Recently, Jiandu City State Tax Bureau in Jiansu Province,
China, collected RMB173 million (US$25.4 million) on capital gain
on an indirect transfer of 49 percent equity interest in a Chinese
company. This is the first publicized victory of Chinese tax
authorities on their campaign against nonresident shareholders for
the indirect transfer of equity interest in Chinese resident
enterprises since the State Administration of Taxation issued the
Notice on Strengthening the Administration of Corporate Income Tax
Concerning Equity Transfer for Non-resident Enterprises, Guo Shui
Han  No. 698, in December 2009.
China tax law and regulations impose 10 percent income tax on
the gains derived by nonresident enterprise shareholders from the
transfer of equity interest in China resident enterprises. Guo Shui
Han  No. 698 requires that if a nonresident shareholder
indirectly transfers the equity of a China resident enterprise by a
transfer of shares of an overseas holding company and the effective
tax in the holding company jurisdiction is lower than 12.5 percent,
the nonresident shareholder should file certain information
including the share transfer agreement with the Chinese tax
authority. If the tax authority believes that the indirect transfer
of equity interest in the Chinese resident enterprise is to avoid
China tax by abusing organizational form and without reasonable
business purpose, the tax authority may recharacterize the equity
transfer based on economic substance and disregard the overseas
holding company. For detailed discussions of the tax circular,
please see our Commentary in December 2009, "
China May Tax Indirect Transfer of Shares in Chinese Companies
In the current case, Foreign Company A owned 100 percent of a
Hong Kong company; the Hong Kong company owns 49 percent of a
Chinese company. In January 2010, Foreign Company A transferred
shares of the Hong Kong company to Foreign Company B with a gain of
US$254 million. It appears that Foreign Company A did not
voluntarily file the required documents with respect to the
transfer in accordance with Guo Shui Han  No. 698. The
Chinese tax authority requested the transfer agreement from the
parties to the transaction, including Foreign Company B. The
Chinese tax authorities determined that the transaction in
substance is to transfer 49 percent of the Chinese company and
therefore should be taxable in China. The facts that the tax
authorities use to support the determination include the
announcement made by the U.S. parent of Foreign Company B that they
completed acquisition of 49 percent of the Chinese company without
mentioning the Hong Kong company, and the Hong Kong company has no
employees, other assets and liabilities, other investment, or other
business. After several negotiations, Foreign Company A paid the
The case has demonstrated that China tax authorities are
aggressive on the enforcement of "anti-tax avoidance"
circulars with respect to nonresident enterprises, including tax on
indirect transfer of equity in China resident enterprises.
Multinational corporations should review their China investment
structure and reassess risks in relation to China anti-avoidance
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