China has clarified the definition of beneficial owners in the provision of tax treaty dividends. The new requirements have been effective since 1 April 2018.
In 2009, the State Administration of Taxation (SAT) issued Circular 601, a unilateral interpretation of the beneficial ownership concept in China's bilateral income tax treaties.
Circular 601 has made it difficult for non-Chinese multinational corporations (MNCs) to derive dividends, interest or royalty income from China and benefit from lower withholding tax rates under China's income tax treaties.
The income recipient must perform substantial business activities in its country of tax residence and cannot be viewed as an alternative for the multinational corporations to enjoy these tax benefits.
Although the SAT issued additional guidance on beneficial ownership in Bulletin 30, Circular 165 and Bulletin 24 in 2017, things were still difficult for the MNCs.
The introduction of Bulletin 9 does not fundamentally change the underlying principles of beneficial ownership determination in Circular 601, but it provides more detailed guidance on how the beneficial ownership test should be applied in practice.
Highlights of Bulletin 9
Circular 601 contains seven factors that are considered by the tax authorities in determining whether a 'recipient' of China-source income is a beneficial owner under a tax treaty.
There are now only five (negative) factors that could determine whether an applicant can qualify as a beneficial owner, or not, under the new Bulletin 9. The MNC will not qualify if it does any of the following.
- The recipient pays more than 50% of the income to a resident(s) of a third jurisdiction within 12 months after it receives the income.
- The business activities carried out by the recipient of the income do not qualify as substantive business activities, including substantive manufacturing, trading and management activities. Whether the recipient has carried out substantive business activities will be made based on the functions performed and risks assumed by the recipient. Substantive investment management activities can qualify as substantive business activities.
- The recipient is exempt from tax on the relevant income or the income is not taxable in the residence jurisdiction, and if the income is taxable, the effective tax rate is extremely low.
- On top of a loan agreement under which interest arises and is paid, the creditor has concluded another loan agreement or deposit agreement with a third party containing similar terms such as the amount, interest rate and signing date.
- A license or transfer agreement exists between the non-resident and a third party relating to the transfer of the ownership of, or right to use, the copyright, patent or technology covered by the license agreement, based on which a royalty is derived and paid.
Safe harbour requirements
Bulletin 9 also expands the scope of the safe harbour to include dividends received by the following:
- the government of the other contracting state;
- individuals resident in the other contracting state;
- companies that are wholly owned, directly or indirectly, by such listed company, government or individual.
However, the intermediary shareholder(s) cannot be a resident in a third jurisdiction.
Other ways to qualify as a beneficial owner
Bulletin 9 allows a dividend recipient to qualify for the tax treaty benefits in the country even if the recipient does not qualify for the status of safe harbour or beneficial owner as long as certain requirements are met.
The bulletin provides that the recipient be recognised as a beneficial owner if it is 100% owned directly or indirectly by a shareholder whom meets the requirements based on an assessment of the five negative factors listed above.
Even when a recipient of China-source income qualifies as the beneficial owner, the tax authorities still can invoke the main purpose test under a tax treaty or the general anti-avoidance rule (GAAR) in domestic tax law.
This could potentially result in the denial of treaty benefits. Some of China's recent tax treaties include a main purpose test that either applies to the entire treaty or only to specific provisions (dividends, interest and royalties).
Talk to TMF Group
Beneficial owner status has been an interesting topic among taxpayers and multinational corporations in China. Bulletin 9 has made the regulations more comprehensive for the businesses and taxpayers.
However, it is not an easy task to navigate through the complex regulation procedures. TMF China works with companies, large and small, to meet their local and global accounting and tax requirements by offering a full CFO suite of services.
Want to know more? Talk to us.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
