On 21st December 2017, the PRC Ministry of Finance (“MOF”), the State Administration of Taxation (“SAT”), National Development and Reform Commission (“NDRC”), and the Ministry of Commerce (“MOFCOM”) jointly issued the Notice of Withholding Tax (“WHT”) Deferral of Dividends Declared by Overseas Shareholder Enterprises for Direct Re-investment in China (i.e., the circular Caishui [2017] No. 88, hereinafter referred to as “Circular 88”). Further, on 2nd January 2018, SAT Announcement [2018] No.3 (“Announcement 3”) was promulgated as a supplementary document, providing administrative guidelines on implementation details of Circular 88.
Circular 88 and Announcement 3 offer WHT deferral policy for dividends declared by overseas shareholder enterprises for direct re-investment in China without actual distribution. Please find below an overview of Circular 88 and Announcement 3 from the following four aspects:
(1) General tax implications of dividend incomes and changes brought by Circular 88 and Announcement 3;
(2) Conditions for qualifying for the dividend WHT deferral;
(3) Procedures and documentation for tax recordal/payment;
(4) Legal consequences of incorrectly enjoying the WHT deferral policy
1. General tax implications of dividend incomes and changes brought by Circular 88 and Announcement 3
Under the current PRC Corporate Income Tax (“CIT”) Law, dividends distributed from Chinese subsidiaries to their overseas shareholder enterprises shall be subject to PRC WHT. The dividend WHT rate is 10%, but such rate can be reduced according to the relevant bilateral double taxation treaty (“DTT”) between China and the jurisdiction of which the foreign shareholder is the tax resident, as long as the foreign shareholder enterprise is the beneficial owner of the underlying dividend incomes. E.g. according to the Sino-German Double Taxation Treaty, the dividend WHT rate can be reduced to 5% if the German shareholder enterprise has directly at least 25% equity interest in the Chinese subsidiary and is the beneficial owner of the dividend incomes. The dividend WHT shall be paid when the dividend incomes are realized. In other words, in the past, as long as the dividends are declared, the WHT liabilities are triggered, regardless whether the dividends are really distributed abroad or kept for direct re-investment in China without actual distribution abroad.
However, Circular 88 and Announcement 3 have offered the WHT deferral policy for dividends declared by the overseas shareholder enterprises for direct re-investment in China without actual distribution, if relevant conditions are met. In other words, as long as the relevant conditions are met, such dividend declaration will not trigger immediate WHT liabilities and the WHT liabilities will be postponed to the future when the foreign investor retrieves the re-investment through share transfer, repurchase, liquidation or other manners. Besides, it is noteworthy that if the re-invested enterprise experiences corporate restructuring to which the Special Tax Treatment is applicable in the future, the deferral continues.
2. Conditions for qualifying for the dividend WHT deferral
The foreign investor can enjoy the dividend WHT deferral policy if ALL the following conditions are met:
a) The direct re-investment must be made on Encouraged Investment Projects for which the re-invested enterprise carries out business activities (including production or service provision, R&D activities, investment in construction projects or purchase of machinery and other business activities) during the foreign investor’s investment period and which are covered by the list of encouraged industries in the Catalogue for the Guidance of Foreign Investment Industries (“Encouraged List of Catalogue I”) or by the Catalogue of Foreign Investment in Advantageous Industries in Central and Western Areas (“Catalogue II”).
b) The qualified direct re-investments refer to the equity investments, including capital increase in the existing enterprise, capital contribution to a new enterprise and acquisition of an enterprise’s shares from nonrelated parties, but excluding capital increase, capital contribution and acquisition of shares of a listed company (unless the investment qualifies for “strategic investment” in listed companies).
c) The dividends used for re-investment shall be generated from the invested PRC tax resident enterprise’s retained earnings.
d) In the event that the dividends for direct re-investment are paid in cash, the relevant payments shall be made from the enterprise that distributes the profits directly to the account of the re-invested enterprise or the party that sells the shares and shall NOT be paid to any other foreign or domestic accounts prior to the direct re-investment. In the event that the dividends for direct re-investment are paid in kind, securities or other non-cash forms, the ownership of the relevant assets shall be transferred from the enterprise that distributes the profits directly to the re-invested enterprise or the party that sells the shares and shall NOT be held by any other enterprises or individuals on an entrustment or temporary basis.
3. Procedures and documentation for tax recordal/ payment
a) Tax recordal when the dividend is declared for re-investment
According to Announcement 3, in order for the overseas shareholder enterprise to enjoy the dividend WHT deferral policy, the Chinese subsidiary that distributes the dividend should submit the following documents to the competent tax authorities within 7 days from the dividend payment date:
(1) WHT declaration return filled out by the Chinese subsidiary that distributes the dividend; and
(2) Information Reporting Form for WHT Deferral of Non-PRC Tax Resident Enterprises filled out by the overseas shareholder enterprise and finalized by the Chinese subsidiary that distributes the dividend
After the tax declaration and recordal above, the tax authorities are empowered to require all relevant parties including the overseas shareholder enterprise, the Chinese subsidiary that distributes the dividend, the invested enterprise, or the seller in a share transfer transaction, etc., to provide relevant documents or information to prove that the overseas shareholder enterprise qualifies for the dividend WHT deferral policy, as follow-up administration procedures.
b) Tax payment when the re-investment is retrieved
The deferred dividend WHT shall be paid within 7 days after the re-investment is retrieved (i.e., the overseas shareholder enterprise obtains retrieved investment amounts through disposal of shares in its Chinese subsidiaries, repurchase of shares in its Chinese subsidiaries, or liquidation of its Chinese subsidiaries). In addition, according to Announcement 3, the overseas shareholder enterprise should submit to the tax authorities in charge of the Chinese subsidiary for recordal the transaction vouchers and accounting records that can prove that the Chinese subsidiary has carried out business activities of Encouraged Investment Projects, before the re-investment in the Chinese subsidiary is retrieved or when the deferred WHT is paid.
It is noteworthy that, according to Announcement 3, the re-investment for which the dividend WHT deferral policy was enjoyed is regarded to be disposed first when the overseas shareholder enterprise disposes the investment in a PRC tax resident enterprise in China that includes both the re-investment with the deferral policy enjoyed and the investment without the deferral policy enjoyed.
4. Legal consequences of incorrectly enjoying the WHT deferral policy
According to Circular 88 and Announcement 3, the tax authorities can initiate follow-up administration on the recordal for the deferral policy. If it is finally confirmed that the conditions for qualifying for the dividend WHT deferral are not met, but the overseas shareholder enterprise has already enjoyed the WHT deferral policy, WHT shall be made up immediately and late payment interest at a daily rate of 0.05% on the WHT overdue will be levied, calculated starting from the date on which the dividend is paid.
To be more specific, if the responsibility lies with the Chinese subsidiary (e.g. the Chinese subsidiary fails to correctly review the documents provided by the overseas shareholder enterprise), the Chinese subsidiary shall be faced with the legal consequences for failure of withholding the taxes, and the overseas shareholder enterprise shall be required to make up the underpaid WHT. However, if the responsibility lies with the overseas shareholder enterprise, the overseas shareholder enterprise shall be faced with the legal consequence for failure of declaring CIT in time, and be required to make up the underpaid taxes and be charged with late payment interest.
