On February 20, 2009, the State Administration for Taxation (SAT) issued the Circular on Certain Issues Regarding the Implementation of Dividend Provisions under Income Tax Treaties which came into effect on its date of issuance.
Although the Circular generally covers all double taxation treaties that the PRC has entered into with other countries and regions (including Hong Kong and Macau) (the Tax Treaties), the Circular does not apply to dividend-related provisions involving business profits. The only dividend-related provisions to which the Circular does apply are those that deal exclusively with dividend income.
Under the Circular, when a Chinese resident enterprise distributes dividends to a foreign recipient, all of the following conditions must be met before the recipient can enjoy the preferential treatments (e.g., a lower income tax rate applicable to dividend income) granted by the relevant income tax treaty:
- The recipient must be a tax resident of the other signatory to the treaty;
- The recipient must be the beneficial owner of the dividends;
- The dividends must be generated from the recipient’s equity investment; and
- Other conditions imposed by SAT.
If the income tax rate applicable to dividends under the treaty is higher than that under PRC domestic tax law, PRC domestic tax law may apply.
Several Tax Treaties have set direct equity thresholds (usually 10 or 25 percent) to qualify for preferential treatments. Specifically, in order to enjoy the preferential treatments granted by an income tax treaty, a tax resident of the other contracting party to the treaty that receives dividends from a Chinese resident enterprise (a Recipient) must directly hold enough equity in the Chinese enterprise to meet the equity threshold set by the treaty. The Circular imposes additional conditions on the Recipient by requiring that:
- the Recipient be a company;
- both the equity and the voting shares that the Recipient directly holds in the Chinese enterprise meet the equity threshold set by the applicable treaty; and
- the Recipient’s direct equity in the Chinese enterprise meet the equity threshold at all times within the 12 months immediately prior to the Recipient’s receipt of dividends from the Chinese enterprise.
The Circular empowers PRC tax authorities to make tax adjustments where a transaction or arrangement is orchestrated primarily for the purpose of taking advantage of the Tax Treaties. In addition, the Circular requires a Recipient and relevant withholding agents to keep, and submit upon request, materials regarding:
- the tax residency certificate issued by the Recipient’s tax authority and other supporting materials;
- the tax status of the Recipient in the country (or region) where its tax residency is established;
- whether or not the Recipient establishes tax residency in any third country (or region);
- whether or not the Recipient is a Chinese tax resident;
- the documents that entitle the Recipient to dividends distributed by the Chinese resident enterprise;
- the equity holding status of the Recipient in the Chinese resident enterprise; and
- other relevant materials required by the income tax treaty.
Generally speaking, the Circular reflects the Chinese government’s attempt to crack down on tax treaty abuses. We recommend that foreign enterprises that receive dividends from Chinese corporations and intend to claim preferential treatments under the Tax Treaties pay close attention to the additional conditions imposed by the Circular, as highlighted above. The preferential treatments granted by the treaties may be barred by failure to meet these conditions.