According to Zhejiang State Taxation Bureau, the State Tax Bureau of Yuhang District, Hangzhou, Zhejiang Province has recently collected RMB10.6159 million in Enterprise Income Tax on an offshore indirect share transfer transaction. This is the first offshore indirect share transfer case closed in Zhejiang Province with over RMB 10 million in total tax revenue.
For the said case, a Hong Kong international holding company transferred its shares of a British Virgin Islands (BVI) company, which holds 49% of the shares of a PRC resident enterprise in Hangzhou, to another multi-national company outside of China. The tax authority ruled that the offshore share transfer transaction, in essence, is for the indirect transfer of the shares of the resident company in Hangzhou and therefore the transferor shall fulfill its obligation to pay enterprise income tax in China. After two years of investigation, communication and negotiation, both sides agreed on the method for the determination of income and cost of the equity transfer transaction and the amount of tax payable, and the transferor settled the tax.
Since the issuance of Guoshuihan  No.698 ("Circular 698"), KWM has been paying special attention to its implementation. We have noticed that the number of cases being reported publicly in China for the taxation of indirect share transfer transactions conducted offshore has been increasing. This phenomenon reflects the fact that the China tax authority, as directed by the ever-increasing mentality of anti-avoidance, has proactively made tax assessment on offshore share transfer transactions based on Circular 698 and the principle of “substance over form”. Technically, since the application of Circular 698 usually relies on the gathering of information about offshore transactions and related disclosures, the increase in the number of reported cases, to a certain extent, reflected the improvement of the China tax authority in its capability for information gathering and the diversity of its source of information. In addition, the SAT has also been improving the administration measures for Circular 698 by providing more practical guidelines for the implementation of the circular.
On such a backdrop, non-resident enterprises, when devising their China investment structure, should fully take into account of the potential tax impact that may arise from exit. For the offshore share transfer transaction proposed by a non-resident enterprise, if reporting to the China tax authority is required under Circular 698, the reporting party should carefully substantiate the commercial substance of the transaction and of the intermediary holding company, ensure its consistency with the disclosure or reporting made in other occasions, and fully prepare the required documentation in order to withstand the inquiries that may be raised by the tax authority.