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China Strengthens the Withholding Tax Administration on the Capital Gain Derived From Equity Transfer by Offshore Companies
The State Administration of Taxation (SAT) released a circular on December 10, 2009 to address various tax issues regarding equity transfers by Non-PRC tax resident enterprises. (Guoshuihan  No. 698, "Circular 698"). Taxand China reviews the withholding tax on non-resident enterprises.
Circular 698 covers both direct and indirect equity transfers conducted by offshore investors, which provides supplementary provisions to Caishui  No.59 on corporate restructuring. The issuance of Circular 698 indicates that SAT will put more emphasis on the monitoring of gains derived from the indirect transfer of Chinese companies' equity via disposing the equity of the Special Purpose Vehicle ("SPV") offshore China.
As stipulated in Circular 698, the capital gain derived from equity transfer refers to the balance of the equity transfer price less the cost of the equity. The equity transfer price shall include retained earnings and surpluses after tax, and the cost of the equity refers to the amount of actual investment occurred or the actual purchase price paid when acquiring the equity.
Circular 698 further prescribes the reporting obligation of the indirect transfer, i.e., within 30 days upon the indirect transfer, the off-shore investor (the actual controller) shall be obliged to report the indirect transfer to the in-charge tax authority of the PRC resident company held by the SPV, provided that the SPV is located in a foreign tax jurisdiction which has any of the following profiles:
- a tax jurisdiction with an effective tax rate less than 12.5%
- a jurisdiction which does not tax foreign sourced income on its tax residents.
The documents required to be provided include:
1) equity transfer contract / agreement
2) documents illustrating the relationship between the offshore actual investor and SPV being transferred in respect of financing, operation, sales and purchase etc.
3) documents illustrating the operation, personnel, finance and properties of the SPV being transferred
4) documents illustrating the relationship between SPV being transferred and the Chinese investee company in respect of financing, operation, sales and purchase etc.
5) documents illustrating the reasonable commercial purpose of the actual offshore investor in setting up the SPV which is being transferred
6) dther relevant documents required by the tax authority.
Furthermore, the Chinese tax authorities will examine the nature of the transfer, and may re-characterise the equity transfer based on its substance and disregard the existence of the SPV if the transaction is considered to be lacking in reasonable commercial purpose and aimed at reducing tax by means of abusing the form of organisation, etc. Once the SPV is disregarded, the transfer should be effectively treated as the transfer of the equity of the PRC resident company, and thus the transfer gain is of China source which should be subject to Chinese Withholding Tax.
The Chinese tax authority may impose withholding tax on non-resident enterprises that indirectly dispose of equity interests in Chinese resident enterprises outside China if there is an abuse of organisational form. Non-resident enterprises should be aware of this potential exposure to withholding tax and review their situation.
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