China: Two cases of income tax in non-resident enterprises equity transfer

Recently, there are two cases posted on the homepage of SAT (State Administration of Taxation of the People’s Republic of China) on transfer of equity ownership of resident enterprises between the non-resident enterprises. This indicates that the SAT is paying attention to the taxation of non-resident companies and is also wishing to tighten management and control transactional tax on transfer of equity ownership by non-resident enterprises. Through the tightening of controls, the SAT would effectively prevent and mitigate the losses of tax revenue. Before going into details of the two cases, let us refresh concept and related tax law governing the activities of non tax resident enterprises. 

Tax Resident Enterprise (“TRE”) 

The new Corporate Income Tax(CIT) law effective from 1 January 2008 introduces Tax Resident Enterprise (“TRE”) concept. TRE refers to an enterprise established according to the Chinese law or an enterprise established according to foreign laws but with its effective management located in China. TREs are subject to CIT on worldwide income while non-TREs only on China sourced income. Enterprise registered in China are always TRE. A foreign enterprise with effective management in China may also be regarded as a TRE. The standard CIT rate is 25%. 

CIT of non-TRE 

Withholding income tax (“WHT”) will apply on passive income derived by Non-TREs. The WHT rate is 20% under the CIT Law and is reduced to 10% under the Detailed Implementation Regulations (“DIR”) of the CIT Law. Under the DIR the unilaterally concessionary WHT rate is applicable to dividend, interest, rental, royalty, and other passive income such as the gains from the sale or transfer of real estate property, land use right and shares in a PRC company. Dividends distributed by a FIE out of its pre-2008 profit are exempted from WHT. WHT rates may be lower than 10% or exempted under certain double tax treaty. For gain on transfer of equity interests of a foreign owned TRE (e.g. WOFE), the applicable WHT rate is 10 %. 

Case 1 

Location: Kunshan Suzhou, Jiangsu Province 

IRD: Suzhou local taxation bureau (China’s tax administration) 

The Non-resident, a company established in the British Virgin Islands, transferred its equity of a resident enterprise at book value. Both transferor and transferee are non-resident of China and the transfer and payment of the consideration are also outside of China. The local tax bureau questioned the transfer price and hence inspected the details of the transaction. However, the respondent objected the tax decision and the revised taxes proposed by local tax bureau. The tax officials enforced their judgement and decision with reference to the following rules: “Income Tax Law and Implementation Rules of the People’s Republic of China”, “The announcement on adjusting the scope of the new enterprise income tax collection and administration issues (new enterprise, established after 2009)”, “Implementation Measures for Special Tax Adjustments (Trial)”. Finally, Kunshan local tax bureau and the respondent agreed a valuation for the transfer of the equity based on “Risk identification model”, which was approximately RMB106,000,000. The relevant taxable base for the transaction was therefore calculated on RMB106,000,000 after deduction of acquisition cost, and the final Income tax payable was approximately RMB6,416,900, and the interest charged was approximately RMB300,540. 

“Risk identification model” mentioned above is referred to “identification of risk on income tax of equity transfer”. This is based on asset valuation and economic value with its key factors that may influence the value of equity transfer. The main index in the model includes: 

First level index:

(1) Disparity in tax amount reported 

Second level index: 

(2) The Proportion of investors’ equity holdings; 

(3) The appreciation of land; 

(4) The appreciation of building;

(5) The appreciation of construction in progress; 

(6) The appreciation of inventory; 

(7) The investment income recognized. 

The above indexes serve as reference to detect the risk of income tax variation upon equity and share transfer by either non-resident individuals or enterprises. Tax officials, using this analysis and model, can determine the fair and equitable valuation for the equity transfer, especially in the circumstances of inactive market. 

Case 2 

Location: Yuhang Hangzhou, Zhejiang province 

IRD: Yuhang SAT 

Recently, an International Holding Group established in HKSAR paid income tax of RMB10,615,900 for an equity transfer transaction. The case was Yuhang SAT’s first case of collection of income tax of equity transfer from a non-resident enterprise, and it was also the first of its kind with collection of income tax over ten million RMB in respect of equity transfer in the Zhejiang Province. 

In January 2012, Yuhang SAT found that 40% of the equity of a resident enterprise was sold by its parent company, a company established in the British Virgin Islands, and the transferee was also a non-resident enterprise. According to the Income Tax Law and Implementation Rules, and its related regulations, this transaction involved the transfer of equity ownership by foreign investor to a non-resident enterprise and therefore the relevant income tax of Equity Transfer should be accounted for according to the rules. After the Yuhang SAT inspected the details of the transaction, and two years of negotiation with the international holding group, finally the SAT and the tax payer agreed on the transfer price and its relevant cost, and the transferor agreed to settle income tax of RMB10,610,000. 

In the year 2013, Yuhang SAT collected a total of RMB483,000,000 taxes from non-resident enterprises, which was 47.73% higher than last year. In order to obtain sufficient information on non-resident enterprises and to improve the tax collection from non-resident enterprises, Yuhang SAT carried out continuous exchange of information with the local Administration for Industry and Commerce and the local Administration for Foreign Trade and Economic. The SAT again effectively prevent and mitigate the losses of tax revenue from non-resident enterprises.