Made public on 17 June 2011 the "Cai Shui (2011) No. 48" dated 10 June 2011 (Circular 48) grants an exemption for the payment of business tax - which is payable in accordance with the "Provisional Rules on Business Tax of PRC promulgated by State Counsel" (which came into effect on 1 January 2009) (Business Tax) - and has alleviated a number of concerns in respect of the treatment of cross-border equipment leasing agreements entered into prior to 2009.
Confuciusly Confused; Provisional Regulations on Business Tax - 1 January 1994 to 31 December 2008
Under the old regulations issued on 1 January 1994 (Old Regulations) a 'service' was taxable by the Chinese tax authorities if it took place in China. However there was uncertainty as to whether the payments under a leasing arrangement (be it loan interest or lease rentals) by a Chinese lessee, constituted a payment for services 'services' and was therefore taxable. Helpfully the State Administration of Taxation (SAT) issued, effective from 1 January 1997, circular Guo Shui Fa (1997) No. 35 (Circular 35). Circular 35 clarified that loan interest and lease rentals relating to tangible moveable assets generated from within China, but paid to foreign companies, was exempt from tax.
However, Guo Shui Fa (2006) No. 62 (Circular 62) issued by the SAT in 2006, abolished, amongst other things, Circular 35. Understandably the leasing community was concerned that, with the abolition of the circular that had clarified the tax exemption, the tax exemption itself was abolished. This took the tax position back to the uncertainty that has existed pre 1997. This was only further complicated by local tax authorities issuing different interpretations of the tax position to Chinese lessees within their jurisdictional remit.
The situation only seemed to deteriorate in 2008 when the "new" Provisional Regulations on Business Tax became effective on 1 January 2009. These regulations appeared to confirm that foreign lenders and lessors would be taxed on cross border lending or leasing if the borrower or lessee were located in China.
Due to the understandable response from the business community to the "new regulations", the Ministry of Finance (MoF) and the SAT quickly issued Cai Shui (2009) No. 112 (Circular 112) in August 2009, which performed a U-turn on the tax position. However it stated that the revenue derived by the lessor from the Chinese lessee would be taxed in accordance with the Old Regulations. It was of course the lack of clarity under the Old Regulations which had started this 'circular' process in the first place - Confucius apparently once said "it does not matter how slowly you go, as long as you do not stop" - however going slowly in a big circle of circulars, would appear to be taking this philosophy a bit too literally.
Pre 2009 Lease Agreements
Issued jointly by the MoF and the SAT, Circular 48 states that the Business Tax exemption applies to finance leases and operating leases entered into from 1 January 2010 to the dates of expiry of the agreements, and shall apply retrospectively to the revenues derived by foreign lessors from Chinese lessees under agreements entered into prior to 2009.
For an agreement to benefit from the Business Tax exemption it must fulfil the following criteria:
- The lease period must exceed 365 days.
- The asset being leased must be an aircraft, ship, aircraft engine, large-scale power generator, machinery, large scale environmental protection equipment, large scale construction project machinery, large scale petrochemical equipment, containers and other equipment.
- The annual average lease rentals cannot be less than RMB 500,000 (approximately US$78,000).
- Any amendments to the agreement shall not include changes to the asset being leased, the rental amounts received or the term of the leasing. However the identity of the lessor may be changed.
- Payments under the lease must have already been remitted by the lessee.
Procedure for Business Tax Exemption
The Chinese lessee must submit the original lease agreement, evidence of the payments under the lease agreement and any other materials required by the relevant tax authority. Such a submission is required to be made by 30 September 2011.
Whilst it is always advisable to seek local law and tax advice in respect of the particular details concerning each transaction, Circular 48 appears to confirm that leasing companies purchasing assets currently on lease with Chinese lessees will not be subject to Business Tax provided that the facility arrangements which is the subject of such novation agreement complies with the requirements set out above.
One Step Forward
Whilst Circular 48 has provided a brief window of clarity and respite it remains to be seen whether the next circular takes the Business Tax one step forward or two steps back.
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.