New Rules on Indirect Transfers of Assets by Non-Tax Resident Enterprises

The China Business Group prepared this alert based on information provided by the Grant Thornton International Ltd member firm in the People’s Republic of China, Grant Thornton China.

On Feb. 3, 2015, the State Administration of Taxation (SAT) for the People’s Republic of China (PRC) issued Announcement [2015] No. 7 (Announcement 7) on the PRC Tax Treatments of Indirect Transfers of Assets by Non-Tax Resident Enterprises to provide additional guidance and  supplement two previous sets of rules issued in 2009 and 2011, namely Guoshuihan [2009] No. 698 (Circular 698), “Notice on Strengthening the Administration of Enterprise Income Tax on Income from the Transfer of Shares by Non-Tax Resident Enterprises” and SAT [2011] No. 24, “Announcement on Issues Concerning the Administration of Income Tax on Non-Tax Resident Enterprises.”

Announcement 7 goes into effect immediately. It also applies to transactions that have occurred but are not yet settled with the Chinese tax authorities.

Pursuant to Circular 698, a non-tax resident enterprise (Non-TRE) transferring shares in an offshore intermediary enterprise that directly or indirectly holds an equity interest in a PRC enterprise is subject to PRC tax on the gains from the transfer, if the PRC tax authorities determine that the arrangement lacks reasonable commercial purpose and recharacterize the indirect transfer as a direct transfer of an equity interest in the PRC enterprise.

Announcement 7 sets out rules in respect to the scope for the application of general anti-avoidance rule (GAAR) measures to indirect transfer of taxable assets in China, the determining factors for assessing reasonable commercial purpose, the internal reorganization transactions and treatment, the reporting and tax filing obligation, the transaction parties’ legal liability, etc.

Highlights Following are some salient points in Announcement 7:
  • Scope of application – Announcement 7 adds the term “Chinese Taxable Assets” to cover assets attributed to an establishment in China, immovable property in China and shares in Chinese resident enterprises, which, effectively, expands the scope of indirect transfers from Circular 698.

  • Reasonable commercial purpose – Overall arrangements of an indirect transfer transaction shall be analyzed. Announcement 7 clarifies the definition of a reasonable commercial purpose. All the following factors shall be considered for determining whether or not the indirect transfer transaction has a reasonable commercial purpose:

  1. Whether the equity value of the foreign enterprise is mainly derived directly or indirectly from Chinese Taxable Assets.
  2. Whether the assets of the foreign enterprise mainly consist directly or indirectly of investments in China or whether the income of the foreign enterprise mainly consist directly or indirectly of income sourced from China.
  3. Whether the functions performed and risks assumed by the foreign enterprise and its direct or indirect subsidiaries that hold Chinese Taxable Assets can justify the economic substance of the corporate structure.
  4. The length of time that the shareholders, the business model and the relevant organizational structure of the foreign enterprise have been in existence.
  5. Whether foreign income tax is paid on the transaction from the indirect transfer of Chinese Taxable Assets.
  6. Whether the indirect transfer could have been replaced for the transferor to directly invest in and directly transfer the Chinese Taxable Assets.
  7. The applicability of a tax treaty to the indirect transfer of the Chinese Taxable Assets.
  8. Any other related factors.

  • Lack of reasonable commercial purpose – There are four sets of specific circumstances that shall result in a ruling that a transaction lacks reasonable commercial purpose and thus is subject to Chinese tax:

  1. 75% or more of the equity value of the foreign enterprise is derived directly or indirectly from Chinese Taxable Assets.
  2. At any time during one year before the indirect transfer of Chinese Taxable Assets takes place, 90% or more of the asset value of the foreign enterprise (excluding cash) is composed directly or indirectly of investments in China, or 90% or more of the income is derived directly or indirectly from China.
  3. The functions performed and risks assumed by the foreign enterprise and any of its subsidiaries that directly or indirectly hold the Chinese Taxable Assets are limited and are insufficient to prove their economic substance.
  4. The foreign tax payable on the gain derived from the indirect transfer of the Chinese Taxable Assets is less than the potential Chinese tax if it is a direct transfer of such assets.

  • Internal reorganization transactions – Transactions meeting all the following conditions shall be deemed to have reasonable commercial purpose and hence are not subject to Chinese tax:

  1. The transferor and the transferee are qualifying related enterprises, which will be the case if any of the following applies: The transferor directly or indirectly owns 80% or more of the shares in the transferee; the transferee directly or indirectly owns 80% or more of the shares in the transferor; 80% or more of the shares of both the transferor and transferee are directly or indirectly owned by the same shareholder.

    Where more than 50% of the value of the equity interest of the foreign enterprise is derived directly or indirectly from immovable assets located in China, the qualifying ownership requirement shall be increased to 100%.

  2. After the indirect transfer (first indirect transfer), the PRC tax payable on a potential subsequent indirect transfer of the same Chinese Taxable Assets is no less than the PRC tax that could have been payable on a similar or an identical indirect transfer if the first indirect transfer did not take place.
  3. All the consideration paid by the transferee must be of its own shares or shares of a related enterprise with which the transferee has a controlling relationship (excluding shares of listed companies).

  • Reporting requirements – Announcement 7 abolishes the mandatory reporting requirement; a relevant party has discretion on whether to report a transaction. Further, a transaction may be reported by any parties to a transaction, such as the PRC enterprise whose shares are to be indirectly transferred.

  • Transactions not subject to Announcement 7 – By meeting any of the following conditions a transaction shall not be subject to Announcement 7:

  1. Gains from indirect transfers of Chinese Taxable Assets by purchasing and selling shares of the same listed overseas companies by Non-TRE in the open market.
  2. Gains from transfers could be exempted from enterprise income tax in the PRC under applicable provisions of tax treaties.

  • Consequences of noncompliance – Failing to comply with Announcement 7 shall be subject to interest and/or penalty.

Summary Announcement 7 is a positive development for investors including U.S. investors who have operations in the PRC. In particular, it provides opportunities for multinational corporations contemplating qualified internal reorganizations without triggering Chinese tax. It also reduces the tax compliance burden of the parties involved and provides certainty on tax treatment for those transactions that are carried out for genuine commercial purpose. However, it still leaves many uncertainties for further clarification. Foreign investers are advised to consult their PRC tax advisors regarding the implication on their contemplated transactions.

Contacts: To find out more about these developments and how they may impact your operations in China, please contact any of the following professionals:

Sandy Chu
Principal & National Leader — China Business Group
Grant Thornton LLP
757 Third Ave.
New York, N.Y. 10017
T +1 212.542.9970

Wilfred Chiu
Head of Tax Services — Beijing
Grant Thornton China
10th floor, Scitech Place, 22 Jianguomen Wai Ave.
Chaoyang District Beijing 100004, China
T + 86.10.8566.5828

Rose Zhou
Head of Tax Services — Shanghai
Grant Thornton China
45/F Raffles City, 268 Xizang Zhong Road
Shanghai 200001, China
T + 86.21.2322.0298

Enoch Chan Tax Partner — Guangzhou
Grant Thornton China
Litong Squre 10th floor, Zhujiang East Road
Zhujiang New City, Tianhe District
Guangzhou 510623, China
T +86 20 3896 3388

Tracy Ying
Tax Director — Shenzhen
Grant Thornton China
Mid-area 14th floor, Great China International
Exchange Square, Jintian South Road
Futian District
Shenzhen 518048, China
T +86 755 3299 5844

This information is potentially subject to translation errors or omissions. It does not represent any type of tax advice whatsoever.

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