Potential for withholding tax on repatriation of dividends?

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By Chris Devonshire-Ellis 

July 24 – A question has been raised concerning an omission that has occurred within China’s new corporate income tax (CIT) law which could mean withholding taxes being levied on the repatriation of after-tax profits for overseas businesses with foreign invested enterprises in China.

Not yet commented on elsewhere, (eagle eyed Dezan Shira & Associates tax lawyers please take a bow), the new CIT laws state that under the existing foreign enterprise income tax (FEIT) law, Withholding tax (WHT) on dividends from foreign investment enterprises (FIEs) to their foreign investors is exempted, while the WHT rate for other passive income (royalties, service fees and so on) is provisionally reduced from 20 percent to 10 percent. The new CIT law states that the standard WHT rate will be 20 percent. However, it is silent on whether or not the existing dividend WHT exemption and rate reduction would be kept intact. It merely states that the State Council may make a call to exempt or reduce WHT for particular types of passive income.

This raises an interesting point of tax law, as the implications are that a mechanism now exists within the CIT to levy withholding tax on after-tax profits to be distributed to an overseas parent company, should the State Council so decide.

The effect would be an FIE contributing income tax in China at the standard rate of 25 percent, yet a further 20 percent then being levied in withholding tax charges to repatriate to the overseas parent as a “service.” This has been further compounded by comments elsewhere that suggest the State Administration of Tax has indeed been looking into this matter. Mindful that many foreign governments levy higher amounts of income tax on their domestic corporations than China does, we are aware that discussions have indeed taken place over the use of double tax treaties to look at the Chinese SAT collecting on any residual balances due that would have previously been collected by the foreign exchequer. Bilateral tax treaties could be used to permit collection of revenues by one government on behalf of another, and there are many tax authorities, such as the IRS, who are actively pushing for greater international collection cooperation.

Could the SAT collect money from American businesses in China, at the applicable U.S. corporate tax rate, keeping its own 25 percent tariff and then passing the rest to the IRS? It would be a novel way of helping fend off trade imbalance problems.

While any action on this is unlikely, and we suspect would be seriously challenged by the Ministry of Commerce who would not wish to see an effective tax rate of close to 45 percent for FIEs in China, the interesting observation is that does not now require a change in China’s tax law to implement this policy.

The ability to collect withholding tax on payment of dividends overseas exists, it is now purely a matter for the State Council as to whether or not they wish to implement this, and in this manner, the SAT has been rather smart in outwitting MOFCOM to get it through as law.

However, foreign investors can breathe easy at the moment. It is one issue for the legal ability to levy withholding taxes on dividends to exist. It is quite another to implement this, and with State Council approval required, plus a well-thought recent income tax policy at 25 percent having been agreed earlier this year, the SAT are not going to be levying taxes on dividends any time soon. But – and here is the point – they could, if the State Council votes to implement it.

It all rather reminds me of my question to Zhang Ziyang at the SAT recently on the collection of individual income tax on worldwide earnings for expatriates if they have stayed in China for longer than five years. “Have you” I asked, “ever collected worldwide income according to this regulation from any foreigner?” The answer was a somewhat bashful no. However the point is, they could.

They could also levy withholding tax on dividend repatriation – and the opportunity to do so has been created. Look out for signs of bilateral double tax treaty negotiations going on as an indicator as to when the State Council may wish to pull that particular trigger.

Hopefully, rather like the collection of worldwide income on expatriates, it will remain as a potential liability, yet not one that is actually enforced any time soon.