The China State Administration of Taxation recently issued a
notice extending the taxation of capital gains by non-Chinese tax
residents arising from indirect transfers of Chinese assets. Where
indirect transfers of equity in Chinese entities were already
subject to capital gains tax based on Circular 698, Notice 7 now
extends taxation to indirect transfers of other Chinese assets.
Notice 7 also provides clearer guidance on what constitutes tax
avoidance by non-Chinese tax residents. We advise clients to
carefully assess the potential impact of Notice 7 on recent and
possible future transactions.
In December 2009, the Chinese State Administration of Taxation
(SAT) published Circular 698. The circular requires non-Chinese tax
residents established in a jurisdiction with an effective tax rate
of less than 12.5% to notify the relevant Chinese tax authority of
any indirect transfer of Chinese equity. (The meaning of an
indirect transfer of Chinese equity is a transfer of shares in an
intermediate offshore company holding equity in a Chinese
subsidiary). If the tax authority finds that the intermediate
offshore company lacks a reasonable business purpose and was put in
place to avoid paying taxes in China, it can disregard the
existence of the intermediate company and treat the transfer as a
direct transfer of equity in a Chinese entity. The seller's
capital gains from the sale will then be treated as income sourced
in China and be taxed at a rate of 10%, subject to a potential
reduction under any applicable tax treaty.
Circular 698 does not define "reasonable business
purpose". And although some guidance can be found in other
regulations, there has been uncertainty among non-Chinese tax
residents about the circular's scope.
On 6 February 2015, the SAT published Notice 7 with immediate
effect. It has retroactive effect on tax obligations that have not
yet been settled with the tax authorities. Notice 7 extends the
scope of taxation on indirect transfers to include movable and
immovable assets and assets attributable to an establishment in
Notice 7 furthermore provides clearer guidance on whether an
offshore intermediate company is considered to have a reasonable
Pursuant to Notice 7, any indirect transfer of Chinese assets
lacks a reasonable business purpose if each of the following
conditions has been met:
at least 75% of the offshore
company's value is derived from Chinese assets
at any time during the preceding
one-year period, at least 90% of the offshore company's total
assets (excluding cash) consisted of investments in China or at
least 90% of the offshore company's revenues were derived from
the offshore company lacks substance
and has limited risk exposure
the foreign income tax burden on the
indirect transfer is lower than the Chinese income tax burden that
would apply in the case of a direct transfer.
Notice 7 contains safe harbour provisions, exempting certain
indirect transfers from taxation in China, such as intra-group
transfers and transfers of shares in companies listed outside
The transaction reporting obligation set out in Circular 698 has
been abolished. Notice 7 introduces voluntary reporting to the
Chinese tax authorities by taxpayers or withholding agents.
However, the transferor will have to pay interest if it fails to
timely pay income tax on the indirect transfer.
Notice 7 does not completely replace Circular 698, but provides
further guidance on taxation of indirect transfers of taxable
Chinese assets. The abolishment of mandatory reporting obligations
under Circular 698 is a welcome change, allowing flexibility
between transaction parties in how they allocate reporting
obligations and indemnities.
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.
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