China’s Circular 30 to help taxpayers gain treaty benefits and reduce withholding tax

Circular 30, issued by SAT on June 29, concerns tax treaty benefits for dividends derived from China by foreign investors.

In October 2009, SAT issued Circular 601 which said a foreign recipient of certain China-sourced passive income must be the beneficial owner of the income to receive treaty benefits available under double tax agreements (DTA) with China.

Circular 601 set out a series of “adverse factors” that SAT would consider in deciding whether the foreign recipient was the beneficial owner, including that sufficient substance – staff, premises and business operations – were in place at the level of the DTA benefits claimant.

Khoon Ming Ho, head of tax for KPMG China (left), said these requirements caused a lot of problems for foreign investors with genuine business reasons to set up special purpose companies to hold investments in China, including listed vehicles.

Circular 30, which is now in effect, says that a company which is a tax resident of a DTA partner and is listed in that jurisdiction will automatically satisfy the beneficial ownership criteria for China-sourced dividends received.

This treatment will seemingly apply regardless of the outcome of an assessment under the Circular 601 adverse factors test and therefore represents a safe harbour provision.

“Under the newly issued Circular 30, if the foreign investor is a listed company in a relevant treaty jurisdiction then the assumption is that those companies satisfy the beneficial ownership criteria in relation to dividends derived from China,” said Ho.

“Circular 30 also goes further and says even if the offshore holding company is not a listed company but is 100% directly or indirectly owned by a listed company then the relief will also apply as well,” he added.

However, if the subsidiary is indirectly held by the listed parent through an intermediate holding company that is not a tax resident of the DTA partner country the safe harbour will not be available.

Under Circular 601, if an offshore holding company did not have any substance because it had insufficient people or business function it would receive no treaty relief.

But Ho said that now, if there is another company within the group which is the real owner of the dividends, then the treaty benefits can still be applied.

“This gives taxpayers a chance to identify the true owner of the dividends and then apply the relief and I think that is a very positive development for foreign investors since it gives a lot more flexibility to foreign companies in designing their holding company structures for investment into China,” said Ho.

“Sometimes a company will intentionally put a special purpose vehicle on top of a Chinese subsidiary because they want to achieve special asset protection or they want to facilitate future restructuring. If they know that this will not disadvantage them in terms of obtaining tax treaty benefits and they know they will be in a position to identify and inform the Chinese tax authorities who the real beneficial owner of the dividends is, they will have more freedom and clarity in designing their holding structure,” he added.

Circular 30’s arrival is timely for companies as they have just submitted their financial statements and tax returns to the Chinese authorities for last year.