three years of tax levied at a 12.5% rate.

With the 2011 revision of the Catalogue, a boon to advanced film equipment manufactures was discovered in the Encouraged category. Foreign investment into the manufacturing of digital camera (with resolutions above 10 million pixels); film equipment manufacture of 2K and 4K digital film projectors, digital video production and certain editing equipment. So for a foreign entity that wants to set up shop related to film equipment manufacturing in China, the tax incentives outlined above may well be available. The foreign entity should, of course, first confirm the details of the business and equipment models involved with PRC Customs and other government authorities to be sure that the preferential policies will be available and what precise restrictions will still apply for setting up enterprises such as a WFOE or JV.

Repatriation and Exchange Controls

China is a foreign exchange controlled country. Cross-border trade and services transactions settled in foreign exchange, overseas financing and profit repatriations, etc. are subject to the exchange control regulations. The foreign exchange authority is the SAFE and its local branches.

Generally, the real difficulties in repatriation occur where a corporation wishes to have access to its China cash in a hurry. There are no good solutions in this circumstance. For a foreign co-producer, the hurdles to be overcome in receiving their fees and appropriate share of profits (at least from the foreign exchange perspective) are much less than reports would have one believe. That is, the Chinese producer, after having paid all the appropriate taxes, armed with a tax clearance certificate from SAFE, can simply submit the certificate with an approved bank for foreign exchange and make the remittance to the foreign co-producers bank account (with certain bank fees, of course).

The taxation landscape of the Chinese film industry can surely seem like a formidable obstacle – yet another hurdle in breaking into the second-largest film market in the world. Yet, in practice, the taxation and other financial issues surrounding a film project are often handled with greater ease than one might imagine.