The Agreement ("DTA") signed 27 June 2011, enters into force once both countries have completed their legislative procedures. The provisions of the Agreement will then take effect from the following year. For China this typically takes 12-18 months.The earliest this can be implemented now is 1 January 2013.

Taxand China and Taxand UK provide a general analysis of the DTA focussing on the change between the old UK-China DTA (effective from 1984) and the new one.

The table below compares the two DTAs.

Taxand's Take
CHINA
PE and Service Income
Under the old DTA, there is no specific term regarding service PE classification, which led to a situation where the UK company derived service income from China, even if it did not constitute as a PE under OECD rules, it may still be subject to China Enterprise Income Tax ("EIT"). The new DTA has set up the service income classification and deleted the service income term. The UK company's service income in China will not be subject to China EIT provided that it does not constitute as a PE in China under the new treaty.

Capital Gains
Under the new DTA, for non-property-rich alienation, capital gains will not be taxed in that other Contracting State if the resident, at any time during the 12-month period preceding such alienation, owned directly or indirectly, at least 25% of the shares of that company. This may encourage future investment from the UK into China.

Dividends
The beneficial rate of 5% on dividends is provided in the new DTA, compared to the original 10%. Please note that the definition of the word "indirectly" in the term "directly or indirectly, at least 25% of the shares of that company" still does not have official explanation, which should be available in the later stage.

Restriction Terms and Prevention of tax evasion and avoidance
To prevent the abusive usage of the preferential treatment in DTA, the relevant restrictive terms and prevention of tax evasion and avoidance has been added into the new DTA. If the main purpose or one of the main purposes of any person concerned with the creation or assignment of the activities is to take advantage of the DTA, the DTA's preferential treatment will not be applied.

It is likely that all structuring between China and the UK will be reviewed by the tax bureau by quoting the new restrictive terms of DTA and the domestic laws and measures concerning the prevention of tax evasion and avoidance such as Circular [2009]698 on indirect transfer of China company equity and Circular [2009]601 on qualified beneficiary under DTA.

UK
The changes to be introduced by the new DTA are generally positive for UK companies investing in China and result in a number of potential benefits, including:

• The reduction in the dividend withholding tax rate to 5% (from 10%) where Chinese companies pay dividends to UK shareholders beneficially holding, directly or indirectly, at least 25% of the share capital
• The introduction of a safe harbour provision for services PEs whereby a PE will not be created by the provision of services unless present for a period of 183 days in any 12 month period
• The extension (from 6 to 12 months) of the period required to create a PE as a result of construction or installation projects
• The elimination of China’s right to tax Chinese source service income even in the absence of a PE
• The limitation of China’s right to tax capital gains on dispositions of domestic interests

Looking ahead there will be less reason for UK companies to invest in China via Hong Kong or other “treaty shopping” structures. Furthermore, the combined effect of the proposed changes and recent changes to the UK’s domestic tax regime is to make the UK a more attractive holding company location for onward investment into China.

Your Taxand contacts for further queries are:
Kevin Wang
T. +86 21 6447 7878 ext 526
E. Kevin.Wang@hendersen.com

Kevin Hindley
T.  +44 207 715 5235
E.  khindley@alvarezandmarsal.com

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