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China Sets Guidance on the Cognisance of Beneficial Owner under Tax Treaties

28 Jan 2010

The State Administration of Taxation ("SAT") issued a circular on 27 October 2009 to regulate the interpretation and cognisance of Beneficial Owner under Double Tax Treaties and Arrangements between China and other countries (Guoshuihan [2009] No. 601, "Circular 601"). Taxand China considers the compliance requirements for multinationals.

Circular 601 provides specific standards on determining whether a resident of a contracting state is the Beneficial Owner of income with respect to dividends, interest and loyalties, aiming to reinforce the administration of underlying tax evasion by means of abusing treaty benefits.

As prescribed by Circular 601, the term "Beneficial Owners" means persons/entities who possess ownership and rights of control on their proceeds, or rights/properties generated from such proceeds, who shall engage in substantive operation activities.

Circular 601 further stipulates that, a Beneficial Owner could be individuals, companies or any other associations, while agents and conduit companies are excluded. The Circular introduces the concept of conduit companies, which refers to companies established for the purpose of tax evading, tax reducing, transferring or accumulating profits. Such companies are only registered in the country where they are located so as to satisfy organisational form requirements in law and do not engage in any substantive operational activities such as production, marketing and management.

According to Circular 601, the following factors are negative in the determination of an applicants' status as Beneficial Owners.

1. The applicant is obliged to pay or distribute all or a major part (e.g. above 60%) of the proceeds within a specified time limit (e.g. within 12 months after receiving) to residents of a third country (region).
2. The applicant has no or hardly has any other operational activities except the properties or rights from which the proceeds generate.
3. For a company, the applicant's limited assets, scale and staff are mismatched with the proceeds.
4. The applicant has no or hardly has any right to control or dispose, nor does it assume substantial risk on the proceeds or the properties or rights from which the proceeds generate.
5. The counterparty country (region) to the tax conventions does not levy tax or grants tax exemption on the proceeds or levies tax at an extremely low rate.
6. Besides the loan contract based on which interest accrues and is paid, the applicant has other similar loan or deposit contracts in respect of amount, interest rate and execution date with a third party.
7. Besides the transfer contracts of copyright, patent or technology based on which royalties are generated or paid, the applicant has other transfer contracts in respect of right to use or ownership of copyright, patent or technology with a third party.

Circular 601 also stipulates implementation approaches on the application of Beneficial Owner status.

  • The taxpayer shall provide materials to certify its status as the Beneficial Owner as specified in the above provisions.
  • Tax authorities could adopt the information exchange mechanism when determining the Beneficial Owner status, and may refer to the State Administration of Taxation (SAT) for national level cognisance on complicated cases.

Taxand's Take

SAT has released a batch of regulations with respect to the administration of tax treaties. Prior to the issuance of Circular 601, SAT released a notification on the ruling of abusing tax treaty benefits by a company registered in Barbados (Guoshuihan [2008] No. 1076) in 2008 and a circular on the implementation of the dividends article under tax treaties (Guoshuihan [2009] No. 81).

The issuance of Circular 601 indicates the trend that SAT would put more emphasis on possible tax evasion/avoidance by multinational companies by means of establishing conduit companies in regions/countries with lower withholding tax rates under the relevant tax treaties.

Multinational companies should prudently consider the compliance requirements and re-evaluate current investment structures as well as take appropriate measures to avoid being challenged by tax authorities on this issue of who is the Beneficial Owner.

Your Taxand contacts for further queries are:
Dennis Xu
T. +8621 6447 7878 ext 506

Kevin Wang
T. +8621 6447 7878 ext 526

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