UK: Use Of UK And Irish Structures For Chinese-Resident Individuals And Companies

Last Updated: 27 February 2012
Article by Terence Pay

Chinese entrepreneurs and their businesses have often used classical offshore companies to minimise their Chinese tax liabilities. Often these structures have relied upon simple non-disclosure and the inability of the Chinese tax authorities to detect them.

In recent years, the Chinese tax authorities have begun to develop a number of sophisticated anti-avoidance rules targeting such structures. The rules, which include deemed residence, CFC and anti-treaty shopping provisions, generally attack structures deemed to have little commercial substance. There has also been an increase in international co-operation in the form of tax information exchange agreements with tax havens, making shareholders of offshore companies more identifiable to the Chinese authorities.

As such, it is now important for Chinese entrepreneurs to consider more robust structures in onshore jurisdictions to replace or complement existing offshore companies. The UK and Ireland, with their unrivalled commercial reputations, extensive tax treaty networks and generous foreign profit exemptions, are natural choices.

Chinese Anti-Avoidance Rules

When considering effective international tax planning structures for Chinese residents, serious thought needs to be given to the raft of Chinese anti-avoidance provisions which have recently been put into place by the Chinese tax authorities. If a structure falls foul of these provisions it is likely to be ineffective for individual and / or corporate income tax purposes.

Resident Enterprise Rule

Consider the following simple but popular structure:

Typically the structure is not disclosed and the income and gains arising in the BVI company are rolled-up tax-free.

The Resident Enterprise Rule (RER) (akin to a "personal CFC rule") attempts to recharacterise the BVI company as a Chinese-resident company, by virtue of the de facto management and control of the enterprise by the Chinese-resident shareholder. A company found Chinese resident in such a way will be taxable in China on all income and gains as they arise.

The RER can apply to any foreign incorporated company with majority Chinese ownership if its effective management in exercised in China. Tax Circular 82 sets out 4 criteria which, if all met, will deem the enterprise resident in China:

  • The senior management personnel responsible for the day-to-day operations of the Company are located primarily inside China and their management duties are performed primarily inside China;
  • The Company's financial decisions (e.g. borrowing, lending, raising capital and financial risk control etc) and decisions on employment (e.g. appointment, dismissal, wage and compensation, etc) are made or approved by the Chinese residents;
  • The Company's major properties, financial and accounting books and minutes of meetings of board of directors and meetings of shareholders are located or stored inside China; and
  • At least half of its directors or senior management personnel who have voting rights reside in China.

In determining "place of actual management", the authorities will look at substance over form.

In the case of a simple BVI shell company with little substance, residence is likely to be deemed Chinese under the above rules. An alternative more robust structure might look like this:

What the replacement structure achieves:

  • Direct ownership of BVI shares severed: shares now owned by independent trustees on behalf of a class of potential beneficiaries
  • More difficult to attribute income / gains directly to settlor
  • Trustee companies resident outside China: no management and control issues
  • Higher level of confidentiality due to trust structure
  • Dual trustees ensure residence of trust is outside UK and not taxable

CFC rules were introduced in 2008 with the aim of tackling perceived abuse by using (investment) companies incorporated in low-tax jurisdictions to defer tax at Chinese level. The above example shows a typical structure which is targeted by the CFC rules, whereby group intellectual property has been transferred out to a tax haven jurisdiction so that royalties can be received tax-free.

A foreign enterprise will be deemed to be a CFC where:

  • Chinese-resident enterprises or individuals each own more than 10% of its share capital and jointly more that 50%, or exercise effective control by virtue of their holdings; and
  • The effective tax rate in the jurisdiction in question is less that 50% of the applicable Chinese rate – i.e. below 12.5%
  • Exceptions for:
    • CFCs in 13 "white list" jurisdictions
    • Companies conducting active trade or business
    • CFCs with annual profit of less than RMB 5 million

In cases falling foul of these rules, the income and gains of the overseas companies will be attributed directly to the Chinese-resident owners on an arising basis. Instead, the following structure is proposed:

The revised structure achieves the following:

  • The Irish company is subject to a tax rate of 12.5%, meaning it should fall outside the CFC rules
  • Active management of IP in Ireland may attract generous tax allowances, meaning effective rate of tax may be well below 12.5% (as low as 5%), whereas the headline rate remains 12.5% for CFC purposes
  • A UK holding company operates trading branches in low tax EU jurisdictions, where the tax rate on its profits is between 5% and 10% depending on jurisdiction
  • UK is on Chinese CFC "white list" – cannot be a CFC
  • Active foreign trading profits of branches are exempt from tax in the UK
  • UK domestic CFC rules not in point
  • Both the UK and Irish companies can pay up dividends to China free of withholding taxes under domestic law

Anti-Treaty Shopping (Circular 601)

Indirect Disposals of Chinese Enterprises (Circular 698)

Two Circulars recently issued by the Chinese tax authorities have sought to attack the use of offshore "conduit companies" with little substance in Chinese-based corporate groups:

Circular 601 seeks to deny double tax treaty benefits to conduit companies which have little or no commercial substance. In the example above, favourable withholding tax rates due under the China-Hong Kong treaty may be denied if the Hong Kong company is found to be a pure conduit to allow flows of income from China to the BVI.

Circular 698 concerns the use of non-resident companies indirectly to dispose of Chinese enterprises and avoid Chinese tax on resultant capital gains. The rule will only apply where the level of tax in the disposing jurisdiction is less that 12.5%. Referring to the example above, a common planning technique before the Circular was published was to form two shell companies above a Chinese-resident entity. The Chinese company would then be sold indirectly by transferring the shares of the Hong Kong company to the purchaser, escaping tax at Chinese and Hong Kong level.

Both anti-avoidance provisions can only be invoked where there is insufficient commercial substance in the non-resident company which is where planning becomes important.

Circular 601 requires that the non-resident is able to demonstrate that it is the beneficial owner of the income in question in order to claim treaty benefits. Among factors given as demonstrating lack of true beneficial ownership are:

  • Third party control over the income received by the holding company (for instance, a real or implied requirement to pay the income on to the ultimate shareholder)
  • Lack of substantive operations
  • Minimal level of capital
  • No employees

Circular 698 refers to the requirement for a holding company to have "reasonable commercial purpose" and the avoidance of tax will not be considered commercial in its own right. However, what might constitute a reasonable commercial purpose is not clearly definedand it has been suggested that it might include the need for business and foreign exchange flexibility, centralised back office functions, funding needs, regulatory concerns and even foreign tax planning.

A UK/Irish Solution?

A UK/Irish corporate structure may be a very effective way of defeating these Chinese anti-avoidance rules, given that the main requirements are:

  • Non-tax haven status
  • Sufficiently high rate of domestic tax to defeat CFC rules
  • Justified commercial requirements in the form of an international holding company in a recognised jurisdiction
  • Substance achieved through Verfides full management services in the UK and Ireland

An alternative compliant structure might therefore look as follows:

This structure provides:

  • An on-shore holding structure with headline tax rates in UK and Ireland of 26% and 25% respectively
  • Substance in respect of each company to be provided by full Verfides management services, including resident professional directors, and can include rental of office space and employment of staff (again arranged by Verfides)
  • Such substance should attract treaty benefits under the China/Ireland double tax agreement, which provides for a 5% withholding tax on dividends (identical to the China/HK agreement)
  • No WHT on payment of dividends from Ireland to UK and on to the trust
  • Dividends received from Ireland exempt from tax in the UK
  • Dividends received in Ireland from China taxed at 12.5% (trading group) but this will be entirely covered by Chinese tax credit on such dividends – no further tax payable in Ireland
  • Ultimate sale of Chinese business to be achieved by sale of Irish shares by the UK company. Substance and UK headline rate of 26% on capital gains should defeat Circular 601. In reality, the gain will be exempt in the UK under the participation exemption providing certain conditions are met.
  • Trust provides an extra layer of protection against deemed Chinese residence of underlying holding companies, as well as increased confidentiality and asset protection.

Conclusion

It is clear from our discussions with Chinese clients, contacts and professional advisers that simple offshore structuring will no longer be tolerated by the Chinese tax authorities and presents a considerable tax risk. As a result of this we have been working on finding solutions for such clients through the use of robust UK and Irish structures.

The key to combating the Chinese anti-avoidance rules is sufficient substance. This is where Verfides has particular expertise as it specialises in the provision of full professional management services in the UK and Ireland. We do not believe that the provision of letterbox companies and nominee directors is sufficient in such circumstances, and can help to arrange a whole host of services to ensure the structure is effective. These include resident professional directors, rental of office space and provision of employees plus full day-to-day back office management of contracts and payments.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Terence Pay
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.