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China Advisory: New Tax Circular Targets Gains Arising from Sale of Equity Interests in PRC Companies by Non-Residents - 国家税务总局关于加强非居民企业股权转
February 26. 2010
Edward J. Epstein
The State Administration of Taxation ("SAT") issued a Circular 698 on December 10, 2009. Circular 698 applies to the transfer of equity interests in PRC companies by non-resident shareholders, except transfer of stocks in PRC companies listed on public stock exchanges. Circular 698 imposes some new requirements which will impact M&A transactions in connection with the sale of the equity interests in PRC companies.
1. Tax declaration
Where the tax withholding agent of a non-resident which has transferred its equity interests in a PRC company fails to withhold the tax or is unable to withhold the tax, the non-resident must file a tax declaration in relation to such transfer with the competent tax authority in charge of the PRC company. This tax declaration must be filed within seven days after the effective date of the transfer. If the consideration is paid before the effective date of the transfer, the declaration must be filed within seven days after the consideration for the transfer is paid.
This is not a new requirement but gives teeth to previous tax laws and regulations.
Under the PRC Enterprise Income Tax Law, China sourced income of a non-resident is subject to a 10% withholding income tax in China and the payor has the responsibility to withhold the tax. However, the tax authority has realized that it is impossible to enforce that withholding obligation where the payor is also a non-resident. The SAT later issued a regulation on January 29, 2009 on the administration of tax withholding regarding non-residents' China sourced income. Article 15 of the January 2009 regulation provides that where the tax withholding agent of a non-resident fails to withhold tax or is unable to withhold tax, the non-resident shall be responsible for filing a tax declaration within seven days after the due date the withholding agent is required to pay the tax to the tax authority on behalf of the non-resident.
2. Reporting of offshore indirect transfer
Where a foreign investor indirectly transfers its equity interests in a PRC company by transferring the PRC company's offshore holding company and the offshore holding company is domiciled in a country or region which does not tax its residents' offshore income or where the tax rate is no more than 12.5%, the foreign investor must submit the following documents and information to the PRC tax authority in charge of the PRC company:
- Equity transfer agreement
- The relationship between the foreign investor and the offshore holding company in terms of finance, operation, sale and purchase and others
- Information related to the operation, personnel, accounting, assets and other information of the offshore holding company
- The relationship between the PRC company and the offshore holding company in terms of finance, operation, sale and purchase and others
- A statement to explain that the establishment of the offshore holding company serves reasonable business purpose
- Other information required by the tax authority
3. Reorganizations or Disposals involving multiple PRC Companies
Where a foreign investor transfers several on-shore or offshore holding companies at the same time, which results in the transfer of equity interests in PRC companies, each PRC company involved in the transfer is required to submit the master transfer agreement and specific transfer agreement for that particular PRC company to the competent Chinese tax authority. If there is no specific transfer agreement signed for that particular PRC company, that PRC company must provide the competent PRC tax authority detailed information of each of the on-shore or off-shore holding companies involved in the transaction and the value of the transaction correctly allocated to the equity interests in that particular PRC company. If the foreign company fails correctly to allocate the value of the transaction to the equity interests of each of the PRC companies being transferred, the PRC tax authority may adjust the transfer price.
4. Adjustment of transfer price
If the Chinese tax authority determines that a transfer of the equity interests in a PRC company is not at arm's length, it may adjust the transfer price for taxation purposes.
In addition, if the PRC tax authority determines that an offshore indirect transfer does not have reasonable business justification and it is aimed to avoid tax in China, the PRC tax authority may re-assess the nature of the transfer based on its economic substance and disregard the existence of the offshore holding company.
Circular 698 also sets forth various mechanisms for the calculation of gains arising from transfer of equity interests in PRC companies by non-residents.
Circular 698 is another example of the growing complexity of merger and acquisitions in China and the need for comprehensive legal and tax planning.