Nov. 17 – The State Administration of Tax has issued new guidelines on the determination of the “beneficial owner” during the application of double tax treaties with China.

According to Circular Guoshuifan (2009) 601, effective from October 27, 2009, any applicant who fails to substantiate that they are a beneficial owner will be denied treaty benefits.

Many offshore jurisdictions have been used to establish corporate enterprises in China and to date the beneficial ownership of these has generally not been challenged by the Chinese tax authorities. However, tax rulings on recent cases concerning withholding tax imposed on capital gains derived from the disposal of their Chinese investments have implied that tax beneficial treatments may not necessarily be applied.

This circular can affect property for investment held by as offshore entity such as the British Virgin Islands, Seychelles and other similar offshore tax havens, and potentially also businesses whose China subsidiary entities are also held in such jurisdictions. In one case, the tax benefit applicable was denied to a Barbados registered entity as the beneficial ownership was not declared. The Chinese authorities have now adopted the “substance over form” practice of general anti-avoidance guidelines in such cases.

Under the circular, a “beneficial owner” is defined as a person who owns or controls income or the rights and assets deriving from income. This person can be an individual or a company. The circular specifies that neither agent nor conduit company can be the beneficial owner. It further defines the “conduit company” as being established for the purposes of tax avoidance or reduction, profits transfer or accumulation. Under the circular’s definition, the company only exists as a legal entity as a registration and does not have operations such as manufacturing, trading or management; placing it instead as an investment company.

The implications dictate that when applying for tax relief under an applicable treaty, the applicant should provide supporting documentation to substantiate it is the beneficial owner. In practice, it means that investors looking at such entities in China should determine that such a structure does not trigger treatment as an investment company and nullify the benefits of the treaty. For investors with such an existing structure, advice needs to be sought to ensure whether the current structure is now sufficient or if changes need to be made to continue to qualify for tax treaty benefits.

For more information concerning China’s tax regulations in relation to offshore entities, please email Sabrina Zhang, the national tax partner for Dezan Shira & Associates, at tax@dezshira.com.