CMS Tax Connect Flash | China tax regulation update

New requirements for Foreign Invested Chinese Holding Companies (“HoldCo”) to reinvest their earnings in China

Circular Number: SAFE Circular [2011] No. 7 Issuance & effective Date: 2011-3-29

Circular issued by the State Administration of Foreign Exchange (“SAFE”) to its local branches regarding new requirements for Foreign Invested Chinese Holding Companies (“HoldCo”) to reinvest their earnings in China. This is a SAFE Circular, not a Tax Circular. However, it has important tax implications for HoldCos in China.

HoldCos are allowed to use their earnings to reinvest in China by establishing new companies or increasing the registered capital of its existing subsidiaries.

The new SAFE Circular now requires a HoldCo to first use its earnings to increase its own registered capital before it can reinvest the same amount in China.

This means the foreign investors of HoldCos will have to pay 10% withholding tax in China because converting earnings into registered capital is regarded as a dividend distribution followed by a reinvestment of such dividends.

Corporate Income Tax (“CIT”) rate for High and New Technology Enterprises (“HNTEs”) for their overseas income

Circular Number: Tax Circular Caishui [2011] No. 47 Issuance & Effective Date: 2011-5-31

HNTEs are entitled to a reduced CIT rate of 15%. This Tax Circular further clarifies that the 15% CIT rate also applies to their income sourced outside of China.

Individual Income Tax (“IIT”) for foreign individuals on dividends from Chinese B shares and overseas listed Chinese companies

Circular Number: SAT Announcement [2011] No.24 Issuance & Effective Date: 2011-1-4

The SAT Announcement 2011 No.2 provides two lists of old Tax Circulars which were either fully abolished or partially abolished. However, the impacts are only felt now by the capital market due to the abolishment of the Tax Circular Guoshuifa [1995] No. 45 (“Circular 45”).

Circular 45 provided that foreign individual investors should be exempted from IIT in China for dividends received from B-share companies and Chinese companies listed in overseas stock markets.

Starting from 2011, with the abolishment of the Circular 45, B share companies deduct 10% IIT from the dividends paid to foreign individual investors.

Foreign individuals holding shares in overseas listed Chinese companies may face the disadvantage of being taxed 20% for the dividends. The Chinese standard IIT rate for dividends is 20%. Under the still valid Tax Circular Caishui [2005] No. 107, dividends from “listed companies” shall be taxed at 10% IIT. However, the “listed companies” mentioned in Circular 107 refer to companies whose shares are traded in the Shanghai or Shenzhen Stock Exchange, not including any other stock markets. Under most Double Taxation Treaties, dividends are taxed at a lower rate of normally 10%. However, it might be administratively troublesome for foreign individuals to apply for a lower treaty rate.

Another Tax Circular which is still valid makes the above tax issues further complicated. According to the Tax Circular Caishuizi [1994] No. 20 (“Circular 20”), dividends received by foreign individuals from foreign invested Chinese companies (“FIEs”) shall be exempted from IIT. Since many B-share companies and overseas listed Chinese companies are officially registered in China as FIEs, as long as Circular 20 still applies, IIT shall still be exempted for the moment. However, in light of Circular 45, it is unclear whether the tax authorities in charge of B-share companies and overseas listed Chinese companies will continue to implement Circular 20.