Clarification of Beneficial Ownership in Double Tax Agreements

For the purpose of enjoying tax treaty benefits, the determination of beneficial owner (BO) status for non-tax residents who derive dividend, interests and royalties from China has always been a major concern. According to the most recent Announcement on Clarification of Beneficial Ownership in double treaty agreements (DTA) issued by the State Administration of Taxation effective as of 1 April 2018 (the No.9 Announcement), additional guidance on assessing the BO status has been provided. 

1. Unfavorable factors for BO assessment
In the No.9 Announcement, 5 unfavorable factors are clearly listed out that would affect the qualification as BO which include:

1. The recipient is obligated to pay more than 50% of the income to a resident of a third jurisdiction within 12 months after it receives the income. ‘Obligated to pay’ for this purpose means that the recipient of the income has a contractual obligation to pay or if there is no contractual obligation to pay, the recipient actually has made a payment(s);
2. The business activities carried out by the recipient of the income do not qualify as substantive business activities; substantive business activities include substantive manufacturing, trading and management activities, etc;
3. The recipient is exempt from tax on the relevant income or the income is not taxable in the residence jurisdiction, and if the income is taxable, the effective tax rate is extremely low;
4. In addition to the loan contract for which interest is derived and paid, there is/are other loan or deposit contract(s) between the creditor and the third party where details such as the amount, interest rate and date of execution are similar; and
5. In addition to the transfer contract for usage rights such as copyright, patent and technology for which the royalties are derived and paid, there is/are other transfer contract(s) for usage rights or ownership in relation to copyright, patent, technology etc between the applicant and a third party.

2. The derivative interest test
In addition, in the case of dividend deriving, the No 9 Announcement for the first time introduces the derivative interest test, meaning that even though the direct recipient of China-sourced dividends (the Direct Recipient) does not pass the 5 unfavorable factors tests, it can still, according to the No.9 Document, be deemed as BO insofar as:

1. The parent company directly or indirectly holds 100 percent equity interest of the Direct Recipient and qualifies as a BO upon assessment based on the five unfavorable factors in No.9 Document; or
2. The parent company is tax resident in either the same jurisdiction as the Direct Recipient or in another jurisdiction that has a DTA with China that provides the same or more favorable treatment.