Eye-on-China Webinar Series. Befriend the Chinese Tiger Keep Risk At Bay and Optimize Your China Opportunities

Transcription

1 Eye-on-China Webinar Series Befriend the Chinese Tiger Keep Risk At Bay and Optimize Your China Opportunities

2 Eye-on-China Webinar Series Taxation of Foreign Investors in China: Dramatic Climate Change Wednesday, November 3, 2010 Jon Eichelberger Beijing Lance Martin Palo Alto Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm.

3 Our Speakers Jon Eichelberger Beijing Lance Martin Palo Alto 2010 Baker & McKenzie 3

4 Agenda Anti-avoidance: treaty shopping and indirect share transfers Corporate reorganizations Taxation of expatriate secondments 2010 Baker & McKenzie 4

5 Anti-Avoidance: The Old FEIT Law versus the EIT Law Anti-Corruption and State Secret Laws 2010 Baker & McKenzie 5

6 Commonly Used Holding Structures Structure 1 Structure 2 Structure 3 Overseas Foreign Investor WHT: Dividends(10%) Royalties(10%) Interest(10%) EIT of 10% on capital gain upon exit Foreign Investor HoldCo 1 HK/Singapore Dividends/ Royalties/ Interest taxed at lower rates Avoid 10% EIT on capital gain by selling Holdco HoldCo 1 HK/Singapore Foreign Investor HoldCo 2 HK/Singapore PRC PRC FIEs PRC FIEs PRC FIE 1 PRC FIE Baker & McKenzie 6

7 Anti-Avoidance: FEIT Law Pre-January 1, 2008, Foreign Enterprise Income Tax ( FEIT ) Law had no general anti-avoidance principles and little anti-avoidance guidance: Notice 207 (1997): reasonable business purpose required for inter-group, tax-free share transfers Rarely implemented in practice 2010 Baker & McKenzie 7

8 General Anti-Avoidance Rules: EIT Law The Enterprise Income Tax ( EIT ) Law and its Implementation Regulations Effective Date: January 1, 2008 Article 47 of EIT Law empowers tax authorities to make special adjustment on arrangements without reasonable commercial reasons Article 120 of the Implementation Regulations defined the term of without reasonable commercial reasons as primary purpose is to reduce, avoid, or defer tax payments 2010 Baker & McKenzie 8

9 Chronology of Anti-Avoidance Developments Increased focus on anti-avoidance and taxation of non-resident enterprises ( NREs ) since 2008 Chongqing case: indirect share transfer November 2008 Xinjiang case: residency for treaty purposes December 2008 Circular 2: disregard of enterprises lacking economic substance January 2009 Circular 81: treaty benefits on dividends February 2009 Circular 124: approval procedures for treaty benefits August 2009 Circular 601: beneficial ownership under treaties December 2009 Notice 698: indirect share transfer January 2010 Xuzhou case: residency for treaty purposes February 2010 Jiangsu case: indirect share transfer June 2010 Dalian case: cross-border reorganization June 2010 Fuzhou case: treaty cap gain exemption June Baker & McKenzie 9

10 Treaty Shopping Anti-Corruption and State Secret Laws 2010 Baker & McKenzie 10

11 Comparison of Tax Treaties Category of Income / Location Domestic Law (No Treaty) Prior 2008 Post 2008 Hong Kong Singapore Barbados Ireland Mauritius Dividends Exempt 10% 5% 1 5% 1 5% 1 5% 1 5% Interest 10% 10% 7% 10%/ 7% 2 10% 10% 10% Royalties 10% 10% 7% 10%/ 6% 3 10% 10%/ 6% 3 10% Capital Gains 10% 10% 10% 10% 10% 4 Exempt 10% Notes: 1 25% shareholding is required, or the rate increases to 10% 2 7% on interest paid to a Singapore financial institution, and 10% in all other cases. 3 6% on lease payment for industrial, commercial or scientific equipment 4 A new protocol amending the PRC-Barbados tax treaty was signed on February 10, Among other things, the general capital gain exemption on share transfers was eliminated. The protocol entered into force on June 9, 2010 and will become effective on January 1, Baker & McKenzie 11

12 Recent Trend The PRC tax authorities are increasing their efforts to tighten the administration and granting of treaty benefits January 2009: Circular 2 disregard enterprises without economic substance February 2009: Circular 81 treaty benefits for dividends August 2009: Circular 124 approval procedures for treaty benefits December 2009: Circular 601 beneficial ownership for treaty purposes 2010 Baker & McKenzie 12

13 Circular 2 - Trial Measures for Special Tax Adjustments Specifies certain tax avoidance activities: abuse of tax incentives; tax treaty shopping; abuse of a company s legal form; use of tax haven to avoid tax; and other arrangements without bona fide business purposes The tax authorities can disregard the existence of an entity that lacks economic substance, particularly one established in a tax haven 2010 Baker & McKenzie 13

14 Circular 81 - Treaty Benefit for Dividends Conditions for enjoying reduced withholding tax rate on dividends: The recipient of the dividend must be a tax resident of the other treaty jurisdiction; The recipient of the dividend must be the beneficial owner of the dividend; The dividend must qualify as a dividend under the tax law of China; and Other conditions that the SAT may impose Detailed documentary requirements economic substance 12-month holding period for shares or equity interest Denial of benefit if main purpose of structure or transaction is to obtain treaty benefits 2010 Baker & McKenzie 14

15 Circular Procedures to Claim Treaty Benefits Approval Procedure Dividend Recordal Procedure PE and business profits Interest Independent personal services Royalties Dependent personal services Capital gains All other benefits 2010 Baker & McKenzie 15

16 Circular Beneficial Ownership Applies when tax authorities process applications from NREs (foreign companies) for tax benefits related to dividends, interest and royalties. Additional enforcement tool besides residency special case of Hong Kong? Beneficial owner: Must have legal and economic ownership of the dividend, interest and royalty income, or of the rights or properties giving rise to such income Must engage in substantive business operations Agents or conduit companies do not qualify as beneficial owners for treaty purposes 2010 Baker & McKenzie 16

17 Conduit Company Purpose of Establishment? Substantial Business Operation? Other Factors? 2010 Baker & McKenzie 17

18 Indirect Share Transfers Notice 698 Anti-Corruption and State Secret Laws 2010 Baker & McKenzie 18

19 Chongqing Case: Precursor to Notice 698 Company B SG Transfer Company A PRC Company A PRC 100% 100% Company C SG Company C SG 31.6% 31.6% FIE D PRC FIE D PRC Pre-acquisition Post-acquisition 2010 Baker & McKenzie 19

20 Notice 698 Issued December 2009 codified the Chongqing Case Two key elements: Reporting Re-characterization 2010 Baker & McKenzie 20

21 Notice 698: Reporting Obligation Reporting obligation if either of the following is present: The actual tax burden of the jurisdiction in which an intermediate holding entity is established is lower than 12.5% (e.g., Mauritius, Barbados, Cayman Islands, BVI), or The jurisdiction exempts income tax on foreignsourced income (e.g., Hong Kong, Singapore) A host of documents need to submitted if there is a reporting obligation 2010 Baker & McKenzie 21

22 Notice 698: Potential Re-characterization Potential disregard of intermediate holding companies: Use of abusive form; EIT avoided; and Lack of reasonable commercial purpose 2010 Baker & McKenzie 22

23 Notice 698: M&A Seller Considerations Report or not to report? When there is a high risk of re-characterization When there is a low risk of re-characterization Formulating argument for not reporting Deals signed before the issuance of Notice 698 Controlling shareholder Tax exemption on offshore income Risk to pre-sale positioning 2010 Baker & McKenzie 23

24 Notice 698: M&A Buyer Considerations Reporting or withholding obligation on buyer? No tax basis step-up in Chinese subsidiary Post-acquisition operation in China Potential impact on price negotiation? Indemnity provision? 2010 Baker & McKenzie 24

25 Notice 698 Sale of Holdco w/ One FIE Issues: Controlling Foreign Investor 100% HoldCo Hong Kong Transferor Overseas - Direct match to Notice 698 concerns - If sold as pre-positioning for M&A transaction with third party, business purpose tough to defend - Is substance in Hong Kong enough? - Are internal restructurings safe? FIE 100% PRC 2010 Baker & McKenzie 25

26 Notice 698 Sale of Holdco w/ Multiple FIEs Issues: Controlling Foreign Investor Transferor - Is shareholding efficiency sufficient as a business purpose? 100% - Management of investments HoldCo Hong Kong - Tax-efficient financing - Cash pooling Overseas China 100% 100% - Non-PRC tax planning - Non-tax concerns, e.g., corporate law FIE 1 FIE Baker & McKenzie 26

27 Notice 698 Sale of Worldwide Business Controlling Foreign Investor HoldCo Transferor Issues: - Is transfer of HoldCo still captured under Notice 698 reporting? - Any risk of re-characterization with such a large structure? HoldCo 1 Europe HoldCo 2 Asia HoldCo 3 US HoldCo 1 Hong SubsKong HoldCo Hong Kong HoldCo 2 Hong Subs Kong FIE 1 FIE 2 Overseas China 2010 Baker & McKenzie 27

28 Corporate Reorganizations Anti-Corruption and State Secret Laws 2010 Baker & McKenzie 28

29 Corporate Reorganizations Circular 59 Share transfers (including share swaps)* Asset transfers (including share for asset swaps) Mergers Demergers Debt restructuring Changes in legal form * Focus of this presentation 2010 Baker & McKenzie 29

30 Tax Treatment of Reorganizations 2010 Baker & McKenzie 30

31 Taxable Share Transfer B cash shares of T S B S T T S recognizes gain or loss B s basis in shares of T steps up or down based on FMV In principle, no change in tax attributes of T 2010 Baker & McKenzie 31

32 Tax-Free Reorganizations General Criteria Reasonable commercial purpose and main purpose not to eliminate, reduce or defer tax Transferred, merged or demerged assets or shares meet prescribed ratios No substantial change in original business activities during the 12 months following the reorganization Share consideration must comprise at least 85% of the total consideration Main original shareholder of the enterprise undergoing reorganization must hold the shares acquired as consideration for 12 months following the reorganization* Special criteria for cross-border deals 2010 Baker & McKenzie 32

33 Tax-free Share for Share Swap (cross-border) Type 1 Type 2 shares of B S S shares of B S Overseas B shares of T B OR shares of T S PRC T T B T B T 2010 Baker & McKenzie 33

34 Pending Issues for Tax-free Reorganizations (cross-border) Tax-free Cross-border Merger? Other qualified transactions? Does a buyer have an obligation to assist with tax collection? 2010 Baker & McKenzie 34

35 Corporate Reorganizations Bulletin 4 Follow-up interpretations and clarifications on Circular 59 Documentation and procedural requirements for corporate reorganizations in various scenarios Significant uncertainties remain Tax treatment of cross-border reorganizations Advance ruling A new concept but unresolved Not clear whether parties can apply for an advance ruling before the parties start the reorganization 2010 Baker & McKenzie 35

36 Expatriate Secondments Anti-Corruption and State Secret Laws 2010 Baker & McKenzie 36

37 Expatriate Secondment: Old Policy In place from 1980s until 2009 Secondment of expatriate to a foreign invested enterprise ( FIE ) in China not regarded as a permanent establishment ( PE ) of overseas employer if: Secondee worked under control and supervision of FIE FIE reimbursed only the actual costs of the employee Overseas employer did not charge any mark-up 2010 Baker & McKenzie 37

38 Expatriate Secondment: Now a PE? Investigation of expatriate secondments launched in mid by the SAT Local tax bureaus in many places began not to process tax clearance for reimbursement payments unless the FIE withheld business tax and income tax on PE basis New rules were drafted and went through several rounds but were not issued Local practices varied somewhat, with some tax bureaus treating as a PE in all circumstances and others allowing applications for non-pe treatment 2010 Baker & McKenzie 38

39 Expatriate Secondment: Now a PE? New guidance from Notice 75 Whether the parent has the right to direct the work of the secondee and bears the risks and responsibilities for the work decides the number of and standards for the secondee(s) who are sent to the subsidiary bears the salaries of the secondee; or derives profit from the subsidiary because of the activities of the secondee If any one of the above conditions is met, the secondee will be viewed as working for the parent company Then relevant treaty clauses will be applied to determine whether the parent company creates a PE 2010 Baker & McKenzie 39

40 Questions? 2010 Baker & McKenzie 40

41 Our China Practice Rated a Tier 1 firm for China Antitrust Law Chambers Asia 2010, 2009 Recommended for China Antitrust and Competition work PLC Which Lawyer? Once again, Baker & McKenzie has the second-largest competition group in the Global Elite highlighting one of the firm s key strengths its impressive geographical spread. Global Competition Review, GCR100, 2010 Edition Ranked 4 th in PLC Which Lawyer? Competition Law Super League 2009 PLC Cross-border Competition Handbook 2009 China Client Choice Award International Law Office 2008, 2007, 2006, 2005 Leading Law firm for China PLC Which Lawyer 2009, 2008, 2007, 2006, 2005 Key Facts and Figures Office Openings Hong Kong 1974 Beijing 1993 Shanghai 2002 Beijing Lawyers: 45+ Fee Earners: 75+ Total Staff: 135+ Shanghai Lawyers: 45+ Fee Earners: 95+ Total Staff: 160+ Hong Kong Lawyers: 180+ Fee Earners: 280+ Total Staff: 620+ A good relationship with a lot of strategic investors in China has given Baker & McKenzie s Beijing and Shanghai offices a distinct advantage in the Chinese market. Commentators praised the lawyers knowledge grasp of the PRC aspects of deals. Chambers Asia, Baker & McKenzie 41

42 Eye-on-China Webinar Series Befriend the Chinese Tiger Keep Risk at Bay and Optimize Your China Opportunities Upcoming Webinar Local Time 09:00 (Pacific) 11:00 (Central) 12:00 (Eastern) 17:00 (United Kingdom) 18:00 (Central Europe) 20:00 GMT+3 (Moscow) 01:00 GMT+8 next day (Beijing/Hong Kong/Shanghai) 04:00 GMT+11 next day (Sydney) Wednesday, December 1, 2010 When Litigating in China is Forced upon You: The Mechanics and Peculiarities of Chinese Litigation 2010 Baker & McKenzie 42

43 Questions? Jon Eichelberger Beijing Lance Martin Palo Alto Thank you! 2010 Baker & McKenzie 43

44 Eye-on-China Webinar Series Taxation of Foreign Investors in China: Dramatic Climate Change Wednesday, November 3, 2010 Jon Eichelberger Beijing Lance Martin Palo Alto Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm Baker & McKenzie 44