The accounting books for the 2009 financial year are being closed. Foreign invested enterprises will be seeking to utilise double taxation agreements (DTAs) to reduce withholding taxes when making dividend payments to foreign holding companies. Since 2009, explicit approval is required to seek tax treaty benefits. Pursuant to China’s State Administration of Tax (SAT) circulars Guo Shui Han [2009] No. 81 and Guo Shui Fa [2009] No. 124, pre-approval from SAT is required before the reduced withholding tax is used.

The withholding tax rate on dividends is currently 10% under PRC domestic tax law. However, most investments into China are structured through one of China’s DTAs, most notably those where the withholding tax rate may be reduced to 5%: Hong Kong, Singapore, Mauritius, Barbados, Ireland, Lithuania, and Luxembourg, The recent circulars prescribe a host of requirements that must be met to enjoy treaty benefits.

In very broad terms, the requirements are:

• The recipient of the dividends must be a tax resident of the treaty partner jurisdiction;
• and The recipient of the dividends must be the beneficial owner of the dividends.

In accordance with Guo Shui Han [2009] No. 601 (Circular 601), the holding company should NOT be incorporated for the purposes of avoiding/reducing tax or shifting/parking profits and should engage in substantive business activities, otherwise it will not be deemed as the beneficial owner of the dividends and treaty benefits will be denied. The key determining factor in the SAT analysis will be whether the holding company is the beneficial owner of the income (see the list of negative factors employed by the SAT as released in Circular 601 at the end of this article) or whether it has been set up only as a conduit for tax avoidance purposes.

The same goes for the transfer of shares in foreign entities that directly or indirectly hold investments in China, when the foreign entities are domiciled in jurisdictions where there is no, or low, capital gains tax. Under recently released Guo Shui Fa [2009] No. 698, such transfers must be reported in China, and where the SAT judges there to be insufficient substance in the entity transferring the shares, they will deem the capital gain to have been made in China, and may charge a withholding tax equal to the capital gains tax. In an environment of increased SAT scrutiny, the message for foreign investors is that they should review their holding structures to ensure there is sufficient commercial substance (e.g., personnel, decision-making activities, etc.) and contemporaneous documentation to support that the business purpose and substance requirements are met.

Amicorp provides company secretarial, bookkeeping, tax filing, payroll, and account maintenance services and, most importantly, helps clients add substance to holding structures. Amicorp can assist in several areas to help companies avoid losing tax benefits in their holding structure:

Building a holding structure that has a valid commercial purpose, other than tax savings, is imperative. Valid commercial reasons could include:

Amicorp can help clients define the right commercial reasons appropriate to their business and its strategy, and prepare documentation to support the choice for a certain holding structure, which will build the commercial case for the structure.

When applying for treaty benefits, the documentation required by the SAT will provide them with the information they need to test whether there is substance in the structure. Amicorp can help clients ensure that the right level of substance is present by:

The key to providing substance in the holding structure is understanding how substance is determined by the SAT. Amicorp appoints only experienced local directors who understand the requirements in both the holding and subsidiary company jurisdictions. Experienced directors ensure that communication with the tax authorities is done correctly, providing the right information, at the right time.

Amicorp also coordinates holding and transactional services through a separate group of entities, where a third party holds the underlying investment on behalf of the client. As the third party holds multiple investments, has offices, local directors, employees, pays taxes in the holding jurisdiction, and meets other substance requirements, treaty benefits can be obtained under a contractual agreement.

Listing shares on a recognized stock exchange can be deemed as a valid commercial reason for setting up a holding company. Amicorp can assist clients in listing shares of their holding companies on a public stock exchange. This has an additional advantage of avoiding the reporting requirement under Circular 698 when transferring shares of a foreign entity directly or indirectly holding investments in China. The Circular states clearly that shares bought and sold on a public exchange are exempt from the reporting requirement.

As a leading global structuring solution provider, Amicorp provides a variety of other tailor-made solutions.

Circular 601 specifies that the beneficial owner must have the right of ownership and disposal over the dividend, interest and royalty income derived from China or the associated properties and rights for that income, and shall engage in “substantive business activities” such as manufacturing, trading and management activities.

The SAT will determine whether the entity claiming benefits is indeed the beneficial owner of the income by evaluating the documentation and assessing the company resident in the treaty jurisdiction against the following set of negative factors: