The existing Double Taxation Agreement (“DTA”) between China and Barbados, which entered into force on October 27, 2000, offers highly attractive treatment for tax residents of Barbados. Under the DTA, dividends distributed to a tax resident of Barbados by a Chinese resident enterprise are subject to the withholding tax at a rate not exceeding 5 percent, regardless of the equity ownership percentage. Furthermore, a tax resident of Barbados is exempt from any Chinese tax on capital gains derived from the disposition of shares in a Chinese resident enterprise without any preconditions. During the past decade, Barbados has become one of the most popular jurisdictions for foreign investors to set up a holding company to make investments in China, especially in Chinese real estates.
On February 10, 2010, China and Barbados concluded a new protocol to the China-Barbados DTA (“New Protocol”), which may materially affect the use of Barbados holding companies in structuring investments in China. We summarize the salient points of the New Protocol as follows.
Dividends, Interest and Royalties
Tax treatment of dividends as revised by the New Protocol is comparable to what is included in most DTAs China has entered into with other jurisdictions in the recent years. According to the New Protocol, dividends distributed by a Chinese resident enterprise will continue to enjoy the withholding tax rate not exceeding 5 percent, only if the recipient is a company directly holding at least 25 percent of the Chinese resident enterprise’s capital as a beneficial owner. In all other cases, the withholding tax rate will be raised to 10 percent on the gross amount of the dividends.
Tax treatment of interest or royalties is not changed by the New Protocol. Interest or royalties paid by a Chinese resident enterprise to a tax resident of Barbados are subject to the withholding tax at a rate not exceeding 10 percent on the gross amount. One exception is that interest received by the governments, including designated institutions, is exempted from the withholding tax.
Capital Gains from the Disposition of Shares
Upon the effectiveness of the New Protocol, tax treatment of capital gains will be in line with the general position China takes in this area. Under the New Protocol, a tax resident of Barbados will be subject to the withholding tax at a rate not exceeding 10 percent on capital gains derived from the disposition of shares in a Chinese resident enterprise, if (i) the Barbados investor's equity ownership in the Chinese resident enterprise is at least 25 percent anytime during the twelve-month period before the date of disposition, or (ii) more than 50 percent of the value of shares disposed of is derived, directly or indirectly, from immovable property situated in China.
Exchange of Information
China has relied upon the information exchange mechanism in examining the availability of the tax treaty benefits to companies incorporated in Barbados. One notable example is the Xinjiang case decided by the Urumqi State Taxation Bureau, as disclosed in Guoshuihan  No. 1076 (Please refer to our China Tax Bulletin November 2008).
The New Protocol revises the provision on the exchange of information in accordance with the current OECD Model Convention. It is worth noting that China also recently concluded the Tax Information Exchange Agreements with the Commonwealth of the Bahamas and the British Virgin Islands, the two popular tax havens, in December 2009 (Please refer to our China Tax Bulletin February 2010).
New Provision on the Domestic Anti-Tax Avoidance Rules The New Protocol would allow China to apply its general anti-tax avoidance rules under the domestic tax laws to override the tax treaty benefits, as long as such application does not give rise to any tax contrary to the DTA. China has included similar provisions in the respective DTAs with Hong Kong and Singapore.
China is essentially seeking to reduce the tax treaty benefits available to tax residents of Barbados on certain income derived from China. Tax treatment of capital gains is particularly affected by the New Protocol. Given the above changes, the New Protocol will shut the door for various tax planning methods involving Barbados. Pending the ratification on both sides, the New Protocol will apply to income arising in the year after its entry into force. In other words, if the New Protocol becomes effective in 2010, it will apply to income arising in 2011 and beyond. Such grace period could offer a window of tax planning opportunities for foreign investors.