2012-04-18-KPMG_China-业并购中的境外间接_境外直接及境内出售股权_10页_356kb

PRC Non-Resident Enterprise Tax Series Summary

Core Content

This document provides an analysis of the taxation implications of investment exits by foreign investors in the People's Republic of China (PRC), focusing on three types of exits: offshore indirect, offshore direct, and onshore. It discusses the impact of two key circulars, Circular 601 and Circular 698, issued by the State Administration of Taxation (SAT), and highlights the evolving regulatory and tax landscape in the PRC for foreign investors.

Main Views

Offshore Indirect Exits – Circular 698

• Introduction: Circular 698, introduced in late 2009, aims to counter the abuse of offshore disposal structures to avoid PRC withholding tax.
• Impact: Offshore indirect exits, where foreign investors sell shares in an offshore holding company that indirectly owns PRC equity, are now subject to taxation in the PRC if deemed an abuse of organizational form.
• GAAR Application: The General Anti-Avoidance Rule (GAAR) is used to treat indirect transfers as sales of shares in the PRC company, especially when the holding company lacks economic substance.
• Uncertainties: There are uncertainties regarding the application of Circular 698, including the treatment of base cost, the interaction with tax treaties, and the role of 'commercial substance' in determining reasonable business purposes.
• Vodafone–China Mobile Case: This case highlighted the PRC's approach to taxing indirect offshore transfers, particularly those involving real estate, and showed that the PRC authorities are increasingly focused on the effective management of offshore entities.

Offshore Direct Exits – Circular 601

• Treaty Relief: Under PRC domestic law, capital gains from the disposal of shares in a Chinese company by a foreign shareholder are subject to 10% tax. Tax treaties may offer relief, depending on the jurisdiction.
• Beneficial Ownership: Circular 601 outlines the criteria for beneficial ownership, which includes substantial business operations and control over the income and underlying property.
• DTA Considerations: Although beneficial ownership is not a formal requirement for capital gains relief under treaties, the SAT has used the concept to challenge treaty-based claims, particularly in cases where the holding company lacks substance.
• Uncertainty: There is still ambiguity around how the SAT will apply the 'substance' criteria to group companies in the same or other treaty jurisdictions, and whether non-resident partners can claim treaty relief.

Onshore Exits – Partnership Arrangements

• Legal Framework: Since March 2010, foreign partners have been allowed to invest in Chinese limited partnerships.
• Taxation: The PRC tax law does not provide explicit guidance on the taxation of non-resident partners in partnerships. There is uncertainty regarding whether the income from the partnership is treated as a flow-through or if it is subject to corporate income tax.
• Regulatory Uncertainty: The exchange control and registration requirements for foreign-invested partnerships are unclear, leading to a need for case-by-case negotiations with local authorities.
• Potential Use: Partnerships are increasingly used for holding minority stakes in Chinese companies, offering potential benefits in terms of reduced regulatory approvals.

Key Information

• Circular 698: Introduced retroactive reporting and tax requirements for indirect offshore transfers, focusing on the economic substance of offshore holding companies.
• Circular 601: Defines beneficial ownership criteria, emphasizing the need for substantial business operations, and has been used to challenge treaty-based capital gains relief.
• Taxation of Offshore Exits: The PRC tax authorities are increasingly applying GAAR and focusing on the 'substance' of offshore entities, making indirect exits more risky.
• Partnerships: While they offer flexibility for foreign investors, they are subject to unclear tax and regulatory treatment, requiring careful planning and negotiation.

Implications for Future Investment Structuring

• Offshore Indirect Exits: These are now more uncertain and may be actively discouraged due to the application of Circular 698 and the SAT's focus on substance.
• Offshore Direct Exits: These may be preferred if the investor can demonstrate sufficient substance to support a treaty relief claim.
• Onshore Exits via Partnerships: These are becoming more viable, but the lack of clarity in tax and regulatory treatment means that investors must be prepared for case-by-case negotiations and adjustments.
• Regulatory Trends: The SAT is expected to continue tightening the application of tax rules, particularly in the context of offshore structures, and to introduce further clarifications on partnership taxation.

Authors and Contact

• John Gu, Christopher Xing, Conrad Turley
• Khoonming Ho, David Ling, Vincent Pang, Lewis Lu, Martin Ng, Anthony Chau, Lilly Li, Jean Jin Li, Eileen Sun, Karmen Yeung

This summary highlights the key developments and challenges in the PRC tax environment for foreign investors, particularly in the context of investment exits. It underscores the importance of understanding the 'substance' of investment structures and the need for careful planning and legal consultation.