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China Implements Measures To Combat Tax Evasion

by Mary Swire,, Hong Kong

30 March 2009

The Chinese State Administration of Taxation has removed tax privileges afforded under various double taxation treaties to foreign investors who misuse the system of 'special purpose vehicles' as a means of reducing their tax liabilities or circumventing exchange controls.

Since the issue of Tax Notice 81 of February 20, 2009 there have been a number of cases where the non-resident status of these entities has been disregarded for tax purposes.

The Special Purpose Vehicle (SPV) allows foreign investors, who create business ventures with local partners in China, two main tax advantages - to apply withholding tax on dividends remitted abroad at a lower rate where this applies under an applicable double taxation treaty and exemption from Chinese capital gains tax on sale of their holdings. At present tax on dividends in China is at the rate of 10% but Singapore and Hong Kong double taxation treaties allow this to be reduced to 5%. Lower treaty rates also apply for Mauritius, Barbados and Ireland.

The tax authorities are now empowered to scrutinise not just the form but also the substance of the ownership structures of SPVs to satisfy themselves that the investors have bona fide residence in the tax havens and that the SPVs are not merely established for the purpose of avoiding tax or remitting funds out of China.

Many Chinese expatriates, who form the largest group of foreign investors, still maintain close family ties within China, and the actual tax domicile of many such people and their businesses can get clouded. The most often cited cases of intervention to remove SPV tax privileges have involved Chinese expatriates deemed to be de facto PRC resident. The deemed abuses came to the attention of the authorities in processing exchange control and other reporting formalities. However treaty abuse, using tax havens such as the Bahamas where none of the parties had any obvious connections in terms of actual residence or economic presence, has played a role too.

Notice 81 imposes certain conditions for remitting dividends overseas at preferential witholding tax rates, namely:

  • The recipient must be properly tax resident of the respective treaty country and be the beneficial owner of the dividend.
  • The dividend must qualify as a dividend under Chinese tax law.

The SAT has the right to set further conditions.

Since the implementation of anti-tax avoidance measures has only started recently with regard to SPVs, it remains to be seen how strictly the requirements will be interpreted.

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