资讯
Feb-10-2010 Notice 698: Challenges from the PRC Tax Authorities on the Offshore Holding Structures of China Enterprises
Notice 698 sets out the basis on which the PRC State Administration of Taxes (“SAT”) may tax a foreign company that “indirectly” transfers equity interest in a subsidiary in China. Broadly, an indirect transfer of an equity interests occurs when a foreign company transfers the shares of a company incorporated outside of China (“Offshore HoldCo”) that is the direct or indirect shareholder of a Chinese enterprise. Provided the Offshore HoldCo is established in a low-tax jurisdiction, the seller must report the transaction to the local tax authorities where the Chinese subsidiary is located. Unless there is a reasonable commercial purpose for the transfer of the Offshore HoldCo, there is a risk that the PRC SAT will “look through” the Offshore HoldCo and re-characterise the indirect transfer as a direct transfer of the PRC subsidiary, and thus impose the PRC income gain at the rate of 10% on the capital gains from the indirect transfer.
Historically, investors have held their onshore investments through intermediate holding companies located in Hong Kong, Singapore, the British Virgin Islands, Barbados, the Cayman Islands or Mauritius. Notice 698 is a major challenge to investors seeking to convert what would have been a taxable onshore sale into a tax-free offshore sale through a divestment of an Offshore HoldCo.
Application of the Notice
Notice 698 imposes reporting requirements on the foreign investor (i.e. the actual controlling entity of the Offshore HoldCo) who indirectly transfers the shares in the China-resident company through a transfer of shares in the Offshore HoldCo under either of the following situations:
i. The effective tax rate in the jurisdiction of the Offshore HoldCo is less than 12.5%; or
ii. The jurisdiction in which the Offshore HoldCo resides does not impose tax on foreign-sourced income.
The following documentation/information must be submitted to the local tax authorities where the transferred China-resident enterprise is located, within 30 days of the transfer agreement being signed:
i. Contract or agreement for the share transfer;
ii. The relationship between the foreign investor and the offshore intermediary holding company being transferred with respect to financing, business operations, purchases and sales etc.;
iii. Details of the business operations, personnel, finance and accounting, assets etc. of the offshore intermediary holding company transferred by the foreign investor;
iv. The relationship between the offshore intermediary holding company being transferred and the China-resident enterprise with respect to financing, business operations, purchase and sales, etc.;
v. Explanation to support the bona fide commercial purposes of establishing the offshore intermediary holding company by the foreign investor; and
vi. Other relevant information required by the Chinese tax authorities.
Reporting Party
While Notice 698 imposes the reporting obligation on the foreign seller, some commentators have argued that reporting obligations have also been imposed on the Chinese subsidiary through the back door. This is because an earlier notice (“Notice of the State Administration of Taxation regarding the issuances of interim procedures for the administration of source withholding for non-resident enterprise income tax, Guoshuifa [2009] No 3”) imposes reporting obligations on a Chinese subsidiary in the case of a direct transfer of equity between a foreign seller and foreign buyer. The argument is that once SAT deems an indirect transfer to be a direct transfer, Notice 3 would apply to impose obligations on the Chinese subsidiary to assist the tax authorities to collect taxes.
Penalties for failure to comply
Potential penalties of RMB 10,000 may be imposed for late reporting of the above information.
Based on information furnished to the SAT, it will determine whether to impose a tax liability on the foreign investor in respect of the income derived from the indirect transfer of a China-resident enterprise. Where the foreign investor had not complied with the reporting requirements, and where the Chinese tax authorities successfully assert that the general anti-avoidance rules apply and proceed to impose a tax liability on the foreign investor, then not only would the tax be payable but the foreign investor could potentially be liable for very significant penalties (up to five times the amount of the tax).
Difficulties for administration by SAT
Commentators have questioned the ability of the SAT to enforce this notice, particularly as the SAT will not be able to readily detect an offshore transfer if the foreign seller does not comply with its reporting obligation.
Further, the drafting of this notice itself makes its implementation difficult. For example, the reporting obligation is triggered where an Offshore HoldCo is established or is resident in a jurisdiction with an effective tax rate below 12.5%. Hong Kong and Singapore have corporate tax rates above 12.5% (though due to tax exemption, tax incentives and exemptions for small companies, the effective tax rate may be below 12.5% for some companies) and no capital gains, so are transfers of holding companies from these jurisdiction caught under the notice?
Secondly, how wide is the concept of “transfer of equity”? Would the reporting obligations be triggered if, instead of an outright transfer of equity, a trust arrangement is entered into offshore whereby beneficial ownership is transferred or the transfer relates to hybrid capital (for example, subordinated debt instruments with rights akin to shares) as opposed to equity? Is a security arrangement in respect of shares treated as a transfer of equity?
Foreign investors who do not comply with the reporting obligations could be at risk of potentially serious tax exposure due to Notice 698. Please contact us if you would like us to review and assess your tax exposure under this Notice.