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Clarification of “Beneficial Owner” Prevents Abuse of Local Level Tax Bureaus
This article has been republished in Bloomberg BNA Tax Planning International Review, December 2012
In 2009 the State Administration of Taxation (SAT) announced Circular 601 which determined the definition of 'Beneficial Owners' (BOs) under all relevant tax treaties. The intention was to provide further clarification on how to assess the status of BOs under Sino - foreign DTAs.
However, there was still much confusion on technical and practical issues surrounding the BO status of treaty resident applicants. In June 2012 SAT issued the long awaited Public Notice 30 as a supplement to Circular 601, in order to further clarify these ongoing problems. Taxand China explains the general implications of Public Notice 30 and what it means for multinationals.
Public Notice 30 provides detailed guidance on the determination of BO status for the purpose of claiming treaty benefit by treaty residents in respect of China-sourced passive income. By definition in Circular 601, BO means "persons who possess ownership and right of control on their proceeds or properties generated from such proceeds". However, agents and "conduit company" purposes are not accepted.
The Public Notice 30 has listed the following implications on the determination of the identification of BO:
1) Various factors should be considered
Public Notice 30 points out that in determining whether a company is the BO of income, all relevant factors listed in Circular 601 should be taken into consideration, which include:
- 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).
- The applicant has no or hardly any other operation activities except the properties or rights from which the proceeds generate.
- As for a company applicant and the like, the applicant's small (few) assets, scale and staff mismatch with the proceeds.
- The applicant has no or hardly any right to control or dispose, nor does it assume little risk on the proceeds or the properties or rights from which the proceeds generate.
- The counterparty county (region) to the tax treaties does not levy tax or grant tax exemption on the proceeds or levy at an extremely low rate.
- Besides the loan contract based on which interests accrue and are paid, the applicant has another similar loan or deposit contracts in respect of amount, interest rate and execution date with a third party.
- Besides the transfer contracts of copyright, patent or technology based on which loyalties generate or are paid, the applicant has other transfer contracts in respect of right to use or ownership of copyright, patent or technology with a third party.
2) Specific reference documentation
For analysing the factors in Circular 601, the Public Notice 30 lists out the documents that could be required from the China tax authorities in the implementation stage.
3) Safe-harbour rule (particular in dividend income)
If an applicant for treaty benefits is a listed entity in the home country, it will be directly classified as the BO of "dividends" received from a Chinese company. The same treatment will apply to 100% directly or indirectly owned subsidiaries that are located in the same jurisdiction as the listed entity. This will exclude indirect shareholding by a resident enterprise in a third party country or region that is not a Chinese resident, or a resident of the treaty counterparty. The exceptional case exists in many MNC structures.
4) "Agency" arrangement.
Where income (dividends, interest or royalties) is received through an "agent", the principal may apply to be considered the BO of the income, provided the immediate recipient of the income declares that it is not the BO.
5) Tax information exchange
The Chinese tax authorities can use the exchange of tax information provisions to investigate whether declarations by persons who claim to be agents or nominees are correct. If not, it is envisioned that revised tax assessments will be made, and late payment surcharge at 0.05% per day will be levied.
6) Clarification of entitlement to refund based on BO determination
In cases where it is difficult to determine whether the recipient of income is the BO, it is envisioned that tax be levied at the non-treaty rate, with a tax refund being available if the recipient is in the later stage classified to be the BO.
7) High level authority
When the China tax authority determines BO status, the local tax bureau must obtain the approval of the provincial level tax authorities, and must report the decision to the SAT's international Tax Department for the record. Co-operation among different tax authorities must also be included in these cases.
Also in these classification cases, a taxpayer that has to apply for treaty benefits to several different local Chinese tax authorities can request that the authorities make a joint determination of the taxpayer's status as the BO of income. If the various authorities are unable to reach a consensus, the case should be referred to a higher level tax authority.
The announcement of Public Notice 30 is a positive step for multinationals as it clarifies the long disputed definition of who falls under the term 'Beneficial Owner'. While all the relevant factors from Circular 601 should still be considered when assessing a BO status, this update will attempt to prevent the previous levels of abuse of authority at local level tax bureaus.
If a BO's income is collected by agents or designated receivers, it will not matter if this agent is not a resident of the treaty counterparty. This allows more flexibility, and as neither Circular 601 nor Public Notice 30 provide a definition of the term 'agent', this will provide a grey area on judgments.
If a taxpayer can be qualified as a BO in more than one jurisdiction, which could often be the case for multinationals, their status will be determined after discussions with the different relevant tax authorities. However, due to the fact that there is no implementation rule concerning joint applications, it is possible that tax authorities will try to avoid making decisions on this.
Taxpayers will now have to apply for the definition of BO at different taxation authorities, and a joint definition of the taxpayer's status as the BO of income will be made after their internal discussions. Since there is no implementation rule regarding how such joint definition will be agreed, it is possible that both authorities could find a pretext for not making the decision in this scenario.
For the potential late payment surcharges on tax reassessment under tax information exchange, this may increase the company's China tax exposure and should be factored into the books as potential liabilities.
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