China issues new indirect equity transfer rules

Transcription

1 from International Tax Services China issues new indirect equity transfer rules February 24, 2015 In brief China s State Administration of Taxation (SAT) released new rules regarding offshore indirect equity transfers. Public Notice [2015] No. 7 (Public Notice 7), which supersedes Articles 5 and 6 of Circular 698 and Articles 6(3), 6(4), 6(5) in SAT Public Notice [2011] No.24, introduces a new tax regime that differs significantly from the prior rules. In assessing whether an indirect transfer of a Chinese subsidiary could give rise to Chinese non-resident capital gains taxation, Public Notice 7 clarifies the concept of reasonable commercial purpose and also introduces safe harbor scenarios. The new rules identify specific transactions that qualify for a safe harbor Green Zone and do not specify any necessary action with respect to transactions that qualify. It also, however, introduces new challenges for both the foreign transferor and transferee of the offshore indirect transfer as now both must self-assess whether the transaction should be subject to Corporate Income Tax (CIT) and whether to file or withhold CIT accordingly. Although Public Notice 7 is effective February 3, 2015, it also applies to transactions conducted prior to this date but have not received a tax assessment from the tax authorities. Since general anti-abuse rules (GAAR) were first introduced on January 1, 2008, technically, Public Notice 7 would extend to cover transactions on or after January 1, In detail What transactions does Public Notice 7 target? When a foreign transferor indirectly transfers China taxable properties in a transaction without a reasonable commercial purpose that results in the avoidance of CIT liability, the indirect transfer will be recharacterized as a director transfer of those properties and subject to CIT. Public Notice 7 widens China s tax net to capture the following transactions, which are deemed an offshore indirect transfer of China taxable properties: offshore indirect equity transfer transactions offshore transactions involving transfers of assets held under the establishment and place (E&P) in China of a foreign company through the offshore transfer of a foreign intermediate holding company, and offshore transactions involving transfers of immovable property in China.

2 Public Notice 7 defines a transfer of the equity interest in a foreign intermediate holding company broadly to cover any changes in the shareholders of the foreign company being transferred including in the course of a group s overseas restructurings. Equity includes other similar rights. General criteria for assessing reasonable commercial purposes Public Notice 7 reiterates the importance of the reasonable commercial purpose as the key principle in the CIT law. It provides several general criteria that should be examined holistically for the assessment, including: 1. whether the Chinese proportion of the equity value is the main value of the transferred foreign company shares 2. whether Chinese investments comprise the majority of the assets or income of the transferred foreign company 3. whether the functions performed and risks undertaken by the transferred foreign company (and its subsidiaries) can substantiate the economic substance of the structure 4. how long the shareholders, the business model of the foreign company, and the related organizational structure have existed 5. foreign income tax payments with respect to the offshore indirect equity transfer 6. whether the indirect investment and indirect transfer can be replaced by direct investment and direct transfer 7. the applicability of any treaty protection, and 8. other related factors. Assessment of these criteria will be crucial for foreign transferors when deciding whether to voluntarily pay CIT or report the transaction to the in-charge tax authority for determination, as well as for the foreign transferee to decide whether to withhold CIT. Observations: Because the criteria lack clear indicative benchmarks, it may be difficult to reach a conclusion in some cases. This lack of clarity invites uncertain application by the China tax authorities while there is no formal process available to seek clarity prior to effectuating a transaction. Nevertheless, the investigation should follow the GAAR procedures in which the final determination should rest with the SAT, which may help provide consistency when applying the new rules. Red Zone : transactions with no reasonable commercial purpose If an offshore indirect equity transfer meets all of the following conditions, it will be considered a transaction lacking reasonable commercial purpose (the so-called Red Zone ) and thus subject to CIT: 75% or more of the value of the overseas company being transferred is derived directly or indirectly from China taxable properties. 2 pwc

3 At any time within one year before the indirect transfer of China taxable properties, 90% or more of the foreign company s total assets (not including cash) is directly or indirectly derived from China taxable properties, or 90% or more of its income is directly or indirectly derived from China. The foreign company and its subsidiaries that directly or indirectly hold the China taxable properties perform limited functions and undertake limited risks that are not commensurate with their economic substance. The foreign income tax payable for the indirect transfer of the China taxable properties is less than the possible tax burden in China on the direct transfer of those properties. Observation: Whether a transaction is immediately safe if it does not meet all of the unfavorable conditions is uncertain. The Chinese tax authorities may not address this issue. Green Zone : transactions with good commercial purpose The following three scenarios will not be subject to recharacterization: Transfer through public stock exchanges: The foreign transferor buys and sells the shares of the listed overseas company through public stock exchanges. Unchanged tax treaty status: When the foreign transferor would otherwise directly hold and transfer China taxable property, the income from that direct transfer would be exempt from CIT under the applicable tax treaty or tax arrangement (see example below for a less than 25% Chinese investment); or Internal group restructurings: Qualified internal group restructurings that meet all of the following criteria will be considered to have reasonable commercial purpose: The shareholding relationship of the foreign transferor and transferee is 80% or more of the equity, calculated by multiplying the shareholding percentages at each level (100% for overseas companies that derive more than 50% of their value, directly or indirectly, from immovable properties situated in China) (see below example); 3 pwc

4 The internal group restructuring would not result in a reduction of the CIT burden on the gain arising from the subsequent potential indirect transfer. The purpose of this requirement is to counteract those indirect equity transfers that have the purpose of obtaining a tax benefit through utilizing the safe harbor rule. See the below examples noting that Cases 1 and 2 involved a less than 25% China shareholding (in which both Hong Kong and Singapore treaties exempt CIT on dispositions) and Case 3 is a 100% China shareholding (in which CIT would apply on a disposition by the US and Luxembourg); and 4 pwc

5 The transfer s deal consideration is completely settled with equity (not including the equity of a listed enterprise) of the transferee or its subsidiaries. Observations: Foreign investors should welcome these safe harbor scenarios. Multinational corporations (MNCs) will welcome the internal group restructuring relief. Some have been waiting to proceed with internal group restructurings that include the indirect movement of both wholly owned Chinese subsidiaries and Chinese joint ventures. Nevertheless, the requirement to settle through equity payment limits the type of consideration that could be used in internal group restructurings, even when there is no intention or potential for abuse. Further, it is important for taxpayers to now examine the Chinese treaty of any foreign transferee and foreign transferor to ensure the taxpayer is not inadvertently in a better treaty position and thus failing the safe harbor. If an offshore indirect transfer does not match any scenario in the Green Zone, it does not necessarily mean the transaction will be subject to CIT. MNCs should still consider the general criteria and assess the transaction s commercial purposes. Reporting requirement and consequences Under Public Notice 7, the transferor should assess whether there are reasonable commercial purposes for an offshore indirect transfer. If the foreign transferor cannot conclude after its self-assessment, it may present its case to the Chinese tax authorities for a determination within 30 days of signing the equity transfer contract. In addition to the requirements it imposes on foreign transferors, Public Notice 7 also imposes reporting and tax withholding responsibilities on transferees, whether foreign or domestic. Should a transaction lack commercial purpose, failure to report and settle CIT liability for a taxable transaction by the transferor and failure to perform reporting or withholding obligation by the transferee will result in an interest levy on the foreign transferor and a penalty on the transferee. Observations: Public Notice 7 clearly states that the payer of the sales consideration (usually the transferee) should report and withhold CIT for the offshore indirect equity transfer if the transaction is subject to CIT. Failure to fulfill the withholding obligation may trigger a penalty ranging from 50% to 300% of the CIT liability based on the relevant provisions of the Tax Collection and Administration Law (TCAL). The penalty may be reduced or waived if the withholding agent reports the transaction to the Chinese tax authorities within 30 days of signing the equity transfer contract. This is the first time the SAT has explicitly stated that a transferee, whether domestic or foreign, could suffer such significant consequences. This provision should remind transferees, especially unrelated parties, to be cautious about the Chinese tax position of the foreign transferor in an offshore indirect transfer deal. Note that even if a taxpayer qualifies for the internal group restructuring safe harbor, a transferor and transferee must assess whether they should report the transfer. Reducing the potential interest levy and penalty If the transferee does not withhold CIT and the foreign transferor fails to pay the CIT in due course, the foreign transferor will be subject to a daily interest levy. The levy is based on the Renminbi loan base rate published by the People s Bank of China plus five percentage points in accordance with the interest levy provisions under the CIT Law (Articles 121 and 122 under the Special Tax Adjustment chapter of the Detailed Implementation Rules to the CIT Law). If the transferor reports the transaction to the Chinese tax authorities within 30 days of signing the equity transfer contract, the additional five percentage points will be waived. Required documentation, if you choose to report Parties to the indirect transfer of Chinese property that chose to report should submit the following documents to the incharge tax authority: equity transfer contract or agreement shareholding structure charts before and after the equity transfer 5 pwc

6 financial and accounting statements of the overseas enterprise and its subsidiary that directly or indirectly holds the China taxable properties for the two years prior to the equity transfer, and an explanation of why recharacterization does not apply to the indirect transfer of the China taxable properties. Further, the tax authorities may request the following additional information: information relating to the decision or implementation process of the overall arrangement of the indirect transfer of China taxable properties information regarding the business operation, personnel, finance, and properties of the overseas enterprise being transferred and its subsidiary which directly or indirectly holds the China taxable properties, as well as the internal and external audit information the asset valuation report and other supporting evidence used to determine the transfer price the situation of overseas tax payments related to the indirect transfer of taxable properties in China relevant evidence and information to support the safe harbor protection, if it applies to the transaction, and other related documents required by tax authorities. The takeaway Public Notice 7 demonstrates the Chinese tax authority s determination to combat erosion of China s tax base through offshore indirect transfers. It imposes more responsibilities on the parties to assess the transaction. Both the foreign transferor and the transferee should examine carefully the facts and merits of each transaction. The foreign transferor should assess the transaction against the seven general criteria holistically to assess whether the transaction has reasonable commercial purpose. If the foreign transferor still cannot decide, it may choose to report the transaction to the applicable tax authority for a determination. Unfortunately, Public Notice 7 does not stipulate whether, how, or when the tax authority should respond to such a report. Thus, uncertainty remains even if the foreign transferor chooses to report. In any event, reporting the transaction will reduce the interest levy by five percentage points if the transaction is determined to be subject to CIT. Foreign transferors therefore should weigh the pros and cons of reporting with regard to the facts and merits of each case. For the transferee, it is equally, if not more, challenging to assess the transaction and decide whether to withhold CIT. Similar to foreign transferors, a transferee may choose to report the transaction to the tax authority to reduce its penalty exposure. Given these complexities, both foreign transferors and transferees should try to agree on how to handle the Chinese tax treatment of an offshore indirect transfer. Public Notice 7 still leaves several important issues unresolved, including the definition of equity, how to allocate gains attributable to China taxable properties in the case of a regional offshore indirect transfer, and the cost base of China taxable properties. Hopefully the SAT will provide additional guidance on these important issues under the new offshore indirect transfer tax regime. 6 pwc

7 Let s talk If you would like further advice or information about the issues outlined above, please contact: International Tax Services Michael Urse +1 (216) michael.urse@us.pwc.com Thomas Hau +1 (646) thomas.cy.hau@us.pwc.com Doug McHoney +1 (312) douglas.mchoney@us.pwc.com Julie Lang Xu +1 (646) lang.xu@us.pwc.com Danny Kwan +1 (646) danny.kwan@us.pwc.com Stay current and connected. Our timely news insights, periodicals, thought leadership, and webcasts help you anticipate and adapt in today's evolving business environment. Subscribe or manage your subscriptions at: pwc.com/us/subscriptions 2015 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. SOLICITATION This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. 7 pwc