China Tax Risks in Indirect Equity Transfer: A Case Study

Posted by Written by Amber Liu Reading Time: 5 minutes

In this article, we explain what an indirect equity transfer is and explore the corresponding tax risks in China by studying a typical case.

When transferring equity interests in a Chinese company, most non-resident enterprises may prefer adopting an indirect equity transfer structure, for the purpose of saving tax or reducing potential red tape in the process.

Indirect equity transfer, as the name suggests, pertains to a situation in which a non-resident enterprise disposes of its equity interests in another non-resident enterprise that directly or indirectly owns certain assets or equity interests of a Chinese entity. The result of this disposal is considered equivalent to a direct transfer of the assets or equity interests of the Chinese entity.

While it is true that mergers and acquisitions (M&A) at the non-China entity level could be more convenient in terms of procedures, an indirect equity transfer will also result in capital gain taxation in China, especially with Chinese tax authorities intensifying their anti-tax avoidance efforts.

In 2015, the State Taxation Administration (STA) released the Announcement on Several Issues Relating to Corporate Income Tax (CIT)  on Transfer of Assets between Non-resident Enterprises (STA Announcement [2015] No.7). This announcement clarified the tax policies regarding the indirect transfer of Chinese equity. If an offshore indirect equity transfer lacks a reasonable commercial purpose, it will be redefined as a direct transfer of equity of Chinese resident enterprises, and Chinese tax shall be imposed accordingly.

Case study of China tax risks in indirect equity transfer

Basic information of the transaction

Company P is a limited liability company incorporated in China, whose assets are mainly composed of land usage rights. It is wholly owned by Company Q, which is Hong Kong resident and mainly engaged in warehousing services, operation and management of warehousing facilities, and related consulting services.

As Hong Kong adopts a territorial principle in taxation, Hong Kong resident entities are generally not required to pay taxes for their worldwide incomes (profits derived from sources outside Hong Kong) in Hong Kong.

In a routine tax inspection, the local tax bureau in charge found that the legal representative of Company P was changed from Person A to Person B in July 2019, and all except for one senior executive had been replaced, although Company Q remained the sole shareholder.

After further investigation, the tax bureau in charge found that at the end of 2018, Company A, the sole shareholder of Company Q transferred 100 percent of its share in Company Q to a Singapore Company B.

Tax result of this transaction

According to Article 4 of the STA Announcement [2015] No.7, the tax bureau conducted an in-depth analysis of the transaction and concluded that it was an indirect equity transfer without reasonable commercial purposes, but solely for circumventing the Chinese tax liabilities.

Article 4 of STA Announcement [2015] No.7:

Except for circumstances stipulated in Article 5 and Article 6 of this Announcement, where the overall arrangements in relation to indirect transfer of taxable assets in China satisfy all the following circumstances, the transaction shall be deemed straight away as not having a reasonable commercial objective, without the need to undergoing analysis and determination pursuant to Article 3 of this Announcement:

(1) 75% or more of the value of the equity of the overseas enterprise is sourced directly or indirectly from taxable assets in China;

(2) At any point in time within the year preceding the occurrence of the indirect transfer of taxable assets in China, 90% or more of the total assets of the overseas enterprise (excluding cash) comprise direct or indirect investments in China, or 90% or more of the income derived by the overseas enterprise within the year preceding the occurrence of the indirect transfer in China is sourced directly or indirectly from China;

(3) Although the overseas enterprise and its subsidiaries and branches in China which hold taxable assets in China directly or indirectly are registered in a country (region) in an organisation form which satisfies the requirements of the law, but their actually performed functions and risks borne are limited and insufficient to prove that they have economic substance; and

(4) The income tax payable overseas for the indirect transfer of taxable assets in China is lower than the possible tax burden in China in the event of direct transfer of the taxable assets in China.

The tax bureau in charge recharacterized the transaction according to Article 47 of Corporate Income Tax Law of the People’s Republic of China and decided to tax it as that of a direct equity transfer, under which Company A was required to pay more than RMB 4 million (approx. US$560,000) of CIT in China for its indirect transfer of its equity rights in Company P.

Article 47 of Corporate Income Tax Law of the People’s Republic of China:

Where the taxable income or amount of income of an enterprise is reduced as a result of arrangements with no reasonable commercial objectives implemented by the enterprise, the tax authorities have a right to make adjustments according to a reasonable method.

Policy analysis

As introduced earlier, the STA Announcement [2015] No.7 is a specific regulation released by the Chinese tax authority regarding the indirect transfers of equity in a Chinese entity by overseas enterprises, aiming to combat unreasonable tax avoidance arrangements.

According to Article 1 of STA Announcement [2015] No.7, when a non-resident enterprise conducts an indirect transfer of assets, such as the equity of a Chinese resident enterprise, through arrangements lacking a reasonable commercial objective to evade corporate income tax payment obligations, the indirect transfer shall be redefined as a direct transfer of assets in accordance with the provisions of Article 47 of the Corporate Income Tax Law.

Moreover, under the STA Announcement [2015] No.7, when determining whether the indirect equity transfer has reasonable commercial purpose or not, several factors need to be taken into consideration, rather than depending on a single factor. These factors are:

  • Whether the main value of equity in the foreign entity is made up of taxable assets in China.
  • Whether the assets of the foreign entity are mainly comprised of investments in China, or whether its income is mainly sourced from China.
  • Whether the corporate structure has economic substance, considering the functions performed by the foreign company and the risks it bears. This is typically assessed by examining related companies’ equity structure, assets, staff arrangements, income, and other operational information.
  • The duration of the foreign company’s business model, shareholders, and organizational structure. The tax authority looks for ‘traces of a plan to avoid tax,’ such as the establishment of an intermediary company shortly before the indirect transfer, which could indicate an attempt to evade tax through foreign corporate structures.
  • Whether foreign taxes are being paid on the transaction. The tax authorities assess whether the transaction results in cross-border tax advantages for both the transferring and receiving parties. If the tax burden is less than what would have been paid in China, it may attract attention from Chinese tax authorities.
  • Whether the transaction could have been substituted by a direct transfer. The tax authorities will consider a variety of matters to determine whether not transferring assets directly serves a reasonable business purpose, such as market access, the need for a review of the transaction, compliance requirements for the transaction, and the goal of the transaction.
  • Whether China has a Double Taxation Avoidance Agreement with the states in question, or other tax reducing arrangements relevant to the case.
  • Other matters deemed relevant.


Since the issuance of STA Announcement [2015] No.7, non-resident enterprises aiming to reduce their tax burden by indirectly transferring the equity of Chinese resident enterprises are strongly advised to evaluate the tax risks in China before proceeding with the transfer. If, upon self-assessment, the transaction is likely to be deemed as lacking reasonable commercial objectives, the indirect equity transfer may not only fail to save on tax costs but also result in increased scrutiny and additional penalties.

In such situations, Chinese resident enterprises should fulfill their reporting obligations and collaborate with tax authorities and non-resident shareholders to establish effective communication among all relevant parties, thereby minimizing tax risks.

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