CHINA Tax Free Reorganisations
- With circulars 109 and 116 jointly issued in December 2014 by
the Ministry of Finance and the State Administration of Taxation,
the Chinese authorities have relaxed the conditions for internal
- Circular 109 deals with internal reorganisations. Provided the
pertinent requirements are met, the transfer of shares of a Chinese
company within the group will not be subject to Chinese income tax.
There must be a reasonable commercial reason for the transfer, the
equity acquired must be at least 50 percent (previously: 75
percent) of the total equity of the target company (in an asset
transaction, the assets acquired should be at least 50 percent
(previously 75 percent) of the total assets of the transferor),
there must be no change in the original operating activities for a
prescribed period of time, shareholder equity must comprise at
least 85 percent of the total consideration (thus: the debt may be
up to 15 percent of the total consideration) and the equity
consideration received should not be sold or transferred within a
prescribed period of time. This facility is applicable for both
domestic and foreign shareholders.
- Interestingly, a new item, which was included in circular 109,
is a deferral treatment, which is applicable only to domestic
intra-group transfers (from Chinese to Chinese company). There will
be no income tax on the transfer of the assets if (a) transferor
and transferee are 100 percent owned by the same direct or indirect
shareholder or own each other for 100 percent, (b) the transfer
takes place at book value, (c) no loss or profit can be recognised
in the financial accounts, the transaction is done for reasonable
commercial reasons other than tax and there is no change in the
operating activities for 12 months after the transfer. This
facility is especially interesting, because it does not require a
certain threshold interest to be acquired and neither does it
require the consideration to be paid for with equity.
- Circular 116 provides for any enterprise income tax liability
arising from a transfer of assets to a Chinese company in order to
pay up shares issued by the latter to be payable over five
Indirect Transfers of Chinese Companies
- As anticipated, on 6 February 2015, China's State
Administration of Taxation (SAT) issued Public Notice  No. 7
(Public Notice 7) dealing with indirect transfers of Chinese
taxable assets. It substantially replaces Circular 698 and Bulletin
24 and introduces a new reporting regime which is significantly
different from the previous rules. Public Notice 7 has retroactive
effect to indirect transfers which have occurred since 1 January
2008 but have not yet been decided upon by the Chinese tax
WHAT IS THIS ABOUT?
- If a foreign investor sells or reorganises shares (and
equity-like interests) in another foreign company (Foreign Company)
which directly or indirectly holds Chinese taxable assets, and if
this effectively has a similar effect to directly transferring
these Chinese assets, then any gain attributable to the Chinese
assets will be subject to Chinese income tax if manner in which the
sale or reorganisation is conducted does not have reasonable bona
fide commercial purpose. There will be no income tax liability if
the manner in which the transfer is conducted has reasonable bona
fide commercial purpose.
- Chinese taxable assets now include (1) assets attributable to
an establishment in China, (2) immovable property in China and (3)
shares in Chinese resident companies.
WHAT HAPPENS IF THE INDIRECT TRANSFER LACKS REASONABLE BONA FIDE COMMERCIAL PURPOSE?
- The gain from an indirect transfer of the property of an
"establishment or place" situated in China will be
treated as income that is effectively connected with that
"establishment or place" and subject to 25 percent
Chinese income tax.
- The gain from an indirect transfer of real property situated in
China and the gain from an indirect transfer of equity interests in
Chinese resident companies will be treated as China-sourced income
and subject to 10 percent withholding tax.
THE GOOD NEWS
- Unlike Circular 698, Public Notice 7 no longer imposes an
obligation on the transferor to report the transfer to the Chinese
tax authorities. However, if the transferor does not report the
transfer and it turns out to be subject to income tax because it
lacks sufficient bona fide commercial purpose, then the transferor
or the transferee will be subject to severe penalties.
- Public Notice 7 e xempts from income tax (1) a s ale of shares
of the Foreign Company if it occurs through normal trading on a
stock exchange and (2) a sale of shares of the Foreign Company
which would have been exempt from Chinese income tax under an
applicable tax treaty if the transferor would have sold the Chinese
- Public Notice provides more guidance as to what constitutes
bona fide commercial purpose1.
- Public Notice 7 gives clarity when an indirect transfer will be
deemed to lack sufficient bona fide commercial
- Public Notice 7 contains a safe harbour for qualifying internal
- Better protection for taxpayers and clarity on procedure if the
Chinese tax authority wants to tax an indirect transfer: they must
first obtain prior approval from the SAT on all major steps of an
investigation and they must give the taxpayer an opportunity to
appeal against an adjustment decision before this decision can be
THE BAD NEWS
- The scope of situations affected by Public Notice 7 now
includes Foreign Companies directly or indirectly owning Chinese
immovable assets and assets attributable to an establishment in
China, whereas previously it only included the transfer of equity
in a Foreign Company which directly or indirectly owns equity in a
- If the indirect transfer lacks reasonable bona fide commercial
purpose, both the transferor, the transferee and the Chinese
company whose equity is indirectly being transferred have a
reporting obligation4 within thirty days of the date of
the transfer, failing which penalties will be due. Under the
previous rules only the transferor had a reporting obligation. This
raises a serious practical challenge for the purchaser, who is
often unable to assess whether the transfer is subject to Chinese
income tax and what the amount of the tax liability is.
- The party acquiring the equity in the Foreign Company or its
paying agent is primarily responsible for paying the Chinese tax in
the event the transaction lacks reasonable bona fide commercial
purpose, failing which the transferor will be liable to pay the
Chinese income tax. If the transferor fails to pay the income tax,
the party acquiring the equity in the Foreign Company will be
liable for the income tax due plus a penalty. The penalty could
range between 50 percent and 300 percent of the income tax
liability, subject to a waiver or reduction of the penalty if the
acquirer reports the transaction within thirty days after the date
of the transfer. The transferor will be liable for a penalty if
neither the transferee or the transferor have paid the income tax
on the transfer. The offshore seller has an obligation to file a
tax return and pay tax within seven days from the date when the tax
liability arises if the purchaser (or its withholding agent) fails
to withhold the tax. If the offshore seller fails to pay the income
tax in full within the prescribed time limit, the offshore seller
is subject to a daily interest rate equal to the benchmark RMB
lending rate published by the People's Bank of China plus 5
percentage points. For the indirect transfer of the property of an
"establishment or place" situated in China, the
"establishment or place" must include the capital gains
in its taxable income of the tax year.
- The SAT has no obligation to make a determination on
taxability. In most cases the offshore seller and the
"establishment or place" are not able to determine
whether the indirect transfer is taxable in China within the
prescribed time limit.
- As Public Notice 7 does not address this point, there is
uncertainty whether the tax authorities will recognize the tax paid
in prior indirect transfers when determining the tax basis in
subsequent direct or indirect transfers.
KEY TAKE AWAYS
- If an indirect transfer of Chinese assets lacks sufficient bona
fide commercial purpose, the seller is still liable for the income
tax liability on the sale, including reporting the same to the SAT,
but the purchaser now has a withholding and reporting obligation
and can be liable if the seller does not pay the tax. This is
problematic as there will now need to be an overt discussion on the
amount of the tax that is to be paid and therefore the amount that
is withheld (or held in escrow), previously something that sellers
in practice were generally very reluctant to discuss with
- Purchasing parties will need to amend their Sale and Purchase
Agreements (SPAs) to reflect the new withholding and reporting
obligations in order to protect themselves when they acquire assets
which are subject to Public Notice 7.
- Investors should keep sufficient evidence on record to
substantiate the reasonable commercial purpose criteria, including
minutes of board of directors meetings, shareholders meetings and
correspondence with the SAT, if any.
Business Tax on Sale of Residential Property
- On 30 March 2015, the Ministry of Finance (MoF) and the State
Administration of Taxation (SAT) jointly issued a notice (Cai Shui
 No. 39) concerning business tax on the sale of houses owned
by individuals. The notice applies as from 31 March 2015.
- According to the notice, the full amount of sale proceeds is
subject to business tax if the house has been in the possession of
an individual for less than two years.
- If the house sold is non-ordinary (large and luxurious with a
surface area greater than 140 m2 and the price more than 120
percent of the average housing price) and has been in the
possession of an individual for two or more years, only the capital
gain is subject to business tax, which means that the acquisition
price can be deducted from the taxable amount, and the balance
between the acquisition price and sale proceeds is taxed.
- An individual is exempt from business tax on the sale of the
house if it is an ordinary house, and the individual has been in
possession of it for two or more years.
- Previously, the exemption from business tax applied if the
holding period of the house was more than five years in the period
from 28 January 2011 to 30 March 2015 (Cai Shui  No. 12).
With this new notice, Cai Shui  No. 12 ceases to apply.
- Further, the relevant tax administrative rules regarding the
definition of a non-ordinary house, application of the exemption
and requirements for documents provided in the notices Guo Fa Ban
 No. 26, Guo Shui Fa  No. 89 and Guo Shui Fa  No.
172 remain applicable.
Tax Incentives for Western Regions
- The State Administration of Taxation (SAT) issued an
announcement on 10 March 2015 (SAT Gong Gao  No. 14)
concerning clarification of enterprise income tax issues arising
from the implementation of the "Catalogue of Encouraged
Industries in Western Regions" (the "Catalogue"),
which has been in force since 1 October 2014. The announcement
retroactively applies from 1 October 2014.
- According to the announcement, an enterprise established in the
designated western regions is subject to enterprise income tax at a
reduced rate of 15 percent if its main business is one that is
newly added as an encouraged business in the Catalogue and the
revenue from the main business accounts for more than 70 percent of
the total revenue.
- The reduced enterprise income tax rate of 15 percent ceases to
apply to enterprises that enjoyed a 15 percent tax rate on the
basis of article 3 of SAT Gong Gao  No. 12 but are no longer
considered to be encouraged under the Catalogue.
Creation of Taxes Can Only Be Done Based on Law
- The National People's Congress, China's highest
legislative authority, on 15 March 2015 passed with immediate
effect an amendment to the 2000 Legislation Law, which provides
that the fundamental taxation system including the creation of a
tax, the determination of a tax rate, and the collection and
administration of a tax can be made only by law.
- Of China's 18 taxes, only the enterprise income tax,
individual income tax, and vehicle and vessel tax are currently
made by law. All other taxes (such as the VAT, business tax, and
consumption tax) are regulated by the State Council (executive
- From a tax perspective, the amendment is a milestone in
China's construction of a democratic and legal society because
the Legislation Law is a law that controls all other laws. The
establishment of the statutory tax principle means the collection
of all taxes and the legislation of tax procedures must comply with
the provisions of the Constitution Law and the Legislation Law.
That will significantly promote the development of the
country's tax laws.
Land Appreciation Tax in Business Restructuring Clarified
- The Ministry of Finance (MoF) and the State Administration of
Taxation (SAT) issued a notice on 2 February 2015 (Cai Shui 
No. 5) concerning the granting of land appreciation tax (LAT)
incentives in a business restructuring. The notice applies from 1
January 2015 to 31 December 2017. The transfer of state-owned land
and residential property is exempt from LAT if an unincorporated
business as a whole is converted into a limited liability company
or a company limited by shares (joint-stock company) or where a
limited liability company as a whole is converted into a company
limited by shares (joint-stock company).
- The notice provides that the exemption of LAT applies in the
case of a merger and spin-off if the main investor of the original
entity remains the main investor after the merger or spin-off. The
exemption does not apply to real estate development
Foreign Investment Catalogue
- On 13 March 2015, the National Development and Reform
Commission (NDRC) and Ministry of Commerce (MOFCOM) jointly
released the 2015 version of the Foreign Investment Industrial
Guidance Catalogue (2015 Catalogue) to replace the current
catalogue adopted in 2011 (2011 Catalogue). The 2015 Catalogue will
enter into effect as from 10 April 2015.
- The Catalogue is one of the most fundamental legal documents in
the regulatory regime of foreign investment in China. It classifies
industry sectors into encouraged, restricted and prohibited, and
any sector not included in the Catalogue is permitted. The
classification of sectors will decide the level of approval
required for, and the type of incentive available to, foreign
investment projects. It is viewed as a guidance from the PRC
government to direct foreign investment. The 2015 Catalogue is the
sixth version of the Catalogue since it was first promulgated in
Amendment to Administrative Measures on Tax Registration
- Courtesy IBFD, it was reported that the State Administration of Taxation (SAT) issued an order on 27 December 2014 concerning the amendment to the Administrative Measures on Tax Registration (SAT Order No. 36). The amendment applies from 1 March 2015 and is summarised below.
- New taxpayer identification number (TIN) system has been
introduced and is used by both state tax bureaus and local tax
bureaus. The entities that have acquired an organisation code will
receive a TIN consisting of nine digits of the organisation code
and six additional digits indicating the administrative region
where the taxpayer is situated. The TIN of the entities without an
organisation code is composed of the identity card number followed
by two additional digits.
- The branches of enterprises operating in other regions do not
need to register with the tax authorities in the places where their
business operations are carried out if the business activities last
for less than half a year.
- The tax authority will no longer need to conduct a field
investigation on the taxpayer, even if dubious documentation is
provided by the taxpayer.
- A withholding agent exempt from tax registration in accordance
with relevant laws and regulations is required to register as a
withholding agent with the tax authority within 30 days after the
withholding obligation arises.
- The tax authority is required to examine and approve the
registration on the same day as the submission of the form of tax
registration alteration if the relevant documents are complete and
- The penalty on the taxpayer failing to make a tax registration
or to file the alteration or cancellation within the time limit is
- The penalty on the taxpayer using the tax registration
certificate inappropriately is repealed.
- The penalty fee on the withholding agent failing to make the
tax withholding registration within the time limit is reduced from
CNY 2,000 to CNY 1,000.
- New taxpayer identification number (TIN) system has been introduced and is used by both state tax bureaus and local tax bureaus. The entities that have acquired an organisation code will receive a TIN consisting of nine digits of the organisation code and six additional digits indicating the administrative region where the taxpayer is situated. The TIN of the entities without an organisation code is composed of the identity card number followed by two additional digits.
VAT Refund for Foreign Visitors – Extended Country-Wide
- The Ministry of Finance issued an announcement on 6 January
2015 (Gong Gao  No. 3) extending to the whole country the
pilot programme of value added tax (VAT) refund for foreign
visitors on consumer goods purchased in China. The pilot programme
was launched in Hainan in 2011. According to the announcement, all
regions that meet the requirements of the state may set up a system
of VAT refund on consumer goods with a value of more than CNY 500
for foreign visitors (including citizens from Taiwan, Hong Kong and
Macau) who stay in China less than 183 days and claim the refund
within 90 days of purchasing the goods. The refund rate is 11
percent of the amount stated on the invoice, including VAT. If the
refund exceeds CNY 10,000, the refund can only be remitted to the
bank account of the visitor and cannot be paid in cash. The
implementation of this policy is intended to boost tourism to the
country and to adopt the common practice of other countries that
are significant tourist destinations.
Draft Foreign Investment Law Released for Public Comment
- On 19 January 2015, the Ministry of Commerce released a draft
of the Foreign Investment Law of the People's Republic of China
for public comment. The new Law contains 11 chapters and will, once
in force, replace the current regulations on foreign investment,
i.e., Regulations on Chinese-Foreign Equity Joint Ventures of 1979,
Regulations on Chinese-Foreign Cooperative Joint Ventures of 1988
and Regulations on Wholly Foreign-Owned Enterprises of 1986. We
note the following two new elements.
- Investments in the form of "variable interest
entities" (control over an enterprise by using contracts or
agencies rather than by shareholding or other forms of ownership)
will be subject to the foreign investment law and therefore to the
restrictions or prohibitions imposed by that law. The same applies
to situations where a foreign party has control over an enterprise
in China using contracts or trusts.
- Although the draft of the new Law emphasises that foreign
investment will receive national treatment, there are restrictions
and prohibitions on foreign investment in certain areas. For this
purpose, the State Council is authorised to issue the Catalogue of
Special Measures of Administration, i.e., the catalogue specifying
the restricted and prohibited industries for foreign investment.
For the restricted industries in the catalogue, foreign investors
need to apply for investment permission (a license). Otherwise no
license is required for foreign investment. The relevant department
of the State Council will issue Guidelines on Permission
Examination of Foreign Investment to provide the details.
QFIIs and RQFII's are Exempt From Non Resident Capital Gains Tax
- The exemption applies to sales made by QFIIs and RQFII's
after 17 November 2014. Any sales before that date can still be
taxed at 10 percent.
Strict Transfer Pricing Rules for Service Fees and Royalties
- In a move to implement the OECD's action plan on base
erosion and profit shifting to tackle international tax avoidance,
China's State Administration of Taxation (SAT) on March 20
issued Public Notice  16, providing tougher transfer pricing
rules for the administration of services fees and royalties paid by
Chinese companies to foreign related parties. It takes effect from
the issuance date, 18 March 2015.
- Enterprises must comply with the arm's-length principle for
expenses paid to foreign related parties. If those expenses are not
at arm's length, they can be subject to a special tax
adjustment up to 10 years after the tax year in which the
- Payments to an overseas related party which has no substantial
operation or activities, does not undertake functions or bear risks
should not be deductible for CIT purpose.
- Where an enterprise makes service fee payments to its overseas
related party, the service received by the enterprise should enable
it to obtain direct or indirect economic benefits. It also lists
out five specific scenarios as well as a catch-all general
condition of service payments that should not be deductible for CIT
purpose by the Chinese payer.
- It also denies deductibility of royalties if the recipient of
the royalties has not contributed to the value of the IP.
International Tax Developments
Japan. China's State Administration of Taxation (SAT) issued an announcement on 26 February 2015 with regard to Japan's local corporation tax which was introduced by Japan on 1 October 2014. The announcement declares that the China/Japan tax treaty applies to this new tax. As a result, the Japanese local corporation tax paid by a Chinese resident can be credited against the Chinese income tax.
- The Budget for 2015-16 was presented to the Legislative Council
by the Financial Secretary on 25 February 2015. The tax-related
proposals will, once they are enacted, apply from 1 April 2015. The
main points are summarised below.
- Subject to a maximum of HKD 20,000 per case, a one-off
reduction of 75 percent of the current profits tax for the year of
assessment 2014-15 is proposed.
- Under specified conditions, interest for corporate treasury
centres is proposed to be deductible under profits tax, and a
reduction of 50 percent of the current profits tax for specified
corporate treasury activities is proposed.
- An extension of the profits tax exemption to private equity
funds is proposed (this is also discussed under the separate
heading in this bulletin).
- A one-off reduction of 75 percent of the current salaries tax
and tax under personal assessment for the year of assessment
2014-15 is proposed, subject to a maximum of HKD 20,000 per
- The child allowance and the additional one-off child allowance
in the year of birth are proposed to be increased from HKD 70,000
to HKD 100,000 from the year of assessment 2015-16.
Termination of Contract Payment NotTaxable
- In the Aviation Fuel Supply case, the Hong Kong court of final
appeal has ruled that a lump sum received by a taxpayer on
termination of a contract was on capital account and not on revenue
account. Consequently the income was not taxable for the
Increased Minimum Wage
- On 16 January 2015, notice was gazetted to adjust the Statutory
Minimum Wage (SMW) rate to HKD 32.5 per hour (up from the current
HKD 30 per hour). It is anticipated that the new rate will come
into effect on 1 May 2015. To reflect the change to the SMW rate,
the current HKD 12,300 monthly cap (above which is not necessary to
keep a written record of hours worked) will be increased to HKD
13,300 per month. The change has consequences for MPF contributions
for employers and employees. Employers should take steps to update
their payroll procedures to reflect this change.
PE Funds Tax Exemption
- Hong Kong's Legislative Council (LegCo) announced on 5
January 2015 that it will issue new tax legislation in the first
half of 2015 to expand the scope of the current tax exemption of
offshore funds managed by Hong Kong fund managers. It will include
in the scope of tax exempt income, qualifying income earned from
private companies (the present law excludes investments in private
companies from the tax exemption). Furthermore it is proposed to
include qualifying income earned by Hong Kong special-purpose
vehicles (SPVs) owned by the offshore Private Equity (PE) Fund in
the scope of the tax exemption.
- This is a significant development and it would offer excellent
scope for tax planning for Hong Kong based investment managers of
offshore PE Funds, who manage investments in private companies.
They could then consider to establish Hong Kong SPVs for these
investments. Given Hong Kong's increasing network of tax
treaties (presently 32) and the good quality of some of these
treaties (especially its treaties with mainland China, Japan and
Indonesia), using a Hong Kong SPV may be tax efficient. Currently,
many of such investments are increasingly structured through
Singapore tax resident companies, as Singapore offers a similar tax
exemption in its current income tax law provided the pertinent
conditions are satisfied.
- The new tax legislation was gazetted by the government on 20
March 2015. The Bill was introduced into the Legislative Council on
25 March 2015.
Forms for Resident Status Certificates Revised
- On 29 January 2015, the Inland Revenue Department (IRD)
released the revised forms for application for certificate of
resident status by a company, partnership, trust or other body of
- In Hong Kong, a certificate of resident is a document issued by
the IRD to a Hong Kong resident who requires proof of Hong Kong
residence status for the purpose of claiming tax benefits under
Hong Kong's tax treaties.
- In general, the following persons can apply for a certificate of residence:
- An individual who ordinarily resides in Hong Kong;
- An individual who stays in Hong Kong for more than 180 days
during a year of assessment or for more than 300 days in two
consecutive years of assessment;
- A company, partnership, trust or other body of persons
incorporated or constituted in Hong Kong; and
- A company, partnership, trust or other body of persons
incorporated or constituted outside Hong Kong but centrally managed
and controlled in Hong Kong.
- An individual who ordinarily resides in Hong Kong;
1 While it says that one should consider all the facts of the case, it singles out the following criteria as being of special importance: (1) whether the equity value of the Foreign Company is mainly derived directly or indirectly from Chinese taxable assets, (2) whether the assets or income of the Foreign Company are mainly derived directly or indirectly from Chinese taxable assets, (3) whether the functions performed and risks assumed by the Foreign Company and its direct and indirect subsidiaries that hold Chinese taxable assets can justify the economic substance of the organisational structure, (4) whether foreign income tax is paid on the indirect transfer, (5) whether and how a tax treaty applies to the indirect transfer, (6) the length of time that the shareholders, business model and the organisational structure of the Foreign Company have been in existence, (7) whether it would have been possible for the transferor to directly invest in and directly transfer the Chinese taxable assets, instead of doing so indirectly.
2 If all the following criteria are satisfied: (1) 75 percent or more of the equity value of the Foreign Company is derived directly or indirectly from Chinese taxable assets, (2) 90 percent or more of the asset value (excluding cash) or the income of the Foreign Company is derived from investments in China during any moment within one year prior to the indirect transfer, (3) the functions performed and risks assumed by the Foreign Company and any of its direct or indirect subsidiaries are limited and insufficient to justify the economic substance of the organisational structure, (4) the income tax paid on the indirect transfer in both the country of the transferor and the country where the Foreign Company is established is lower than the Chinese income tax if a direct transfer of the Chinese taxable assets would have taken place.
3 The following three conditions must be satisfied: (1) the transferor and transferee are related companies, either because one owns at least 80 percent of the equity of the other or a third party owns at least 80 percent of both transferor or transferee (if it concerns immovable assets in China, the test is not 80 percent but 100 percent), (2) the new holding structure created after the reorganisation should not result in a lower Chinese income tax liability if the Foreign Company would be transferred, (3) the transferee acquires the equity of the Foreign Company by either issuing its own equity or equity of a company controlled by the transferee (this excludes publicly traded stock).4 The documents required to voluntarily report the indirect transfer include: (i) equity transfer agreement, (ii) corporate ownership structure charts before and after the equity transfer, (iii) prior two years of financial and accounting statements for all intermediate holding companies, and (iv) a statement that the indirect transfer is not taxable.
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