As recently published in China Taxation News, on March 12, 2014, China Taxation News reported that the Qingdao State Tax Bureau (“QSTB”) had collected RMB 10.28 million in enterprise income tax on the indirect transfer of a PRC real estate company.
The seller was a BVI company that sold its 100% equity interest in a BVI holding company to a Hong Kong publicly traded company in September 2011. The BVI holding company owned a 100% equity interest in a Hong Kong holding company, which in turn owned a 60% equity interest in a PRC real estate company. Four Chinese companies owned the remaining 40% equity interest in the PRC real estate company.
The QSTB assessed the indirect transfer of the PRC real estate company just as it would the indirect transfer of any PRC company. Based on article 6 of Guo Shui Han  No. 698 (“Circular 698”), the QSTB recharacterized the indirect transfer deal as a direct transfer of the PRC real estate company, for the following reasons:
- The BVI holding company and the HK holding company were only shell companies.
- The BVI holding company was founded after the HK holding company and its registered capital was only one dollar.
- Neither company had any assets, employees, operating income, business operations or tax payments.
- Audit reports showed the HK holding company’s only expenses were HKD 30,000 in 2009 and HKD 10,000 in 2010, including start-up costs, registration fees, secretary service fees and audit fees, and there were no directors’ fees or any other expenses.
- The share purchase agreement and the investment facility agreement were guaranteed by the equity interest in the PRC real estate company.
- The arrangement had no reasonable commercial purpose.
- The structure with the two intermediate holding companies inserted between the BVI seller and the PRC real estate company was identical from a legal or financial perspective to what the structure would have been without the two intermediate companies.
- The QSTB stated that each company in the multiple layers of a holding company structure should have its own duties and functions. Since the BVI holding company and the Hong Kong holding company had no business operations and directly or indirectly owned only one target company, the existence of the two intermediate holding companies was unnecessary.
This case showed that Circular 698 clearly aims to prevent the use of shell companies. To avoid an indirect transfer being recharacterized under Circular 698, multinationals should:
- structure the offshore holding company to conduct substantive business activities (e.g. procurement, sales and marketing);
- ensure that the sale of the offshore holding company is not the practical equivalent of the sale of the underlying PRC company; and
- ensure that the share purchase agreement (“SPA”) and other corporate documents do not suggest or indicate that the actual purpose of the disposal is to transfer the underlying PRC company.