China Clarifies the Determination of Beneficial Owners under Double Taxation Agreements

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Recent reports in the media implicating a reduction in withholding tax rates are misleading and inaccurate. There is definitely no tax cut, however certain relief situations apply that can instigate decreased liabilities.

Jul. 18 – Over the past 20 years, China has entered into various DTAs with its foreign counterparts in order to avoid double-taxation regarding dividends, interest and licensing fees, as well as other income. Recently, China’s State Administration of Taxation (SAT) released the “Circular Regarding the Determination of ‘Beneficial Owners’ under Double Taxation Agreements (‘DTAs’) (gonggao [2012] No.30, hereinafter referred to as ‘Circular 30’),” aiming to avoid double-taxation and appropriately reduce tax burdens by clarifying the determination of beneficial ownership. Recent reports in the media implicating a reduction in withholding tax rates are misleading and inaccurate, as there is definitely no tax cut.

Pursuant to the previously released Circular 601 (guoshuihan [2009] No.601), an applicant has to satisfy strict requirements in order to qualify as a beneficial owner, which is a pre-requisite to enjoying the benefits of reduced withholding tax on dividends, interest and licensing fees under DTAs. Circular 601 lists several factors that may adversely affect an applicant in applying for recognition as a beneficial owner, such as low number of staff, smallness in scale and absence of business operations. However, most companies that wish to avail relief from PRC withholding tax on dividends have failed to meet the standards established in Circular 601. Moreover, uncertainties arise when local authorities implement different approval approaches and standards in the determination of beneficial ownership, giving rise to administrative complications.

Circular 30 addresses these issues by setting up clearer guidance in identifying beneficial ownership. According to Circular 30, when authorities are determining whether beneficial ownership exists, the analysis can be based on a number of documents, such as:

  • Articles of association
  • Financial statements
  • Board minutes and resolutions
  • Functional analyses
  • Loan contracts
  • Transfer contracts
  • Asset ownership certificates
  • Invoice registers

More importantly, it points out that tax authorities should not make a decision to approve or reject the recognition based on the mere existence of certain adverse factors, or the absence of ”the purposes of evasion or reduction of tax, or transfer or accumulation of profits.”

Moreover, Circular 30 relaxes the strict requirements of the beneficial owner under Circular 601. According to Circular 30, when claiming relief from PRC dividend withholding tax, a company that is a tax resident of a DTA partner state and is listed in that jurisdiction will automatically qualify as the beneficial owner, regardless of the assessment outcome based on Circular 601. The relief also applies to subsidiaries that are 100 percent directly or indirectly owned by the listed parent and are tax residents of the same DTA partner state. The only exception is where the subsidiary is indirectly held by the listed parent through an intermediate holding company which is not a tax resident of the DTA partner state.

Circular 30 further clarifies that, where an “agent or designated payee”, regardless of residency, receives income on behalf of the applicant, recognition of the true beneficial owner will not be affected. However, the agent in question is required to disclaim its beneficial ownership of the China-sourced income.

According to Circular 30, if the tax authority is unable to make a decision within the designated time due to the difficulties in the process of identification, the tax authority can temporarily suspend the granting of DTA relief. If the treaty benefit claim is later proved to be justified, the tax authorities should return the overpaid withholding tax to the claimant.

Finally, where a tax bureau in charge rejects DTA relief claims on the grounds of a lack of beneficial ownership, the bureau is required to report to and obtain approval from the tax bureau at the provincial level. The provincial level bureau should then report the case to the international tax division of the SAT for filing purposes. Where a DTA relief claim requires approval from several tax bureaus, these tax bureaus should reach a unanimous decision through consultation. If a consensus cannot be reached, tax bureaus involved in the decision should report the case up to a common higher level tax authority.

It is anticipated that the relaxing changes will help companies save billions of dollars worth of tax payments, as it is now much simpler and quicker for them to obtain “beneficial owner” status and thus enjoy withholding tax rates under DTAs (usually ranged from 5 percent to 10 percent, depending on the owner’s country of residence). This may enable China to attract more foreign investment and could ultimately boost the country’s economy.

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