Holding companies and China investment
In spite of China’s Double Taxation Avoidance Treaties (DTAT) with many countries, the value of using offshore holding companies to obtain DTAT relief has been called into question by the country’s ongoing release of tax anti-avoidance measures.
Since enactment of China’s 2008 Enterprise Income Tax Law, a default withholding tax rate of 10% has generally applied to passive income obtained through investment by foreign entities. However, some of China’s DTATs provide for lower withholding tax rates (such as those with Singapore, Hong Kong, Ireland and Mauritius), and some provide for reduced or zero capital gains tax when shares in a foreign invested enterprise (FIE) are sold or transferred. Therefore, many foreign entities have been investing in China through holding companies in DTAT favourable locations.
In 2009, China’s State Administration of Taxation (SAT) released several bulletins containing guidance to help local tax authorities identify tax avoidance through ‘treaty shopping’ by overseas companies. SAT confirmed that to qualify for DTAT relief, the beneficial owner of China-sourced income (e.g. a dividend paid by an FIE to an offshore holding company) must not only control the income and property of the China entity, but also must have business substance, such as having sales or manufacturing functions in addition to holding the investment in China. While ‘business substance’ was not clearly defined, several negative factors that would indicate a lack of business substance were identified, including if the holding company:
Further clarity offered
- remits 60% or more of its income to a party in a third country within a 12-month period;
- has few or no business activities other than holding the rights to the China-sourced income;
- has limited management, staff, assets and business scope;
- has minimal risk, control and decision-making rights over the China-sourced income or underlying assets;
- has income that is non-taxable or subject to a low effective tax rate; or
- has interest or royalty income that by contract is directly passed through to its parent company.
Confusion over how the 2009 guidance should be implemented led to many legitimate applications for DTAT relief being denied, which in turn prompted SAT to release further clarifications in 2012. It is now clear that if a parent company is tax resident and listed on an exchange of a DTAT country, the company is automatically considered the beneficial owner of China-sourced income and DTAT relief is granted. Additionally, if the listed parent company uses a wholly owned subsidiary, e.g. a holding company, tax resident in the same jurisdiction, the beneficial ownership of the China-sourced income will not be called into question by the Chinese tax authorities.
A Singapore tax-resident parent company listed on the Singapore exchange may wholly own a Singapore holding company that owns 100% of a China FIE. The Singapore holding company is automatically considered the beneficial owner of the FIE, even if the holding company lacks other business substance.
It is important to note that the business substance conditions continue to apply when a listed parent company resident in one tax jurisdiction uses a holding company tax resident in a different tax jurisdiction. However, a 2013 SAT clarification states that China’s tax bureaus must consider the ‘totality’ of the substance and form of the holding company. Existence of one negative factor should not be sufficient to deny beneficial ownership and thus DTAT relief.
The Hong Kong subsidiary of a parent company that is listed and tax resident in the US would need to prove its business substance in order to be accepted as the beneficial owner of any China-sourced income. This would be the case even if the US parent company is listed in Hong Kong, unless the parent company is both listed and tax resident in Hong Kong.
Regardless of the corporate and/or holding structure used for China investment, the beneficial owner should provide appropriate supporting documentation when applying for DTAT relief, such as financial statements, asset ownership certificates, articles of association, board resolutions and other documents that may support claims of business substance.
Use of an agent
Another important 2012 clarification relates to the use of an agent that collects China-sourced income on behalf of a foreign investor. Regardless of whether the agent is tax resident in the same country in which the principal is tax resident, the local Chinese tax authority will consider the principal as being the beneficial owner and apply DTAT protections according to the principal’s tax residence. In this case, however, the agent must submit documentation to disclaim ownership of the income.
It’s worth noting that where an application for DTAT benefits cannot be completed in the allotted time period, the local tax bureau may temporarily apply the higher withholding tax rate. The additional tax paid will be refundable when, and if, the beneficial ownership is confirmed and DTAT relief granted.
What are the benefits?
Despite clarifications from SAT, the question of whether or not an offshore holding company structure is beneficial remains. The business substance considerations must be taken into account if the sole purpose of a holding company is to obtain DTAT relief on China-sourced income – in some cases this structure will offer no tax benefit. A holding structure may, however, be beneficial for other legal or strategic purposes, and each case must be evaluated on its particular merits.
For more information, contact:
Nexia TS, China
T +86(21) 6390-6000
Nexia TS, China
T +86 (21) 6390-6000