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China FS sector opens up: Tax opportunities and challenges ahead

Are you ready for the opening up of China’s financial services sector? Henry Wong, Chris Ge, Jean Li and Tracey Zhang look at the latest regulatory relaxation measures, and give insight on industry issues which foreign firms should be aware of before jumping on the bandwagon.

China's financial services industry is now approaching a point where all sectors will be fully open to foreign firms in three years' time. The opportunities ahead for foreign institutions are potentially enormous, but each needs to take a hard look to see if further China market investment makes sense in their specific case. Domestic giants have already established dominance in many fields, many tax uncertainties are yet to be resolved, and the often disconnected policy application by different Chinese authorities can present challenges for new players.

During the last two decades, the China financial services sector has undergone immense change. It has evolved from a mainly state-owned, traditional banking and insurance business-driven sector towards a digital-focused sector, with e-commerce giants taking the driving seat on financial innovation. Many people now make investments, buy insurance products, and pay for goods and services with only a few touches of their mobile devices.

These enormous changes promise exciting opportunities for both domestic and foreign players. However, China's unique regulatory environment for financial services still creates many challenges. For example, rules are often released quickly, without advance public consultation, or may be rolled out without detailed implementation guidelines, leaving many question marks over what to do next. A unique China tax environment also exists for the financial service sector – many industry players are still having a challenging time to truly understand where the risks lie, and when they might surface.

As such, successful investments require a thorough understanding of the continuing changes in the regulatory and tax environment. In this article, we will first introduce the recent announcements by the central government on the opening up of China's financial services sector, along with the expected timetable. Then we will dig a little deeper into the tax and business challenges in certain key financial sectors to give you a flavour of what you need to be prepared for when entering China's financial sector as a foreign investor. Finally, we outline what you can do to be as prepared as possible for the exciting roller-coaster ride ahead.

China's opening up – the regulatory aspect

Starting in the early 1980s, China adopted an open-door policy to welcome foreign-owned, export-oriented, manufacturing businesses to set up operations in China, by providing tariff incentives and tax policies that favoured these foreign businesses. Then, in 2001, China made commitments, as part of its accession to the World Trade Organisation (WTO), to apply non-discriminatory treatment to enterprises of all WTO members who trade with China. China also made commitments to phase out restrictions on foreign investment and business activity in a broad range of service sectors. However, despite this, the China financial services sector remains highly regulated, with many restrictions continuing to be imposed on foreign investment. What is even more concerning is that, after all the years of gradual opening up of the market, foreign companies still face a range of challenges when operating in China. This can include inconsistent application of rules and regulations, as well as a degree of favouritism toward domestic companies for key sectors that are strategically important for China. These can include the telecommunications, medical, and military-relevant sectors, as well as the financial services sector.

The Chinese financial services markets are huge and Chinese financial service companies often rank among the largest in the world in terms of market capitalisation or total assets. For example, according to the latest survey from Forbes – three out of the five largest public companies in the world are Chinese state-owned banks and the world's largest listed insurance company is China's Ping'an Insurance Group. However, reports also indicate that foreign banks account for less than 2% of total banking assets within China. China has the world's third largest bond market, yet foreign holdings in RMB bonds are relatively small, when compared with the situation in the bond markets of other major economies, with less than 2% foreign participation in the Chinese bond market. Starting from this low base, the opportunities for foreign financial sector businesses are huge, especially for the securities and assets management sector.

China is now taking its opening up to the next level with the latest liberalisation measures and this could give foreign involvement a second wind. Specifically, on November 10 2017, the State Council announced plans to liberalise foreign ownership in certain types of Chinese financial institutions. Then on April 11 2018, Chinese officials set out a timetable for this opening up at the Boao Forum for Asia Annual Conference 2018. Table 1 sets out a snapshot of the key changes and related timetable.

Table 1

Banking sector

Planned timeline

Commercial banks in general

To remove the foreign ownership limit in Chinese commercial banks (which was previously limited at 20%).

To allow foreign banks to open both subsidiaries and branches in China, in place of the existing position whereby foreign banks are excluded from having both at the same time.

June 30 2018

To expand the business scope of foreign-invested banks, so that the rules that govern foreign and domestic invested banks will become the same going forward.

December 31 2018

Subsidiaries of banks

To remove the limit on the maximum foreign ownership in financial assets investment management and wealth management companies where they are established by commercial banks.

December 31 2018

Asset management companies

To remove the foreign ownership limit, which was previously set at 25% (asset management companies are primarily engaged in managing non-performing loans).

June 30 2018

Insurance sector

Planned timeline

Insurance companies in general

To remove the requirement for a foreign insurance company to have operated a China representative office, for at least two years, before it can establish a foreign-invested insurance company subsidiary in China.

December 31 2018

Life, health and personal accident insurance companies

To allow foreign ownership of up to 51% (up from 49%) and then remove such limit after three years (i.e. 2021).

June 30 2018

Insurance agents

To allow foreign investors to operate insurance agency business in China.

June 30 2018

Insurance brokerage

To remove the limitation on the business scope of foreign-invested insurance brokerage firms and give them equal treatment to the domestic firms.

June 30 2018

Securities and financial commodities trading sectors

Planned timeline

Securities companies

To allow foreign ownership of up to 51% (up from 49%) and then remove such limit after three years (i.e. 2021).

To remove the requirement to have at least one Chinese securities firm as a domestic shareholder in a Sino-foreign joint venture (JV) securities firm (meaning that a non-securities firm Chinese enterprise could be the JV partner).

June 30 2018

To remove the limitation on the business scope of Sino-foreign JV securities firms and give them equal treatment to domestic firms.

December 31 2018

Futures trading

To allow foreign ownership of up to 51% (up from 49%) and then remove such limit after three years (i.e. 2021).

June 30 2018

Investment management and other non-banking sectors

Planned timeline

Fund management companies

To allow foreign ownership of up to 51% (up from 49%) and then remove such limit after three years (i.e. 2021).

June 30 2018

Stock Connect schemes

To increase the quota size of Stock Connect between China and Hong Kong by quadrupling the daily amount of Hong Kong-listed shares that investors can buy through mainland Chinese stock exchanges from RMB 13 billion ($1.9 billion) to RMB 52 billion.

May 1 2018

To launch a Stock Connect scheme between Shanghai and London.

December 31 2018

Bond Connect scheme

Bond Connect is a scheme that enables overseas investors from Hong Kong and elsewhere to invest in Chinese bonds through investment links between Hong Kong and mainland China. In August 2018, moves were made to fully implement a new settlement system known as real-time delivery versus payment (RDVP).

RDVP ensures that payment and delivery of securities occurs simultaneously. It helps reduce or eliminate the exposure to settlement risk by the counterparties of a trade. This upgrade also enables international investors to join the scheme and seek investment opportunities in the China interbank bond market.

September 2018 and onward


Removal of the three-month lock up period on the repatriation of principal, and the 20% annual limit on repatriation of principal and profit of qualified foreign institutional investor (QFII) investments.

Removal of the three-month lock-up restrictions applicable to the investment principal under both the QFII and renminbi qualified foreign institutional investor (RQFII) schemes.

Allow QFIIs and RQFIIs to enter into forex hedging transactions in China to hedge currency risks related to investing in China.

June 12 2018


Encourage foreign investments in trusts, financial leasing, auto finance, currency brokerage and consumer finance.

December 31 2018

These changes are likely to affect different parts of the financial sector in differing ways, and foreign firms will need to re-evaluate their China strategies. It should be noted that recently there have been many tax administrative changes in China, which could influence financial sector investment and operational plans. These include the activation of tax information exchange with other jurisdictions, as part of China's implementation of the common reporting standard (CRS) for the financial services sector. Also relevant are the forthcoming Tax Collection and Administration Law requirements on domestic financial institutions to provide information on resident account activity to the tax authorities. In addition, the individual income tax (IIT) reform is set to have a big impact on the wealth management industry for high-net-worth individuals (HNWIs); see the chapter, One giant step forward in Chinese IIT reform. As such, foreign firms should take all these into consideration when investing and operating in China.

In a further notable development in November 2018, a three-year exemption from CIT withholding tax (WHT) and value-added tax (VAT) was rolled out for China-sourced bond interest derived by overseas institutional investors. This Circular [2018] 108 (Circular 108) exemption, taking effect from November 7 2018 will be valid up to 2021. This significantly enhances the attractiveness of China's bond market to foreign capital, by limiting the tax leakages that would otherwise reduce their overall return, and is reflective of equivalent cross-border corporate bond investment tax treatment granted by a number of other major economies.

Next, let us take a closer look at some of the key financial services sectors and understand the opportunities as well as challenges, in particular the China tax perspective for foreign investors.

Banking and lending sectors

China's banking sector activity is mainly driven by state-owned banks. The People's Bank of China (PBOC) acts both as the central bank, as well as regulator, along with the China Banking and Insurance Regulatory Commission (CBIRC). The latter is a new body; before March 2018 two separate bodies regulated the banking and the insurance sectors. The tasks of PBOC and CBIRC include overseeing the China banking system, setting rules and regulations, conducting examinations, publishing statistics, and approving the establishment or expansion of banks, including foreign banks, as well as general troubleshooting.

Foreign banks have operated in China for more than a decade, with various different corporate structures ranging from wholly foreign-owned banking subsidiaries, China bank branches of the foreign banks, or representative offices. However, domestic Chinese banks still account for the majority of the market. According to 2015 government statistics, foreign banks account for less than 2% of total banking assets. While, given this low starting point, it may seem that there is great potential for foreign players to grab a bigger share of the China market, in reality this is difficult, because there are many commercial, regulatory and tax hurdles.

On the commercial front, there is tough competition from the domestic giants, as well as the emerging technological disruption from fintech companies for the traditional banking and payment sectors. This means that foreign players may find the China banking sector less lucrative than before.

On the regulatory front, many foreign banks face challenges ranging from tough regulation, ever increasing compliance measures, lack of neutrality in the treatment of domestic and foreign banks, and capital controls affecting foreign debt and maintenance of foreign currency positions. There are also restrictions on providing cross-border services to HNWIs, and restrictions on foreign banks opening up China branches or subsidiaries. All these limit foreign banks from achieving the greater profitability needed to fuel their hope for China expansion. It is to be hoped that the recent announcements on the loosening of regulatory restrictions, set out in Table 1, by expanding the scope of services and activities permitted to foreign banks, and facilitating the establishment of further subsidiaries and branches in China, herald a general improvement in the China regulatory landscape for foreign banks.

On the tax front, foreign players are expecting a set of tax policies that foster the growth of the sector, instead of hindering it or causing uncertainties when doing business. They often find that many China tax rules and policies are not keeping pace with the rapid evolution of financial innovation. At the same time, they also find that, in certain cases, tax rule changes were effected too quickly, without sufficient advance public and industry consultation. In this regard the nationwide VAT reform in 2016 is a standout example, and worth focusing on here.

For many tax jurisdictions, a wide range of financial supplies are generally exempt from indirect tax. While certain banking services, such as advisory services and asset management services, fit reasonably well within value-added tax (VAT)/goods and services tax (GST) frameworks for taxable supplies and services, it is more difficult to apply this framework to deposit taking and lending. In the latter case, the bank is just acting as a facilitator for the use of money, and charges a 'spread' on the interest, reflecting the time-value of money. This is very different from the traditional concept of 'value-adding' activity for the manufacture and trading of goods, or the provision of services, for which one can readily observe and calculate the value added at each stage in the value or supply chain. VAT/GST exemptions for lending income are the practical response taken by many countries to the complexities arising. However, China decided to go in a different direction, by levying VAT on loan interest from 2016 onwards.

Even before the nationwide VAT reform came into effect for the financial services sector, the situation in China was already rather unique. China levied business tax (BT), a form of indirect or turnover tax, on financial services, charging BT of 5% on interest earned by a bank from providing loans. Consequently, the transition to imposing 6% VAT on the financial service sector was argued to preserve a continuity of approach, as well as maintaining tax revenues. However, even after two years of implementation, there are still many areas of complexity and uncertainty regarding VAT rule application to specific transactions, causing continuing pain for the financial sector. Notable VAT issues include:

  • The applicability of VAT is to certain financial products. For example, banks often offer a type of bank deposit product that generates a higher yield than regular term-deposits. This is done by embedding certain financial derivatives (e.g. futures, swap, or options) into the product, in order to mimic similar investment returns of other higher-risk financial instruments. At the same time the bank provides a guarantee for the repayment of the principal, just like under regular deposit arrangements. The question therefore arises whether such a structured-deposit note should be viewed (on the basis of its 'form') as a bank deposit – in this case the VAT rules provide that the deposit interest income would be VAT exempt. By contrast, the investment return might be treated instead as interest on a loan – in such a case it would be subject to VAT on the basis that it is, 'in substance' a product providing a 'guaranteed return or capable of generating fixed income'.

  • Inter-bank lending and funding transactions are essential for banks to maintain liquidity. In the age of globalisation and increasing cross-border transactions, banks need clear taxation policies that enable them to conduct cross-border funding transactions with certainty of tax outcomes. However, despite the broadening of the scope of the VAT exemption on inter-bank transactions to include cross-border funding transactions, this is still rather restrictively applied. The existing VAT exemption on cross-border inter-bank transactions is limited to lending between the Chinese branches (or subsidiaries) of foreign banks and their related offshore headquarters (parent company). The exemption also covers lending between a domestic bank and its related offshore branch (or wholly-owned subsidiary). The neutrality and logic of this treatment may be questioned as it negatively affects the tax treatment of transactions between the China operations of financial institutions and third-party, unrelated overseas financial institutions (including non-banking institutions).

  • With respect to non-performing loans, China's VAT rules do not contain any bad debt relief. However, a specific concession was introduced for the financial services sector to deal with non-performing loans. In essence, where a period of 90 days or more has expired from when interest was receivable (but was not received), the lender is not required to continue accounting for output VAT on interest that otherwise accrued, until such time as the interest is actually paid. VAT accounted for interest accrued as receivable during the initial 90-day period cannot, however, be reversed, despite the fact that this interest may ultimately never be collected. It should be noted that this concession is only available to qualified 'financial enterprises'. These are defined to include commercial banks, credit cooperatives, trust companies, securities companies, insurance companies, financial leasing companies, securities fund management companies, securities investment funds and other entities that are established with the approval of the PBOC, CBIRC and the China Securities Regulatory Commission (CSRC). However, other credit institutions, such as small lending companies governed by local government financial service authorities, or leasing companies governed by the Ministry of Commerce are excluded from the definition of financial enterprises and cannot use the concession. This unfair treatment would definitely place small lending companies at a disadvantage when engaging in lending business. This is because they are mandated to serve mid-to-small enterprises and individual borrowers, where these borrowers are less likely to be able to repay, or are slower in repaying interest and principal. This means that small lending companies will very much need to pre-pay the output VAT on interest receivables that go past the 90-day threshold until interest is actually received.

  • The State Administration of Taxation (SAT) recently released SAT Announcement [2018] 28, which strengthens the requirements for corporate income tax (CIT) deductions to be supported with official tax invoices (fapiao). Under these rules, to support their CIT deductions, a taxpayer must always obtain valid tax invoices, including for interest paid to banks. Traditionally, bank remittance slips could be used as supporting documentation for CIT deductions. However, going forward, it is expected a large number of taxpayers will now demand that banks issue tax invoices, radically increasing the operational burdens on banks relating to millions of interest payment transactions.

Securities sector

China's securities industry, including brokerage and underwriting services, is dominated by domestic firms. There are Sino-foreign JVs, but due to the regulatory restrictions, foreign ownership of a securities JV must not exceed 49%. In addition, the Chinese partner must be another Chinese securities company. This means that foreign firms lack control over their China securities JV operations and strategy, complicating expansion plans. For reference, the total income of the top eight domestic Chinese brokerages was more than eight times the total income of the top eight Sino-foreign securities JVs last year.

As the ownership restrictions are now set to be relaxed between 2018 and 2021, this may attract further foreign securities companies to enter the China market, particularly those with broader global businesses that include investment banking, brokerage and asset management. Foreign firms would be in a position to offer more complex products than those now available on the China market, as well as being in an advantageous position for offering cross-border services.

However, there are still uncertainties. As noted above, one of the liberalisation measures is that the government will remove the limitation on the business scope of Sino-foreign JV securities firms and give them equal treatment to domestic firms in terms of the scoping of their activities. Nonetheless, there are doubts as to whether Sino-foreign securities JVs will be able to widen their scope of activities within a short timeframe. Sino-foreign securities JVs will likely continue to be limited to conducting the activities covered in their underwriting licence, as it was approved at the time of their initial establishment. In order to bring new activities within the scope of their business licence, the Sino-foreign securities JVs will need to show that they have the capacity to conduct such activities. This requires the Sino-foreign securities JVs to meet stringent regulatory and compliance requirements, including minimum head count, local IT infrastructure and other operational setup requirements, before commencing the new activities. This means that foreign firms will need to make substantial investment upfront, with only limited profit-making ability in the beginning.

Similar to the businesses in the banking sector, securities firms also face many tax uncertainties. Some of the more commonly seen tax issues for the securities sector include:

  • VAT input credit complications can arise for securities firms with headquarters registered in one district in China, and branches registered in different tax districts in China. This is due to mismatches arising from the fact that expenses may be incurred, and booked, at branch level, in order to match to brokerage revenue, but the VAT invoices may be received (and paid for) at the headquarters level. For example, where stock exchange charges are billed to the headquarters, the latter cannot issue VAT invoices to each branch; this is in contrast to the position for trading enterprises and many service enterprises, for which such an arrangement would be possible. The end effect of this is that the headquarters may have excess and unusable VAT input credits, while the branches have a VAT payment obligation, which would have otherwise been limited if their output VAT could have been offset by the stock exchange charge VAT input credits.

  • Uncertainty exists for securities companies on whether VAT is payable on their interest earned from deposits with the China Securities Depository and Clearing Corporation (CSDC). Securities companies often need to place substantial returnable deposits with the CSDC in relation to proprietary or customer securities trading and settlement transactions. It is unclear then if interest earned on these deposit balances should be considered as interest on a loan that is subject to VAT at 6%, or interest on a bank deposit that is VAT exempt. Many would argue that it is, in substance, more in the nature of a deposit placed with another financial institution, and interest should therefore be exempt. However, CSDC is not one of the financial institutions specifically mentioned in the SAT's VAT guidance, and uncertainties persist that result in increased costs of doing business in the securities sector.

Investment and fund management sector

China's asset management industry emerged in 1998. It started off from six fund management companies (FMCs) managing about RMB 10.4 billion of assets in 1998. This has risen to RMB 12.6 trillion of assets held by 132 firms today. Such a tremendous growth in assets under management (AUM) is expected to continue in the next 10+ years with forecasts that total AUM will hit around RMB 36.3 trillion by 2025. This would make China the second-largest asset management market in the world.

In addition to the substantial growth in AUM, there are also numerous types of new asset or fund management products that have been introduced in the last two decades. In general terms, asset and fund management products in China are mainly divided into 'public' versus 'private' products. Public products include open-ended retail securities investment funds (similar to mutual funds in foreign jurisdictions) that raise funds from the general public, while private products would be those that privately raise invested funds from qualified and institutional investors.

Private products are further designed to invest into standardised instruments like stock, bonds, funds-of-funds, and private equity funds. There are also non-standardised products that are specially designed for target investors. These non-standardised products can invest into debts and debt-like products, for example asset-backed securities, entrustment loans, specialised trust products, the buying and selling of acceptances, letters of credit, receivables, or equities products with repurchase options, and so on.

The range of fund-related products has also steadily expanded. In the early stages of the asset management industry, market players offered open-ended and closed-ended funds, qualified domestic institutional investor (QDII) funds that focus on offshore capital markets, as well as private securities investment funds that attract HNWIs and institutional investors. With China's strong economic growth and the growing population of middle-class individuals, the industry has moved to develop more sophisticated financial products that can provide higher yields for individual investors. However, with the greater complexity of higher-yield products, individual investors are frequently not fully aware of the underlying investment risks involved. There have been numerous reported cases of financial scams, as well as illegal fundraising activities, which have led the Chinese regulators to tighten oversight of the investment and assets management sector.

In terms of foreign participation in the asset management sector, there are approximately 40 Sino-foreign JV fund management companies in existence; for many of these, the foreign players hold minority stakes. For those who wish to have 100% control over how the asset management firm is run, foreign investors can now set up a wholly foreign-owned enterprise (WFOE) manager and raise private investment fund products entirely within China that target HNWIs and institutional investors. These private funds either invest into the Chinese capital markets or they may obtain special licences from the Shanghai financial services office or Shenzhen authority allowing them to invest into offshore master funds. These master funds must be managed by offshore affiliates of the foreign assets manager controlling the China WFOE manager. These offshore-focused products are commonly referred to as qualified domestic limited partnership (QDLP) funds or qualified domestic investment enterprises (QDIE).

Going forward, however, it will be more attractive to foreign players (from 2021) to launch mutual fund products with a WFOE manager licence. Using such arrangements, foreign firms will be able to serve the larger population of Chinese individual investors, instead of being limited to serving qualified institutional investors and HNWIs, as under the existing private fund regime.

From a tax perspective, the most relevant issue for the investment and fund management sector is (again) the national VAT reform. According to Circular Caishui (2016) 140, Circular Caishui (2017) and Circular Caishui (2017) 56, from January 1 2018, to the extent there are VAT taxable activities conducted by the asset management products, the manager of these asset management products will be the VAT taxpayer. The applicable VAT rate is 3%, charged under the simplified method (i.e. without the ability to claim any input credit).

Interestingly, the subjecting of asset management products to VAT is not common for other developed countries, especially for jurisdictions which exempt financial services from paying VAT. But what is even more interesting is that China decided to levy VAT on asset management products through use of a new deeming rule, which places the tax filing and payment obligations on the fund or asset manager. The main reason for doing so is because most, if not all, of the asset management products existing in China are structured as contractual relationships. There is no product issuing entity which may be treated as a legal person (aside from products organised through Chinese limited partnership or corporate funds). This means that an asset management product (or contractual fund) cannot be registered as a taxpayer under the existing Chinese tax administration system and therefore cannot directly pay the VAT.

Because the VAT rules for asset management products now deem the fund or assets manager to be the taxpayer, when the manager is managing multiple products at the same time, complicated VAT filing and calculation issues arise. For example, trading of financial commodities like listed securities, foreign exchange, derivatives and so on, are subject to VAT with the ability to offset gains and losses within a VAT reportable year. However, what if the asset pool underlying one asset management product (Product A) realises net gains on trading of financial commodities, while the asset pool underlying another product (Product B) realises a net loss? In such a case, the manager will need to decide how to allocate the net VAT liabilities to each product because it is the manager who aggregates all the VAT taxable activities together and pays the VAT on behalf of all of its products under its management. So far, there is still no clear guidance on how to deal with such allocation of VAT cost between products, except to leave it to the manager to decide on what is the most acceptable method to the investors from a business standpoint.

Another challenging issue for fund managers is the VAT treatment on gains from fund investments. The issue has two aspects: (i) whether gains on the transfer of interests in corporate or partnership form funds should be considered to arise from dealings in financial commodities, and be subject to VAT; and (ii) whether fund redemption events should be considered as financial commodity transfers and subject to VAT.

  • According to the national VAT reform rules, set out in SAT Circular 36, the definition of financial commodities includes foreign exchange, securities, non-commodity futures and 'other financial products'. The latter refers to various types of asset management products listed as funds, trusts, financial management products, as well as various types of derivatives. However, Circular 36 does not specify whether the so-called funds category is meant to refer to contractual funds, corporate funds or partnership-form funds.

Historically, the pre-VAT reform BT rules did not consider the transfer of unlisted private equity (i.e. non-listed shares and limited partnership interests) as part of the financial commodities category. This meant that trading gains on such unlisted private equity were not subject to BT (i.e. they were out of scope). Given that the VAT reform rules in the financial services space largely follow the former BT rules, it has been argued that the transfer of unlisted private equity should equivalently not be subject to VAT, post reform.

Most, if not all, QDLP and QDIE products are invested in offshore private funds, which are organised as private companies or private limited partnerships. The position could be taken that VAT is not chargeable on any redemption gains related to QDLP and QDIE investments in these offshore private equities. However, given the ambiguity in the tax guidance, the tax authorities could also argue that offshore private equities are still to be treated as funds for the purposes of Circular 36, and therefore that redemption gains are VAT-able dealings in financial commodities. As matters stand, there is still no clear answer on the appropriate VAT treatment.

  • A further issue relates to fund unit redemption. According to Circular 140, which imposes VAT on assets management products, gains from redemption, where assets are held to maturity, is not within the scope of VAT. According to Circular 36, any transfer of the ownership of financial commodities will be subject to VAT. This leaves a guidance gap for fund unit redemptions.

Typically, investors will subscribe for fund units, and will divest their holdings through redemption by the fund. This differs from exits from listed share investments through equities trading markets. The general market view is that redemption is not a transfer, because there is generally no established marketplace through which one can buy and sell such fund units with another third party. Further, the fund units will not exist after the redemption directly with the fund. It is argued that the redemption should be viewed as a 'held to maturity' case and not be subject to VAT. However, ambiguity and uncertainty persists.

As noted above, the fund or assets manager is treated as the taxpayer for VAT liabilities arising in relation to the assets management products it manages. Therefore, to the extent there are any underpaid VAT liabilities, for example due to the ambiguous interpretation of financial commodities and the meaning of trading, the manager could end up bearing additional VAT liabilities.

There are many other tax issues that are yet to be resolved for investment and fund management:

  • VAT rules stipulate that for investments that provide returns that are 'fixed, guaranteed or principal-protected', the returns should be treated as interest on a loan, and subject to VAT. However, in practice, there are still many ambiguities on the meaning of fixed, guaranteed or principal-protected returns, such as whether one simply looks at the contract terms, or whether a substance-over-form approach needs to be applied. This remains a challenging issue for asset management businesses when designing investment products.

  • Apart from the above-mentioned VAT uncertainties, there are also IIT issues due to a lack of guidance on the treatment of privately offered contractual funds. For example, when contractual fund income is distributed to individual investors it is not clear whether there is an IIT withholding obligation for the fund manager. The recently announced IIT reform does not appear to address this issue and therefore fund managers will continue to walk a fine line on such matters.

  • In relation to the new Circular 108 bond interest tax exemption, a question remains whether this will solely cover interest on bonds per se, or will also extend to other forms of tradable China debt instruments, into which overseas institutional investors are permitted to invest. Until such time as further clarifications are forthcoming, there are likely to be uncertainties arising from differing tax authority and taxpayer interpretations.

What's next?

The relaxation of regulatory restrictions for the China financial sector is certainly good news for foreign firms. However, as discussed above, there are still many areas of tax uncertainty, as rules struggle to keep up with the development of financial markets and investment product innovation.

For foreign firms seeking to operate in China, it is recommended to closely watch tax rule development, seek appropriate advice from tax professionals, fully understand market practices, and participate in industry association representations to the authorities' industry-wide tax issues. Care must be taken to carefully design any investment or financial products with regard to the often ambiguous VAT and income tax treatments and communicate clearly, to potential investors and customers, the underlying China tax risks and their tax compliance obligations. In China, changes to tax rules can often have retroactive impact and parties promoting or selling a product without any disclosure of potential risks in the relevant offering memorandum can end up responsible for the full amount of resultant tax liabilities.

It is to be hoped that, in tandem with the relaxation of restrictions on investment and operations in the financial services sector, the SAT will invest further effort and resources in understanding the operation of the financial services sector, at a commercial level, and refine rules to remove tax uncertainties and ensure the success of the liberalisation.

The authors would like to thank Aileen Zhou and Adam He for their contributions to this chapter.

Henry Wong


Partner, Tax

KPMG China

50th Floor, Plaza 66

1266 Nanjing West Road

Shanghai 200040, China

Tel: +86 (21) 2212 3380

Henry Wong is a tax partner based in Shanghai with KPMG China. Henry has been specialising in tax advisory and merger and acquisition (M&A) services for more than 18 years. He has extensive international and China tax experience in serving clients across different industries on direct and indirect tax advisory projects, due diligence work, M&A advisory, cross-border tax compliance and tax planning, as well as day to day general corporate tax compliance engagements.

Henry leads a large number of tax structuring and due diligence projects involving foreign acquisitions of Chinese target companies in different sectors, including financial services, real estate, manufacturing, retail and distribution, TMT, FinTech as well as healthcare sectors. He also participated in certain outbound related M&A transactions by advising domestic Chinese clients on the related tax implications and financing strategies on outbound investment, including investments into offshore private equity funds or real estate investment funds.

Henry serves many financial sector clients including banks, insurance companies, securities and brokerage, commodity trading companies, derivative and foreign exchange trading companies, as well as leasing, asset management companies and investors in non-performing loans (NPL). He also works extensively with various investment fund clients including private equity firms, mutual funds, fund management companies, QFII, QDII, QFLP, QDLP, hedge funds, and REITs, etc.

His involvement in the investment fund advisory sector includes all phases of the fund lifecycle, onshore and offshore fund formation and structuring advisory from tax and regulatory perspectives, profit repatriation planning for fund as well as its portfolio investment in China, investment entry and exit planning, executives/employees compensation/incentive planning, carried-interest structure planning as well as helping clients in addressing specific partnership taxation issues. He also provides tax due diligence services to private equity investment funds.

Recently, Henry has also led many tax advisory projects for financial services clients including China's VAT reform, US FATCA as well as the common reporting standard (CRS) advisory.

Prior to joining KPMG China, he worked with KPMG's Canadian member firm in Toronto on international and Canadian tax matters for financial services and assets management clients.

Henry holds a bachelor's degree in mathematics and a master's degree in accounting. He is a certified Canadian chartered accountant, US certified public accountant (Illinois State Board of Accountancy) and chartered financial analyst.

Chris Ge


Partner, Tax

KPMG China

25th Floor, Tower II, Plaza 66

1266 Nanjing West Road

Shanghai 200040, China

Tel: +86 21 2212 3083

Chris Ge is a partner based in Shanghai. Chris specialises in advising the financial services (FS) sector including banking, insurance, asset management, and fintech. He has accumulated extensive experiences from servicing both multinational and Chinese domestic FS clients in respect of complex tax projects.

Chris is also a frequent speaker at various FS-related tax events and serves as a specialist for a number of Chinese research bodies and local financial supervisory government bodies.

Chris is a member of the Chinese Institute of Certified Public Accountants (CICPA) and a member of the Chinese Institute of Certified Tax Agent (CTA).

Jean Li


Partner, Tax

KPMG China

9th Floor, China Resources Building

5001 Shenzhen East Road

Shenzhen 518001, China

Tel: +86 (755) 2547 1128

Jean Li has more than 10 years of experience in the KPMG China tax practice and has experience working in the US, as well as Shanghai and Shenzhen in China.

Jean, who is based in the Shenzhen office, is a certified public accountant and holds a lawyer practitioner qualification in China. She is also a China Mergers & Acquisitions Association certified dealmaker.

Jean has extensive experience in Chinese tax consultancy. With her strong accounting, auditing, taxation and legal background, Jean advises clients on their investment and development plans, business structures, merger and acquisition transactions, share transfers, liquidation processes, transfer pricing strategies, as well as customs and foreign exchange matters of business operations. Jean also maintains good relationships with both tax and investment related authorities.

Jean is specialised in retail trade, real estate, financial sector and other new industries.

Tracey Zhang


Partner, Tax

KPMG China

8th Floor, Tower E2

Oriental Plaza

Beijing 100738, China

Tel +86 10 8508 7509

Tracey Zhang has more than 21 years' tax advisory experience in the financial services industry. She is the financial services national tax lead partner at KPMG China, specialising in banking, insurance, real estate funds and leasing.

Tracey is also KPMG national lead partner for tax transformation. She has been seconded to KPMG Holland to study the Dutch horizontal monitoring system and has established extensive knowledge and experience in tax risk control and tax technology. She has led professional teams in assisting a number of state-owned enterprises to establish or improve their tax risk control systems.

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