October
2014
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C
HINA
B
RIEFING
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5
An Introduction to Double Taxation Avoidance
A Background to DTAs in China
China has made significant strides in the past five years in building up its regulation in the area of double taxation avoidance, as well as
implementation assurance techniques. Following the 2008 Corporate Income Tax Law, which laid the basis for anti-avoidance in China,
the State Administration of Taxation (SAT) issued a flurry of related circulars stipulating reporting requirements for offshore transactions,
describing qualification as a beneficial owner, and dictating protocol for claiming treaty benefits.
Before it will grant DTA relief fromWithholding Tax on dividends, interest or royalties, the SAT must be satisfied that the applicant company
in a DTA partner jurisdiction (for example, Hong Kong or Singapore) is indeed the “beneficial owner” of the Chinese subsidiary. The SAT
bases its judgment on a principle of “substance over form” – that is, it is not enough that the applicant company is a tax resident in the
DTA partner jurisdiction in question.
This can pose a significant problem, especially for companies that were established many years ago through a holding company in Hong
Kong, and thus did not consider their future qualification as “beneficial owners.” Therefore, conducting a preliminary assessment of a
company’s situation is typically the first step taken by Dezan Shira and Associates professionals to determine the likelihood of approval
prior to submitting an application for DTA relief.
Based on the experience of Dezan Shira & Associates professionals, the most common difficulty that clients in Hong Kong face in securing
treaty benefits under the DTA between China and Hong Kong is obtaining the tax residency certificate for their Hong Kong entity, especially
when this acts solely as a holding company. In such cases, the China tax authority is likely to refuse to recognize these entities as a beneficial
owner and deny the application for DTA benefits.
The development and current situation of DTAs in China can be summarized according to four legal frameworks:
Anti-avoidance foundations
China’s general anti-avoidance ruleswere first introducedunder the
2008 Corporate Income Tax (CIT) Law, which provides that, where
anenterprise’s taxable income is reduceddue to its implementation
of“arrangements that do not have a reasonable business objective,”
the tax authority will have the right to make adjustments to the
taxes owed. The CIT Implementing Rules further clarified that such
arrangements are those for which the main purpose is to reduce,
avoid or defer the payment of taxes.
Wherethereisabuseofpreferentialtaxpolicies,taxtreaties,enterprise
organizational structures, taxhavens, or other arrangementswithout
reasonable business purpose, the tax authorities are empowered
to launch a general anti-tax avoidance investigation based on the
principle of“substance over form.”
Qualifying as beneficial owner
Circular 601 states that a recipient of dividends, royalties or
interest from a Chinese resident enterprise is entitled to treaty
benefits if the recipient can be named “beneficial owner” of
such income.
Circular 30, released in late June 2012, built upon Circular 601 to
make it simpler to obtain “beneficial owner” status. This circular
presented a “safe harbor” of sorts, where listed companies are
automatically considered beneficial owners of dividend income.
In addition, local tax authorities were prohibited from simply
rejecting DTA relief claims; but rather required to first receive
approval from the provincial level tax authority and then report
the case to the SAT for filing.
Claiming treaty benefits
In August 2009, Chinese tax authorities introduced administrative
requirements for non-residents to undertake in order to enjoy
benefits under DTAs. Details on these requirements were given
in Circular 124 and its supplementing Circular 290, which also
stated that a withholding agent should complete registration
procedures regardless of whether the taxpayer has provided
relevant information to the tax authorities.
The procedure for claiming DTA benefits is divided into two
pathways of administrative measures—either “approval” or
“record-filing” with the relevant tax bureau—, depending on
the type of relief being claimed. Details for both methods are
provided in the chart on page 11 below.
Reporting offshore transactions
Where an offshore investor indirectly transfers equity in a Chinese
resident enterprise and the actual tax burden in the jurisdiction
of the offshore holding company is lower than 12.5 percent, or
the country in question exempts tax on offshore income, the
Chinese authorities should be notified.
This requirement, derived from Circular 698, further states that
where the transfer involves the abuseof anorganizational structure,
and the arrangement (i.e. the offshore holding company) has no
reasonable business purpose or has the main purpose of evading
the obligation to pay CIT, the tax authorities can disregard the
offshore holding company following an investigation into its
ownership and operations.
