Focus: Tax on sale of indirect interests in PRC companies by non-residents
4 February 2010
In brief: The PRC State Administration of Taxation has recently issued a circular stating that PRC non-residents may be liable to pay PRC tax when transferring offshore companies that directly or indirectly hold shares in PRC companies. Partner Campbell Davidson , Senior Associate Ross Keene and Consultant Wen Zhang report.
How does it affect you?
- Under the circular, the income from the indirect transfer of the shares in a PRC resident company by a PRC non-resident company may be subject to PRC enterprise income tax (EIT).
- A filing needs to be made with the PRC tax authorities if an offshore company that directly or indirectly holds a PRC company is transferred, and the actual tax burden in the relevant offshore jurisdiction on the transfer of the offshore company is less than 12.5 per cent (or no tax at all is imposed). The authorities will then decide whether to impose EIT.
- The circular applies retrospectively from 1 January 2008.
On 27 November 2008, the Chongqing State Tax Bureau published a decision under which PRC tax was imposed on the gains derived from the transfer of an offshore company.
The case involved the transfer by a Singaporean company of its wholly controlled Singaporean subsidiary (Sing co) to a PRC company. The sale realised a gain of more than RMB9 million. The Chongqing State Tax Bureau ascertained that Sing co's only asset was 31.6 per cent of the shares in a PRC company (PRC co) and Sing co had paid-in capital of only SD100 and conducted no activities other than holding shares in PRC co. Accordingly, the Tax Bureau concluded that the offshore transfer of Sing co was in fact an indirect transfer of the shares in PRC co, and that the income from such transfer should be subject to PRC tax.
This was the first time PRC tax authorities treated the income of non-resident companies (from the indirect transfer of shares in a PRC company) as income sourced from the PRC.
Since the Chongqing State Tax Bureau issued this decision, there had been much speculation as to whether the PRC State Administration of Taxation (the SAT) would take a similar approach.
The Circular on Strengthening the Administration of Enterprise Income Tax on the Income of Non-resident Companies from the Transfer of Shares (Circular 698) was issued by the SAT on 10 December 2009. It takes retrospective effect from 1 January 2008. Although in the PRC a circular does not have the same legal force as a law or regulation, a circular will indicate how the authorities (in this case, the SAT) will implement existing laws and regulations.
Under Circular 698, the income from the indirect transfer of the shares in a PRC resident company (other than a PRC listed company) may be subject to EIT.
Circular 698 states that if an offshore company (the Target co) is transferred, that offshore company directly or indirectly holds a PRC company, and the actual tax burden in the relevant offshore jurisdiction on the transfer of Target co is less than 12.5 per cent (or no tax at all is imposed), then the transferor must make a filing with the PRC tax authorities within 30 days of signing the transfer contract.
The information required to be lodged includes but is not limited to:
- the transfer contract or agreement;
- an explanation of the relationship between the transferor and the Target co, and between Target co and the PRC company, with respect to funding, operations, sales, distribution and so on;
- information as to the Target co's production and operations, personnel, financial affairs, assets and so on; and
- an explanation as to the reasonable commercial rationale for the establishment of the Target co by the transferor.
If the tax authorities conclude that there is no reasonable commercial rationale for the interposition of the offshore holding companies, and that this has been done simply to avoid EIT, the tax authorities may, with the approval of the SAT, disregard the offshore holding structures and recharacterise the transfer as effectively a direct transfer of the PRC company which is subject to EIT.
Under Circular 698, if the Target co has a number of direct and indirect subsidiaries including non-PRC subsidiaries, the total purchase price for the Target co will need to be allocated between the PRC subsidiaries and other subsidiaries.
Circular 698 also sets out how the transfer price and cost base are calculated for the purposes of calculating the income from the direct or indirect transfer of shares in a PRC resident company.
As with the recently issued Circular 601, by issuing Circular 698 the PRC tax authorities have made clear that they will look at 'substance over form' when analysing offshore holding structures for PRC entities. If the PRC tax authorities conclude, in the case of the transfer of an offshore company that directly or indirectly holds a PRC company, that there is no commercial rationale behind the establishment of the offshore holding structure apart from avoiding EIT, the tax authorities may impose EIT on the income from the transfer. It remains unclear as to the basis for a non-PRC resident to be taxed on the indirect sale of a PRC company and how the collection of this tax will be enforced. Notwithstanding this uncertainty, foreign investors should consider the impact of Circular 698 on offshore transfers implemented since 1 January 2008, and should also consider the likely impact of Circular 698 on future offshore acquisitions and disposals of companies that hold indirect interests in PRC companies.
- Charles ArmitagePartner, Practice Leader, Tax,
Ph: +61 2 9230 4756