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Tax Treatment on Share Disposal Income of Non-Resident Enterprises / Individuals
Recent laws and regulations, and a State Tax Bureau Announcement, have provided additional explanations regarding the share transfer income of non-resident enterprise resulting directly / indirectly from disposal of equity interest in Chinese companies.
Definition of Non-Resident Enterprises
From a PRC tax standpoint, an entity may qualify as a Non-Resident Enterprise whenever:
1. it has China-sourced income and does not set up any organisation/structure in China
2. it has China-sourced income and has set up its organisation/structure in China, but the income is not related to the mentioned organisation / structure.
Indirect Share Disposal
Regarding the offshore indirect share transfer, the investor has to perform specific formalities before the Chinese tax authorities in order to declare this transfer of share within the 30 days following the signing date of the deed, when the tax burden is lower than 12.5% in the State of the target company or when the State of the target company imposes free of tax their overseas income.
Furthermore, the Chinese tax authorities are allowed to re-characterise an offshore indirect transfer as a direct disposal if the company is deemed to have abusively used various organisational forms to avoid any PRC taxation. Tax authorities may check the economic substance of these organisational forms to see whether they are set up for reasonable business purpose. They could also request any other supporting documents justifying the economic substance.
Particularly, one municipal local tax office in South China is said to have just collected tax over RMB13 million from the indirect disposal of shares among Non-Resident Individuals. However, whether it was collected as Individual Income Tax or Enterprise Income Tax is unclear. Therefore, we cannot rule out the possibility that the above-mentioned indirect disposal regulations will be extended to individuals as well.
Un-deductible Retained Earnings
For the relevant tax calculation, the taxable baseis determined as follows:
Taxable Share Disposal Income = Share Disposal Price - Share Cost
In the above calculation, retained earnings of the target company cannot be deducted, so that these retained earnings will be taxed twice under the current PRC tax regulations. To prevent double taxation, it would be advisable to anticipate the payment of all retained earnings as dividend or interest to shareholders prior to the transfer of shares.
Under the current practice, estimating tax exposures for both companies and individuals on the share disposal directly / indirectly related to a Chinese company is quite complex, especially since so many foreign investors have previously been advised to use buffer companies in Hong Kong or BVI to become the holding company of their pre-existing Chinese entity.
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