On September 3, 2014, China Taxation News13 reported that the Ningbo State Tax Bureau (“NSTB”) collected RMB3.6 million of EIT on the indirect transfer of a Chinese resident enterprise from a German company.
The shareholders of the Hong Kong target company were a German company and a Chinese individual. Each shareholder held 50% of the shares in the Hong Kong holding company, which was a sole parent company of a Chinese resident enterprise incorporated in Ningbo city, Zhejiang province. The Hong Kong holding company being transferred was a pure shell company without assets, employees or operations. Therefore, the taxable nature of the transaction under China’s indirect share transfer rules was not in dispute.
While the facts of the case have little reference value, the tax treaty application is noteworthy. The transferor, a German company, was from a tax treaty jurisdiction. According to the report, the NSTB confirmed that the tax treaty between Germany and China should apply to the indirect transfer. However, the tax treaty between Germany and China did not prevent China from taxing capital gains from the indirect transfer
because Article 13(4) of the treaty provides that China has a right to tax capital gains derived by a German resident from the transfer of shares in a Chinese resident enterprise. Upon re-characterization under Notice 698, the transferor was deemed to transfer shares in a Chinese resident enterprise.
Although the tax treaty in this case did not prevent China from taxing the indirect transfer, this case is notable because it confirms that in an indirect transfer, tax treaty between the transferor’s jurisdiction and China should be applicable as the tax treaty would be in a direct transfer. In other words, the indirect transfer of minority shares may not be taxed in China under most of China’s tax treaties.