- Announcement 72 to elaborate on how the cross-border equity transfer can qualify for the special tax treatment
- Clarifies the rules to ensure no tax-avoidance purpose would be involved in the restructure as well as sets forth the rule on relevant filing procedures
Since 2009, when the special income tax treatment rule was promulgated under the new Corporate Income Tax (“CIT”) regime, there have been questions about how foreign enterprises can enjoy the special income tax treatment in a cross border equity transaction. At the end of 2013, the State Administration of Tax (“SAT”) promulgated the Matters Concerning Special Taxation Treatment Applicable to Non- Resident Enterprises’ Equity Transfer (“Announcement 72”) to clarify some of these issues.
Highlights of Announcement 72
Regulatory Background: Circular 59
Back in 2009, SAT has promulgated Several Issues relating to Treatment of Corporate Income Tax Pertaining to Restructured Business Operations of Enterprises (“Circular 59”), allowing a seller to claim special tax treatment. In certain instances, the seller not required to recognize its gains (or part of its gains) at the time of the transaction.
According to Circular 59, equity acquisition can be qualified for “special tax treatment” if it meets certain general criteria including reasonable commercial objective, minimum shares to be transferred in the target, how the consideration is paid, maintenance of the original substantive business, and a 12-month lockup period for the shares. If the equity transfer involves overseas entities, there are special conditions that apply to the special tax treatment – only those cross-border equity transfers with exactly the same structure specified in the Circular can obtain special tax treatment.
Announcement 72 is intended to elaborate on how the cross-border equity transfer can qualify for the special tax treatment for both types of structures mentioned in the Circular 59, clarifying rules to ensure no tax-avoidance purpose would be involved in the restructure, and explains the rules on how to complete the relevant filing procedures.
Two Types of Cross-Border Equity Transfer
Structure I – transfer of the equity of a resident enterprise (Company C) held by a non-resident enterprise (Company A) to another non-resident enterprise (Company B) in which Company A holds 100% direct controlling shares.
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Under this structure, Circular 59 provides that:
- There should be no subsequent change in withholding tax on the capital gain.
- The seller, Company A, should provide a written undertaking to the tax authority that it will not transfer the equity of Company B owned by it within three years after the restructure.
Filing Requirement under Announcement 72
If special taxation treatment is selected by the non-resident seller, they must file with in-charge tax bureau of the target company within 30 days after the equity transfer contract becomes effective or the registration has been changed in the Administration of Industry and Commerce. Within 30 working days of filing, the taxation authority will investigate and verify the filing matters and reach a decision on whether the special tax treatment is applicable or not. Decisions will be subject to provincial tax authority’s review and record. The special tax treatment shall be denied if the applicable capital gain withholding tax rate, in relation to the transferred equity, will be different from the capital gain tax rate before the transfer.
More importantly, Announcement 72 asserts that if the seller enjoys the special tax treatment in the restructure, the buyer may not be able to utilize the treaty benefits for dividend distribution in the future. The buyer shall not be entitled to reduced dividend tax under a tax treaty if the distributed dividends come from the undistributed profits generated before the equity transfer. In this instance, Company B shall have the same tax position as Company A in terms of dividends distributed from the profits earned when Company A was holding the target. However, technically, the seller can choose whether to apply the special tax treatment or not. Such a rule seems to imply that the buyer may enjoy lower withholding rate for dividend distribution if no special taxation is selected by the seller.
After Circular 59 became effective, cross-border equity transfer was rarely granted with special tax treatment. Announcement 72 appears to give guidance to local tax officer in permitting “tax-free” cross- border restructure, but the taxpayers can either choose the “tax-free” restructure or the treaty benefits, but not both.
Structure II - transfer of the equity by a non-resident enterprise (Company A) of the equity of another resident enterprise (Company C) owned by the non-resident enterprise to a resident enterprise (Company B) in which Company A holds 100% direct controlling shares. held by a non-resident enterprise (Company A) to another non-resident enterprise (Company B) in which Company A holds 100% direct controlling shares.
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This structure can be commonly seen when a foreign investor tries to restructure all its China WFOE under a China Holding Company.
Filing Requirement and Procedures
The filing timeline for structure II is similar but the buyer, Company B, shall have the filing obligation, because under structure II, the buyer is a China tax resident and accordingly will be obliged to complete the filing obligation as a withholding agent for the seller.
The rules for structure II are comparatively simple and straightforward. There are few special conditions, as the shareholder of Company C will be changed from a foreign company to a domestic company. This leads to more control imposed by the Chinese government and there will additionally be no change in terms of future dividend withholding tax and capital gain tax.