Jan Holthuis
Partner | Lawyer
Send me an e-mail
+86 (0)21 61730388
Introduction
On February 6, 2015, the State Administration of Taxation promulgated the Announcement on Several Issues of Income Tax of Enterprises with Indirect Transfer of Property by Non-resident Enterprises (Announcement No. 7 of the State Administration of Taxation, 2015, hereinafter referred to as "An-nouncement 7") and related interpretations. This is the third time since the State Administration of Taxation promulgated the Notice on Strengthening the Income Tax Administration of Non-resident Enterprises Income from Equity Transfer in 2009 (State Tax Letter [2009] 698, hereinafter referred to as "Article 698") and the Announcement on Several Issues of Income Tax Administration of Non-resident Enterprises in 2011 (State Administration of Taxation Announcement 24, hereinafter referred to as "Announcement 24").
According to Article 698, if a non-resident enterprise transfers an overseas intermediate shareholding enterprise that directly or indirectly holds the equity of a Chinese resident enterprise, which is deemed by the Chinese tax authorities to have unreasonable commercial purposes, the transaction will be reclassified as a direct transfer of the equity of a Chinese resident enterprise, thus creating an enter-prise income tax obligation in China. Announcement 24 gives a more detailed explanation of some clauses in Article 698.
Announcement 7 abolished part of the provisions of Article 698 and Announcement 24, and made more detailed provisions on some income tax matters concerning indirect transfer of property such as equity of Chinese resident enterprises by non-resident enterprises. This article will discuss several key points of Announcement No. 7.
Scope of application
Article 1 of the Announcement 7 clearly states: "If a non-resident enterprise evades the tax obligation of enterprise income tax by indirectly transferring property such as equity of Chinese resident enter-prises through arrangements without reasonable commercial purposes, it shall redefine the indirect transfer transaction in accordance with the provisions of Article 47 of the Enterprise Income Tax Law, and confirm it as direct transfer of property such as equity of Chinese resident enterprises".
Property which is directly owned by non-resident enterprises and from which the income is subject to enterprise income tax in China can be divided in the following three categories according to the provi-sions of the Chinese Tax Law, collectively referred to as "China's taxable property":
Article 698 does not use the expression of "China's taxable property", but only refers to the indirect transfer of equity in Chinese resident enterprises. Therefore, the scope of indirect transfer of property covered by Announcement 7 is broader than that in Article 698.
Announcement 7 defines the concept of "indirect transfer of taxable property in China” as: non-resident enterprises making transactions with the same or similar substantive results as transferring Chinese taxable property directly, including change of shareholder(s) of overseas enterprises caused by restructuring non-resident enterprises, directly or indirectly transferring the equity and other similar rights and interests of overseas intermediate shareholding enterprises (excluding overseas registered Chinese resident enterprises, hereinafter referred to as "overseas enterprises"). Therefore, it is neces-sary to analyze relevant transactions from a substantive point of view in order to determine whether a transaction constitutes an indirect transfer of Chinese taxable property as stipulated in Announcement 7.
According to Article 5 of Announcement 7, the following two types of transactions do not apply (i.e., constituting essentially the "Safe Harbor Rules"):
Transaction Report
Announcement 7 has made the following major changes to the reporting requirements for indirect transfer transactions in article 698:
Judgment of Reasonable Business Purpose
Compared with article 698, Announcement 7 gives more detailed guidance on how to judge "reasona-ble commercial purposes". Announcement 7 lists the relevant factors to be taken into account in judg-ing "reasonable commercial purpose". For some specific cases, it is directly recognized as "unreasonable commercial purpose", and introduces the Safe Harbor Rules applicable to intra-group reorganization.
Judgement factors:
Transactions directly identified as not having reasonable commercial purposes
In addition to the two types of circumstances that do not apply to Announcement 7 (see the "Scope of Application" section above) and the application of the Safe Harbor Rules (see point 4 below), if the overall arrangement relating to indirect transfer transactions meets the following four conditions simul-taneously, the arrangement will be directly recognized as having "unreasonable commercial purposes":
The interpretation of Announcement 7 explains the "tax payable abroad" in the fourth condition men-tioned above. The tax burden includes not only the tax payable by the transferor in the country where the transaction is located, but also the tax payable by the transferor in the country where the trans-ferred overseas enterprise is located.
Reorganization of Safe Harbor Rules within the Group
For eligible intra-group reorganization, Article 6 of Announcement 7 introduces a Safe Harbor rule. If the indirect transfer transaction meets the following three conditions at the same time, it shall be deemed to have reasonable commercial purposes without having to pay enterprise income tax in Chi-na:
1) The equity relationship between the two parties involved in the transaction has one of the following circumstances:
If more than 50% of the value of foreign enterprises' equity (excluding 50%) comes directly or indirectly from real estate in China, the above-mentioned share-holding ratio will increase to 100%.
2) Compared with the same or similar indirect transfer transaction without the indirect transfer transac-tion, the income tax burden of China will not be reduced.
3) The transferee of shares shall pay the equity transaction consideration in full with the equity of the enterprise or the enterprise with a controlling relationship (excluding the equity of the listed enter-prise).
Although the aforementioned Safe Harbor Rule has facilitated the reorganization of the group, the provisions on equity consideration in Item 3 still set a certain threshold for the treatment. In addition, the announcement does not have a clear definition of "the enterprise with controlling relationship with it". Literally, this concept may be understood as either the parent company of the transferee or the subsidiary company of the transferee.
Consequences of failure to withhold or pay corresponding taxes
Announcement 7 clarifies two controversies related to article 698: whether the transaction party con-cerned has tax withholding obligations and how to calculate interest related to indirect transfer of tax.
In most cases, the transferee of equity is the payer of the transaction, so it will be liable for tax with-holding. This provision derives from Article 8 of Announcement 7: "Where income from indirect trans-fer of real estate or equity is subject to enterprise income tax in accordance with the provisions of this Announcement, the entity or individual directly obligated to pay the relevant amount to the transferor of equity shall be the withholding agent in accordance with relevant laws or contractual agreements."
Article 8 also stipulates that if the withholding agent fails to withhold the tax payable and the transferor of equity fails to pay the tax payable, the competent tax authorities may pursue the responsibility of the withholding agent in accordance with the relevant provisions of the Tax Administration Law and its implementing rules. If the withholding agent should withhold the tax withheld, the tax authorities may impose a fine of not less than 50% but not more than three times of the tax withheld on the withholding agent. However, in indirect transfer transactions, where the withholding agent has submitted the transaction data within 30 days from the date of signing the equity transfer contract or agreement, Article 8 allows the withholding agent to be mitigated or exempted from liability.
If the transferor fails to declare and pay the taxable income from indirect transfer of Chinese taxable property on time or in full, and the withholding agent fails to withhold the tax, Announcement 7 clearly says interest should be imposed on the transferor. Interest shall be calculated at the benchmark inter-est rate if the transferor provides transaction information or declares and pays taxes in accordance with regulations within 30 days from the date of signing the equity transfer contract or agreement for overseas enterprises; if the transferor fails to provide information or declare and pay taxes in accord-ance with regulations, interest shall be calculated at the benchmark interest rate plus 5 percentage points.
Because of the risk of fines imposed by withholding agents, transferees of equity in indirect transfer transactions would prefer to report relevant transactions to tax authorities, or at least negotiate with transferors of equity in order to protect their own interests. Similarly, in order to avoid the possibility of applying higher interest rates to calculate interest rates, the willingness of the transferor to report transactions will also increase.
Coordination with general anti-tax avoidance management measures
Article 11 of Announcement 7 stipulates that if the tax authorities need to investigate and adjust the indirect transfer of taxable property in China, they should implement the relevant provisions of the general anti-tax avoidance. This regulation is expected to improve the tax collection and management of indirect transfer transactions by tax authorities, and to improve the certainty and protection of the tax law applicable to relevant enterprises. For example, according to the regulations, the competent tax authorities must obtain the approval of the State Administration of Taxation for major decisions in the examination and treatment of general anti-tax avoidance cases, and the enterprises concerned may express their objections to the adjustment decisions before the closure of the cases according to the methods.
Do you want to receive news and updates directly in your mailbox? Subscribe to our newsletter. Or follow us on LinkedIn or on WeChat.