On 10 December 2009, the State Administration of Taxation issued a circular on strengthening enterprise income tax ("EIT") administration on gains from equity transfers by foreign non-resi¬dent enterprises ("Circular 698").

Circular 698 not only provides for a capital gains tax on direct transfers of equity of a PRC-resident enterprise by its non-resi¬dent shareholder, it also strengthens tax oversight on the indirect transfer of equity of an offshore intermediary holding company that owns a PRC-resident enterprise. As such, it increases admin¬istration and control over foreign enterprises that use offshore holding companies to invest in China.

Two of the provisions under Circular 698 that may create practical difficulties are described below.

  • If the withholding agent fails to fulfil its withholding obligations concerning the equity transfer, the non-resident shareholder shall be required to declare and pay EIT within seven days after the contractual date of equity transfer, or when the equity transfer gains are received if this occurs at an earlier time. This timeline will be difficult to meet.
  • With indirect equity transfers, if the actual tax burden in the jurisdiction of an offshore holding company being transferred is less than 12.5%, or if there will be no income tax for for-eign-sourced income in such jurisdiction, the actual controlling non-resident investor must submit comprehensive documents within 30 days after signing the equity transfer contract. This tax burden will be difficult to assess, and the timeframe and documentary requirements will be difficult to satisfy.

Should the actual controlling foreign investor use the intermediary holding company to evade taxes, the Chinese tax authorities may disregard the existence of the offshore holding company and redetermine the nature of the equity transfer.

Furthermore, Circular 698 is effective retroactively from 1 January 2008. Foreign investors who conducted an indirect equity trans¬fer involving their Chinese companies over the last three years should reexamine their transactions to ensure full compliance with this circular.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.