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Possible Policy Update on Chinese Direct/Indirect Share Transfer
The latest information from the Chinese tax authority is that a favourable update regarding the Chinese tax implications in direct/indirect share transfer will be issued soon. The expected update is still subject to government internal discussions and has not yet been officially announced. Taxand China explores the expected policy updates and their implications for indirect share transfers in China.
Regarding China's current tax implications on share transfer cases, Circular Cai Shui  No. 59 and Guo Shui Han  No. 698 ("Circular 698") provides general guidance on the normal tax treatment and special ruling conditions/opportunities in the area of direct share transfers. For indirect share transfers, the current rules are found mainly in Circular 698 and State Tax Bureau Announcement Year 2011 No. 24.
Under Circular 698, the Chinese tax bureau is allowed to re-characterise an offshore indirect share transfer as a direct disposal, if they view the company to be abusing organisational forms to evade Chinese tax. A review of the business substance of these overseas holding levels will typically be conducted by Chinese tax authorities. In past years, this uncertainty around deemed direct disposal led to a potential Chinese tax risks in most M&A and restructuring transactions in China.
The current tax rules do not provide clear interpretations of the following important conditions and points involving share transfers in China:
- The tax implications of an indirect share transfer in group internal restructuring cases
- The definition and evaluation of business substance in circumstances where abusive usage of forms is asserted by Chinese tax authorities
- The tax implications of multiple layers of shareholding structures
- The application of a tax treaty with another country "when there are multiple layers of shareholdings"
- The clawback issue on the withholding tax rate for dividends in circumstances where an indirect transfer is deemed to be a direct transfer, and the shares held by the intermediate holding company are deemed to be cancelled from a tax perspective.
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Although not officially announced, the rumour of the mentioned change in the direct/indirect share transfer rules can be summarised as follows:
- "The re-characterisation of an offshore indirect transfer as a direct disposal" will not be applied to group internal restructuring transactions, provided that the group background is supported with good documents and accepted by the Chinese tax authority.
- The required documents will be much fewer and simpler for group internal restructuring transactions.
The timing for approval and feedback from the Chinese tax authority on a direct/indirect share transfer status review will be shortened.
- The tax payment deadline will be extended to provide more flexibility to non-residents, compared to the current practice.
- Detailed rules on determining share transfer cost during a series of indirect share transfer related to a Chinese tax resident (among which the direct share transfer is deemed).
With the above in mind, this favourable update is valuable because it reduces the current uncertainty around tax exposures/risks in group internal restructurings with Chinese aspects. Taxand will closely monitor and follow up in the upcoming months. If a large MNCs' group internal restructuring is being considered, it may be worthwhile delaying the implementation stage for a period of time to maximise on any potential benefits from the new policies.