Recent months saw various important developments that are relevant to Sino-European trade and investment. These include (i) changes to the EU Parent-Subsidiary Directive, (ii) the entry into force of the double tax treaty between Luxembourg and Taiwan, and (iii) proposed changes to China’s Foreign Investment Catalogue and the Governmental Verifications Catalogue. Finally, today marks the inauguration of the linkage between the stock exchanges of Shanghai and Hong Kong. Each of these developments will be discussed in turn below.
1. Changes to the EU Parent-Subsidiary Directive to prevent double non-taxation
One of the key pillars of the EU internal market, the Council Directive 2011/96/EU of 30 November 2011 (the “Parent-Subsidiary Directive”) was originally conceived to prevent the double taxation of same-group companies based in different Member States. At the time the original Parent-Subsidiary Directive was adopted (in 1990), European cross-border groups were generally at a disadvantage in comparison to domestic groups because of the double taxation to which profit distributions were subject.
To achieve the aimed neutrality, the Parent-Subsidiary Directive’ objective was to (i) exempt dividends and other profit distributions paid by subsidiary companies to their parent companies from withholding taxes and to (ii) eliminate double taxation of such income at the level of the parent company.
However, due to different tax qualifications given by Member States to hybrid loans (financial instruments that have characteristics of both debt and equity), payments under a cross-border loan have in certain situations been treated as a tax deductible expense in the Member State of the payor and as a tax exempt distribution of profits in the Member State of the payee. This may result in an unintended double non-taxation that can however only be achieved by cross-border groups, not by mere national groups, and therefore potentially distorts the common market in addition to depriving Member States from tax revenue.
Since the benefits of the Parent-Subsidiary are not intended to lead to situations of double non-taxation, the Parent-Subsidiary Directive was amended on 8 July 2014 by the Council Directive 2014/86/EU to avoid situations of double non-taxation deriving from mismatches in the tax treatment of profit distributions between Member States (the “Amending Directive”).
In particular, pursuant to the Amending Directive, the Member States of a parent company should not allow it to benefit from the tax exemption applied to received distributed profits, to the extent that such profits are deductible by the subsidiary of the parent company; in that case, such received distributed profits should be taxed by the parent company.
The amendments brought about by the Amending Directive are required by be implemented into national law by 31 December 2015.
Whilst the Amending Directive follows the recent international trend to combat base erosion, profit shifting and non-taxation schemes resulting from mismatches of different domestic regulations, it will directly impact the tax situation of European groups the subsidiaries of which are financed by hybrid instruments that qualify as debt in the relevant subsidiary’s Member State but as equity in the parent’s Member State. Any groups using hybrid structures would therefore be well-advised to consider and potentially revisit their existing corporate and financing structures.
2. Double tax treaty between Luxembourg and Taiwan
The Grand Duchy of Luxembourg has ratified the first double tax treaty (the “Treaty”) with Taiwan on 12 July 2014. Taiwan had already signed the Treaty and its protocol. Accordingly, the new Treaty will come into force on 1 January 2015.
The Treaty joins in a long list of over 70 comprehensive double tax treaties entered into by Luxembourg, all of which contribute to Luxembourg’s unrivalled position as a major hub of international trade in the sectors of banking and finance, investment funds and holding companies. It is the 27th comprehensive double tax treaty agreement entered into by Taiwan and the 12th such treaty it has signed with a European country.
The main features of the Treaty include a reduction of withholding tax rates for dividends, interests and royalties to 10% (domestic rates in Taiwan are generally 20% or 15%; Luxembourg does either not levy withholding tax or provide in exemptions for distributions to treaty jurisdictions under certain conditions) or 15% (if the beneficial owner of the dividends or interest is a collective investment vehicle established in the other territory and treated as a body corporate for tax purposes in that other territory).
Capital gains in respect of movable assets may be taxed in the territory where the asset is situated (since that territory has the right to tax both the property and the income derived therefrom, without regard to the question whether such gain is a capital gain or a business profit). The influence of the OECD model can also be seen in the provision on exchange of information.
3. Proposed changes to China’s Catalogue of Foreign Investment
On 4 November 2014, China’s National Development and Reform Commission (the “NDRC”) released an “opinion-seeking draft” of proposed changes to the Catalogue of Industries for Guiding Foreign Investment (the “Foreign Investment Catalogue”), which is China’s guide to foreign investment, classifying projects into any of the three encouraged, restricted and prohibited categories.
The proposed changes will be implemented on 3 December 2014 (subject to any further modifications as a result of the ongoing public consultation).
Under the revised Foreign Investment Catalogue, the number of restricted sectors will be significantly reduced, from 79 to 35. Wholly owned foreign-invested enterprises (WFOEs) will be allowed in various industries that before only accepted Sino-foreign joint ventures, such as oil exploitation, automobile parts, accounting and auditing, and aircraft and vessel engines and components. Furthermore, foreign investors will benefit from relaxed restrictions on the percentage of shareholder equity that must be controlled by the Chinese partners to joint ventures across a number of industries, including international sea transportation, aircraft manufacturing, and the design and manufacture of civil satellites. For a full overview of the changes, please see MOFCOM’s overview of the differences between the current new draft and the version of the Foreign Investment Catalogue which is currently in force, here.
This draft, and the call for public commentary, follow earlier statements by LI Keqiang (announced in the margin of the Executive Meeting of the State Council on 8 October 2014) that China will abolish the approval requirement for outbound investment, subject to only a few exceptions. This will require a revision of the Catalogue of Investment Projects Subject to Governmental Verifications 2013 (the “Governmental Verifications Catalogue”) and is expected to a significant lowering of the approval requirements for outbound investment projects.
Together, both proposed amendments underscore China’s ambition to further facilitate both inbound and outbound investments and thereby to further integrate China’s economy into the world.
4. Shanghai – Hong Kong Stock Connect
Today marks the launch of two significant developments for the further integration of China into the global financial markets: the launch of the Shanghai-Hong Kong Stock Connect and the removal of limits on the conversion of HKD into RMB and vice versa.
The Shanghai-Hong Kong Stock Connect will allow investors of Mainland China and of Hong Kong to trade designated equity securities listed in each other’s stock market. In order to facilitate the stock connect between the two cities, the Hong Kong Monetary Authority announced on 12 November that it will lift the daily cap for converting HKD into RMB on the same date as the inauguration of the linkage between both stock markets (until today, Hong Kong residents were allowed to convert only up to RMB 20,000 per day into or out of the Chinese currency).
The Shanghai-Hong Kong Stock Connect and the increased convertibility of HKD into RMB demonstrate that China, using Hong Kong as a platform, is keen to integrate its stock markets into the global financial system and to provide its domestic enterprises with more options to access foreign capital.