In a long-awaited move to provide clarity to the capital gains tax for QFIIs and RQFIIs, the PRC Ministry of Finance, State Administration of Taxation and China Securities Regulatory Commission jointly released the Circular on Issues Relating to  Temporary Exemption of Enterprise Income Tax(“EIT”)on Gains from Transfer of Equity Investment Assets Obtained within China by QFIIs and RQFIIs(Caishui [2014] No. 79, “Circular 79”)1along with the Circular on Issues Relating to the Tax Policy of the Pilot Inter-connected Mechanism for Trading on the Shanghai and Hong Kong Stock Markets (Caishui [2014] No. 81, “Circular 81”)2 on November 14, 2014.Circular 79 and Circular 81 will become effective on November 17, 2014 when the Inter-connected Mechanism for Trading on the Shanghai Stock Market and the Hong Kong Stock Market (“Shanghai-Hong Kong Stock Connect Program”) is officially launched.

  1. Tax Policy for Income Tax on Capital Gains Derived by QFIIs and RQFIIs 

Since the beginning of the PRC qualified foreign institutional investors (“QFIIs”) regime in 2002,the PRC tax policy relating to the taxation of income from the transfer of equity investment assets (“Capital Gains”) derived by QFIIs has been unclear. The capital gains tax for RMB Qualified Foreign Institutional Investors (“RQFIIs”) program launched at the end of 2011 has similarly remained uncertain.

Circular 79 clarified the tax policy relating to the income tax of Capital Gains derived by QFIIs and RQFIIs.

  1. Temporary exemption of EIT: EIT will be temporarily exempt on income from the transfer of equity investment assets derived by QFIIs and RQFIIs within China on or after November 17, 2014.
  2. Temporal application of aforementioned exemption: Capital Gains derived by QFIIs and RQFIIs prior to November 17, 2014 should pay EIT according to law.
  3. Scope of aforementioned exemption: Circular 79 explicitly provides that the scope of the exemption is limited to QFIIs and RQFIIs that do not have an establishment or office in China, or that have an establishment or office in China but whose income is not connected with such establishment or office.

Given that Circular 79 takes the segmentation approach on the temporary exemption of EIT, which may pose a challenge to the potential tax adjustment on the profits previously distributed to foreign investors by QFIIs and RQFIIs, we suggest that QFIIs and RQFIIs confirm with the competent tax authority as soon as possible.

  1. General Analysis of Tax Policy of Shanghai-Hong Kong Stock Connect Program

Regarding the tax policy relating to investments in shares listed on the Stock Exchange of Hong Kong Limited (“HKEX”)conducted by mainland investors through Shanghai-Hong Kong Stock Connect Program and the investments in A-shares listed on the Shanghai Stock Exchange (“SSE”) conducted by Hong Kong investors through Shanghai-Hong Kong Stock Connect Program, Circular 81 has made a systematic stipulation.

  1. Comparison of income tax policy for Shanghai-Hong Kong Stock Connect Program

Click here to view the table.

  1. Tax policy of business tax on stock trading through Shanghai-Hong Kong Stock Connect Program
  • Business tax is temporally exempt on income arising from the price difference of trading A-shares listed on the SSE derived by Hong Kong investors (including entity and individual) through the Shanghai-Hong Kong Stock Connect Program.
  • Business tax is temporally exempt on income arising from the price difference of trading shares listed on the HKEX derived by mainland individual investors through the Shanghai-Hong Kong Stock Connect Program.
  • Business tax is exempt on income arising from the price difference of trading shares listed on the HKEX derived by mainland entity investors through the Shanghai-Hong Kong Stock Connect Program.
  1. The tax policy of the stamp duty on stock trading through Shanghai-Hong Kong Stock Connect Program

CSDCC and HKSCC may collect stamp duty on stock trading for each other.

  • Where Hong Kong investors trade, inherit and gift A-shares listed on the SSE through the Shanghai-Hong Kong Stock Connect Program, the stamp duty on security (stock) trading shall be paid according to currently effective mainland tax laws and regulations.
  • Where mainland investors trade, inherit and gift shares listed on the HKEX through the Shanghai-Hong Kong Stock Connect Program, the stamp duty shall be paid according to currently effective Hong Kong tax laws and regulations.

The release and implementation of the tax policy on QFIIs, RQFIIs and the Shanghai-Hong Kong Stock Connect Program is a significant milestone for the opening-up of China’s capital market.