A newfound zeal among Chinese tax authorities has led to a new cost of doing business for global fund managers running international investment mandates for mainland institutions.

Fund executives in Singapore and Hong Kong report that this year their firms have, for the first time, been required to pay business tax, as well as income tax if their business is deemed a ‘permanent establishment’.

Given the size of overseas investments from the likes of China Investment Corporation and Safe Investment Corporation, the newly enforced tax must be considered a new cost of doing business.

“It’s only 5% of the gross fee, so it’s not really a big deal,” says one institutional sales head at a big US asset manager.

But tax authorities in Beijing are not just enforcing a long-standing business tax on financial services transactions, the above-mentioned 5% on gross.

They are also taking a closer look at which companies are – or are not – ‘permanent establishments’. Until 2009, foreign firms could reduce their tax exposure by claiming business was being done offshore. A new tax measure that became effective in early 2009 did away with any onshore-versus-offshore distinctions, and charges any business done by foreign financial entities.

Such taxes apply if a company is deemed a permanent establishment. That is, if the government deems the firm’s business activity is sufficient to consider it onshore, the firm is liable to income tax.

Last year, China renegotiated its preferential taxation treaties with jurisdictions such as Hong Kong and Singapore to give them some breaks. For a business to be considered a permanent establishment (and be taxed), it must conduct more than 183 days of business on the mainland per year.

Until this year, foreign fund managers were either able to claim their work in China involved fewer than 183 days or that the tax authorities had yet to implement the new treaties.

This year, however, Beijing has become more aggressive about enforcing the tax – perhaps as a function of time required to digest the new rules, or due to a new urgency to collect tax in the wake of the government’s 2009 fiscal binge.

This means fund managers are being required to prove their onshore work comprised fewer than 183 days of activity, a process so arduous that firms aren’t bothering to try. (For one thing, it is cumbersome for exempt businesses to repatriate capital.)

Therefore more fund-management offices are being declared permanent establishments, which means anywhere from 15-50% of profits can be deemed eligible for an income tax on services, which is 25%.

LS Goh, a China tax expert at PricewaterhouseCoopers in Hong Kong, says firms should be aware of a further potential tax -- on individuals. Employees of permanent establishments are liable to mainland income tax, even if they declare they work there for just one day. That rate can be as high as 45%, and if the individual doesn’t pay it, the employer is held responsible.

Goh says foreign financial institutions hadn’t taken this rule seriously, but it is now being enforced, in some cases.