China: New Chinese indirect offshore disposal rules issued
On February 3 2015 the Chinese State Administration of Taxation (SAT) issued Announcement 7 (SAT Announcement  No.7), replacing the PRC's indirect offshore equity disposal reporting and taxation rules in Circular 698, promulgated in 2009, with a substantially new and more comprehensive approach. Announcement 7 will likely have a significant impact on M&A transactions and corporate restructurings undertaken by multinational enterprises involving China enterprises and assets. Announcement 7 expands the scope of indirect transfer transactions potentially subject to corporate income tax (CIT) from the Circular 698 rules and provides that "indirect transfers of assets, including shares of Chinese resident enterprises, by non-resident enterprises, through arrangements without reasonable business purposes which aim to avoid CIT, are to be re-characterised and treated as direct transfers of Chinese taxable property in accordance with CIT Law article 47".
"Chinese taxable property" refers to assets of a Chinese establishment or place of business, immovable property in China and equity investment in PRC resident enterprises, and so on. Any transaction involving a "transfer of equity and other similar interests" in the foreign enterprise which "results in identical or similar transactional outcomes to a direct transfer" is caught. This includes "a restructuring by a non-resident enterprise that results in a change of the foreign enterprise's shareholders". Potentially caught transactions include transfer of partnership interests or convertible debt, and share dilutions.
In assessing how reasonable business purposes are to be determined, Announcement 7 calls for a "comprehensive analysis of real facts and circumstances" and clarifies several specific factors to be considered. It also specifies certain arrangements which can be "automatically" deemed to lack reasonable business purposes. However, on the positive side, Announcement 7 provides safe harbour rules, that is, intra-group reorganisation relief will apply where a commonality of ownership test is met.
For indirect offshore transfers of assets of a Chinese establishment or place of business of a foreign enterprise, the resulting gains are to be included with the annual CIT filing of the Chinese establishment or place of business being transferred and be taxed at the 25% CIT rate on an assessment basis. For Chinese immovable property or equity in a Chinese tax resident enterprise, a withholding tax (WHT) mechanism is applied. The WHT agent is who owes an obligation to make the relevant payments to the share transferor. Compared to Circular 698, Announcement 7 constitutes a significant acceleration in the timing of tax payments.
The transaction reporting arrangements are also significantly altered. Firstly, the tax authorities are empowered to request documentation and information from the transferee, the transferor, the transferred Chinese enterprise and tax advisers. Besides, as Announcement 7 introduces a withholding obligation for the buyer, where neither the WHT agent nor the share transferor has paid tax, the WHT agent/buyer may be relieved from potential penalty by voluntarily submitting specified documentation and information within 30 days of the conclusion of the transfer agreement.
Announcement 7 provides that the in-charge tax authorities must conduct indirect transfer investigations and adjustments in line with the general anti-tax avoidance rules (GAAR). However, the in-charge tax authority will report the case up to the SAT within 30 days after the tax is paid.
Announcement 7 is effective from the date of issuance and will apply to transfers occurring before the issuance, in respect of which no Circular 698 tax filing or processing procedures have yet been conducted.
Khoonming Ho (email@example.com)
KPMG, China and Hong Kong SAR
Tel. +86 (10) 8508 7082
Lewis Lu (firstname.lastname@example.org)
KPMG, Central China
Tel. +86 (21) 2212 3421