China cross-border e-commerce enterprises with key North American and European markets are facing challenges with respect to tax compliance issues given the complex tax regime in the US and the new tax policies issued in Europe this year regulating cross-border e-commerce. Our observation from the rules that govern companies’ initial public offering is that most cross-border e-commerce enterprises that are going for IPO or already listed do place emphasis on disclosing overseas tax risks. Regulators have raised queries on tax compliance issues when they perform the review of the listing application. On the other hand, facing such strict supervision, due diligence advisors engaged by investors and IPO auditors would usually, in a full scale, investigate and disclose the tax risks faced by cross-border e-commerce enterprises. Our view is that improving tax compliance is one of the essential and key issues to be addressed by cross-border e-commerce enterprises that are on their way to the capital market. We therefore summarize below EY teams’ observation with respect to the typical tax challenges encountered by Chinese cross-border e-commerce enterprises in the two major markets, i.e., US and Europe.
China cross-border e-commerce enterprises are facing challenges in handling US tariff, despite the different operation model they adopt, having a local operating entity or not and whether the import is realized by general trade or postal parcel. Common issues that we have seen in the market include:
• Identification of importer of Record (IOR)
• Whether the imported merchandise is valued reasonably
• Whether the US Customs special rules for low-value shipments are properly used
In addition to the local tax issues, China cross-border e-commerce enterprises also need to pay attention to the selection of appropriate export codes, when dealing with exportation from China. Submission of supporting documents, settlement of foreign exchange, tax refund and other relevant issues relating to exportation declaration shall also be properly handled.
Federal income tax
The particular business model of cross-border e-commerce allows a foreign company to carry out business and sell goods to US consumers without actually setting up a company in the United States. However, not having a company in the United States does not imply that it is not subject to US taxes. Instead, the company should consider whether its activities (including the activities of its agents) in the United States performed by its foreign entity are sufficient to constitute a US trade or business (USTB) or permanent establishment (PE) in the United States. If a USTB or PE is constituted, the profits attributable to the USTB or PE could be subject to federal income tax in the United States.
Some Chinese cross-border e-commerce enterprises sell goods to US consumers through Hong Kong entities within the group. Since Hong Kong does not have a double tax treaty with the US, the PE concept would not apply and instead, USTB standard with lower threshold and hence easily to be met, will be applicable when determining whether any federal income tax liability will arise in the US. Therefore, there may be high risk for Hong Kong entities to be considered by the IRS as a USTB and thus be required to pay federal income tax in the US.
State and local taxes
In terms of sales and use taxes in the US, the third-party e-commerce platforms have been required to withhold and pay sales and use taxes on behalf of platform sellers since 2018 in certain states. As of 1 July 2021, most states have made such requirement. Enterprises should carefully assess whether they are subject to state and local income taxes based on factors such as whether they hold inventory in the US, whether they have employees or offices located in the US, the volume of sales in each state, etc. Due to the absence of a third-party platform to withhold and pay the taxes, the enterprises adopting the self-built website operation model shall pay special attention to its compliance of sales and use taxes, including pricing, the criteria for determining the economic nexus, filing and payment of sales and use taxes according to state regulations, etc. For the enterprises adopting the transshipment and distribution model, it is necessary to determine whether the end retailer or the transshipment and distribution party is obliged to withhold and pay the sales and use taxes.
EU’s VAT reform brings compliance challenges to Chinese cross-border e-commerce enterprises
The reformed VAT rules related to cross-border e-commerce enacted by the EU officially came into effect since 1 July 2021, while UK underwent VAT reform on 1 January 2021. The regulations cover sales within the EU and also distance sales from non-EU countries to EU countries. The newly formulated regulations can be complicated for cross-border e-commerce enterprises, who may be exposed to tax risks if they fail to comprehend the regulations and fulfill the requirements of tax compliance.
We have summarized the most relevant tax policy changes in EU that are applicable for Chinese cross-border e-commerce enterprises as follows: