The Tax team at CMS, China worked with Getting the Deal Through again this year and published an updated analysis in key areas of tax issues affecting foreign investors in China. The report consists of an updates and trends analysis and answers to a group of pre-set questions covering areas such as acquisition, step-up, transaction, stock issuing, insolvency proceedings, interest relief, restructuring, spin-offs, disposals, etc.
Update and trends
The foreign exchange regulations recently eliminated the restriction of using registered capital contributed by foreign investors to non-holding company foreign-invested enterprises (FIEs) for equity investment by the FIEs in China.
In the past, one of the conditions for qualifying for the special tax rules under which no capital gain tax is triggered was that the assets or shares for acquisition should be at least 75 per cent of the total assets or shares of the target company. Such percentage has now been reduced to 50 per cent.
During post-acquisition periods, the foreign affiliates or parent company may charge service fees or royalties to the Chinese target company as means of profit extraction. The newly promulgated tax regulations have clarified various tests to assess the deductibility of service fees before tax on the Chinese target company’s side under the service arrangements between the Chinese target company and the foreign shareholder or related parties. In particular, under the following situations, the charged ‘service fees’ are not tax-deductible:
- the service fees charged by overseas affiliates are for activities which are not relevant to the functions and risks undertaken by the Chinese company;
- the charged fees are for investment-related activities that directly or indirectly benefit the shareholders (eg, activities of controlling, managing and supervision of the invested companies);
- the services provided by affiliated companies overlap with the activities already conducted by the charged company itself or those purchased by the charged company from third parties;
- although the company benefits from being a member of a certain company group, it has not received specific services from overseas affiliates;
- the relevant activities of overseas affiliates have already been compensated for in other transactions; and
- other ‘service’ activities of overseas affiliates that do not bring benefits to the Chinese company.
In respect of royalties, the licence fee rate shall be determined considering the contributions made by the relevant parties in the creation of the intangibles as well as the extent to which such intangibles benefit the Chinese company.
The PRC State Administration of Taxation (SAT) has strengthened the subsequent administration of restructuring transactions to which special tax rules are applied. In addition, the transaction parties are no longer able to get confirmation from the tax authorities for the application of special tax rules.
In many cases, when a foreign investor decides to exit an investment in China, it may consider disposing the offshore intermediate holding company which holds the equity interests in the Chinese enterprise. During the past year, the SAT has clarified that the entity or individual who owes payment obligations to the share transferor (which would usually be the buyer) has the obligation to withhold the income tax for the foreign transferor within seven days of the withholding obligation arising if such indirect transfer of the Chinese company does not have reasonable business purposes and aims to avoid PRC income tax liabilities. The foreign transferor has the obligation to self-declare income tax to the PRC tax authorities if the withholding agent does not fulfil the withholding obligation in time. The SAT has also defined the ‘reasonable business purposes’ with various assessment factors, including but not limited to the source of the offshore share value, constitution of offshore intermediate holding company’s assets and incomes, function and risk of the offshore intermediate holding company and the Chinese enterprise, surviving period of the holding structure and business model, offshore income tax liabilities, scenario analysis of replacing the indirect offshore disposal with direct onshore disposal and relevant treaty arrangements.
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