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The new DTA between China and Germany has been signed but is not yet in effect. If the ratification is completed in due time within the year 2014, the DTA would be applicable for withholding taxes from 1st January 2015 respectively for all other taxes for all tax years, which start on or after 1st January 2015. In the meantime the previous DTA is in effect until then.
In the following some major changes are summarized:
Intercompany Dividends
The withholding tax (WHT) for certain dividends is reduced from 10% to 5%. As a precondition, the beneficial owner receiving the dividends is a corporation (not in a legal form of a partnership) and directly holds at least 25% of the capital of the company distributing the dividends. Only direct equity interests are included in the calculation of the 25% threshold. Majority of the Germany business in China are “Wholly Foreign Owned Enterprises” (WFOE) Therefore in general the 25% threshold should not be an issue. In consequence it is advisable for German investors to distribute the profit after the new DTA enforced.
Permanent establishment (PE)
The period for constituting a PE for a building site, construction, assembly or installation project or supervisory activities connected therewith is now twelve months instead of the current six months.
Both DTAs include a regulation for service PEs. Even if no fixed place of business has been established, a mere service activity could still lead to constituting of a PE. But the current regulation for service activities caused many problems in China, based on the local interpretation of the 6 months threshold to establish a PE. According to the current DTA a part of a specific month has been considered as a full month in terms of calculating the PE threshold.
An improvement is that the threshold for establishing a PE by means of carrying out service activities will be 183 days (within a 12 month period) instead of current six months. This offers a clearer approach to count the day in the determination of the service PE. For the calculation of the 183 day-threshold only days with the presence of at least one employee are taken into account.
Royalties
For royalty payments which are received as a consideration for the use of, or the right to use, any industrial, commercial or scientific equipment the WHT is reduced from 7% to 6%.
Capital gains
Regarding the transfer of shares generally the country of residence has the right of taxation. But the new DTA also includes specific regulations:
• Gains derived from a German resident can only be taxed in China, if more than 50% of the value of the shares sold is derived from immovable property situated in the resident country of the subsidiary
• Gains derived from a German resident can also only be taxed in China, if the seller of the shares has directly or indirectly owned at least 25% of the shares in the corporation at any time during a twelve months period preceding the sale of the shares.
183 Day Rule
The 183 Day Rule is applicable for individuals that are resident in one state and work in the other state and derive income from independent personal services or employment. The main purpose of this rule is that employees will not be subject to the Individual Income Tax of this other state if they just work for a short time in the other state. In the current Chinese German DTA an individual exceeding 183 days in the calendar year in the other state, can be taxed in this other state. The new DTA changes the period in which these 183 days refer to. Now an individual exceeding 183 days in any twelve months period in the other state, can be taxed in the other state.
Example:
A German Individual works for his German employer in China from 1stJune to 20th June 01 (20 days) and from 1st October 01 to 31st May 02 (90 days) and from 25th June to 31st September 02 (97 days)
China can tax the Income referring to 1st October 01 to 31st September 02, as the employees stayed more than 183 day (here 187 days) in a twelve months period in China. But for the Income referring to 1st June to 20th June 01 China is not allowed to tax this income, as here the 183 days requirement within a twelve months period is not met.
Switch-over clause
In order to avoid of double non-taxation, a switch-over clause has been introduced for business income and dividend income. If a Chinese PE or subsidiary of a German corporation does not generate active income in the meaning of the German Foreign Tax Act (AStG), the switch-over clause is applicable. In this case the exemption method is then replaced by the tax credit method.
Conclusion:
The revision of the previous DTA between Germany and China (dated on 1985) was long overdue. Several European countries recently renegotiated their DTA with China. So the new DTA eliminates competitive disadvantages in comparison of Investors of other European countries. In particular the reduction of the WHT regarding intercompany dividends (previously 10% to 5%) is very much to be welcomed and represents a significant facilitation for German investors having profitable subsidiaries in China.
