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China tax for foreign corporate investors investing in the stock of Chinese listed companies
In the time when the global stock markets are suffering heavily since the last quarter of 2008, the Chinese State Administration of Taxation ("SAT") has issued new circulars to reinforce the collection of Withholding Income Tax ("WHT") on the income to foreign investors derived from the Chinese listed companies' shares.
The relevant SAT circulars are:
- Guoshuihan [2008] No.897 ("Circular 897") issued in November 2008 addressing the WHT treatment on dividends from H Shares; and
- Guoshuihan [2009] No.47 ("Circular 47") issued in January 2009 addressing the WHT treatment on dividend, bonus profits and interest derived by Qualified Foreign Institutional Investors ("QFIIs").
In this Issue, we will share with you the salient points of these new circulars, our observations, as well as some critical outstanding issues in these circulars.
Recap of the former tax rules and practice
Foreign corporate investors are allowed to invest in Chinese listed companies' shares of the following categories:
- Overseas Listed Shares (e.g. shares listed in the Hong Kong Stock Exchange, also known as H Shares, shares listed in the New York Stock Exchange, also known as N Shares, etc.);
- B Shares (i.e. shares listed in the Chinese stock exchanges for subscription by foreign investors); and
- A Shares (i.e. shares issued in the Chinese stock exchanges for subscription by Chinese companies and individuals). Foreign corporate investors can only invest in A Shares via QFIIs.
(Note: Foreign individual investors investing in the Overseas Listed Shares and B Shares are governed by a separate tax regime, i.e. the Individual Income Tax Law. The relevant China tax implications for these foreign individual investors are not covered in this News Flash.)
Under the former Foreign Enterprise Income Tax ("FEIT") Law, foreign corporate investors were specifically exempted from WHT in respect of dividends payable from Overseas Listed Shares and B shares, as well as transfer gains arising from the sales of these shares in accordance with an SAT circular issued back in 1993 (Guoshuifa [1993] No.45) ("Former Circular 45"). However, there had not been any clear WHT exemption policy for income from A Shares invested by QFIIs under the FEIT regime. Nevertheless, as a matter of practice, the Chinese tax authorities did not collect any WHT on the income to the foreign corporate investors derived from all these shares.
Since the new Corporate Income Tax ("CIT") Law effective 1 January 2008 does not clearly specify any WHT exemption on such dividends and transfer gains, foreign corporate investors have been eagerly awaiting SAT's clarification on the WHT treatments in relation to their holding of these shares under the CIT regime.
New development
The SAT finally released the two circulars to clarify the WHT treatments on dividends for H Shares and QFIIs. We summarise the salient points as follows:
Circular 897
It was issued in November 2008 addressing the WHT treatment on dividends derived from H Shares:
- The Chinese listed companies issuing H Shares have to withhold WHT at the rate of 10% on the distribution of dividends for 2008 and beyond to foreign corporate investors of H Shares; and
- If the foreign corporate investor is eligible for tax treaty rate (usually lower than 10%), it is allowed to apply for refund on the overpaid WHT upon application and approval by the Chinese tax authorities.
Circular 47
It was issued in January 2009 addressing the WHT treatment on dividends, bonus profits and interest derived by QFIIs from A Shares:
- The Chinese listed companies issuing A Shares have to withhold WHT at the rate of 10% on the payment of dividends (also bonus profits and interest) for 2008 and beyond to QFIIs.
- If the QFII is eligible for tax treaty rate (usually lower than 10%), it is allowed to apply for refund on the overpaid WHT upon application and approval by the Chinese tax authorities.
PwC observations
On one hand, the clarification of WHT treatments on dividends and permission for refund of overpaid WHT is good news to the foreign corporate investors as they can now be more certain about the China tax liabilities on their income (dividends) from their investment. However, apparently the SAT circulars do not confirm a continuation of WHT exemption which would cause additional cost to their investment. The timing of such clarification is not really desirable.
On the other hand, it is also welcomed by the Chinese listed companies which pay the dividends. They are now sure about how much exactly the WHT amounts to withhold upon distribution of the dividends.
Unfortunately, Circular 897 and Circular 47 still fail to address a few key concerns of the foreign corporate investors:
Common issues on both Circular 897 and Circular 47
Both circulars are silent on the WHT treatment on transfer gains (or technically called capital gains).
The practical difficulties in reporting and settling WHT to the tax bureaus in China on transfer gains derived from the disposal of the Overseas Listed Shares (e.g. H Shares and N Shares, etc.) have always been a key concern to foreign corporate investors. Actually, the SAT has already appreciated this situation because the shares are traded outside China, and they have practical difficulty in enforcing China's tax laws outside their tax jurisdiction.
On a contrary, since A Shares are traded on the Chinese stock exchanges, the collection of WHT on the transfer gains derived by the QFIIs from trading of A Shares should be easier. Even so, the Chinese tax authorities have never actually collected the WHT on such transfer gains since the permission of QFIIs investment in A Shares back to year 2002.
We understand that the SAT is studying this issue and hopefully will clarify their position on the transfer gains for all these Shares soon. From the perspective of the foreign corporate investors, it would be most desirable if the WHT exemption policy under the former FEIT regime could survive in the CIT regime. One of the technical arguments is that even Chinese tax rules do not provide unilateral exemption for capital gains, some of the foreign corporate investors should still be able to invoke double tax treaty protection which normally states that the "taxing right" on capital gains should belong to the home country / region of the foreign corporate investors given certain prescribed conditions are met. Then even if the Chinese tax authorities decide to collect WHT on transfer gains, the tax proceeds to be collected may not be justifiable against the costs of collection to the tax bureaus and the foreign corporate shareholders.
Issues on Circular 897
Circular 897 opens up a few issues:
- Circular 897 only addresses the WHT treatment for the dividends from H Shares. The outstanding issue is how to deal with the dividends from B Shares and other shares listed in other overseas stock exchanges than Hong Kong. Our preliminary discussion with the SAT seems to suggest that the principles in Circular 897 should also apply to B Shares and overseas listed shares other than H Shares.
- In addition, the phrase of "dividends for 2008 and beyond" per Circular 897 is still unclear as to whether it refers to the dividends distributed in 2008 and beyond or to the dividends distributed out of profits earned in 2008 and beyond. There is a technical argument that the WHT exemption treatment granted in the Former Circular 45 issued in 1993 shall still apply to the dividends payable out of pre-2008 profits.
Issues on Circular 47
Circular 47 has also left some questions unanswered, namely:
- Circular 47 is silent on its effective date but only refers to the CIT Law which came into force on 1 January 2008. Then the issue is whether the effective date of Circular 47 should be the issuance date of the circular (i.e. 23 January 2009) or 1 January 2008 retrospectively. If the effective date is 1 January 2008 and the Chinese A-Share companies have distributed dividends without withholding the relevant WHT, would the Chinese tax bureaus recourse such WHT from the QFIIs? It still remains to be seen how the local-level tax bureaus would interpret and implement Circular 47.
- Another challenge to the QFIIs is: if a QFII received dividends from the Chinese A-Share companies which were paid out of pre-2008 profits but the QFII did not remit it to outside China before Circular 47, should such dividends be subject to WHT? There was no clear technical ground to support WHT exemption policy because the Former Circular 45 did not cover QFII's income.
- Lastly, the typical legal structure of QFIIs is very unique, namely the beneficial owner (or investors) of A Shares is not the foreign financial institutions holding the QFII licence, but the ultimate foreign investors who subscribe for the units in the QFII. It has been a concern whether the Chinese tax authorities would treat QFII as the investors of A Shares or look through the QFII to the ultimate investors for determining the beneficial owners of the A Shares and thus the entitlement to the tax treaty benefits. Circular 47 is silent on whether the tax authorities may look through the QFIIs to identify the beneficiary owners as the taxpayer in applying the WHT. In other words, it seems to suggest that the QFIIs shall be treated as the investor of A Shares and hence the taxpayer of WHT. As a result, for the purpose of claiming tax treaty benefits, one should look at China's treaty with the country / region where the place of the QFII is located.
Suggestions for foreign corporate investors
Before the SAT clearly addresses its positions for the aforementioned issues, it is imperative for foreign corporate investors, including QFIIs and their custodian banks, to seek the positions of the local in-charge tax bureaus on their interpretation of the two circulars.
If the foreign corporate investors are eligible for a lower tax treaty rate on dividends or non-China taxing right on capital gains, it is time to develop plan and prepare proper documentation in order to claim treaty benefits or apply for tax refunds. As a related matter, we understand that the SAT will provide further detailed guidance to foreign corporate investors for claiming treaty benefits in the near future.
Now that China begins to collect WHT on such dividends (but yet transfer gains), the foreign corporate investors should also revisit their home country tax treatments for WHT payable in China and evaluate the impact to their overall tax burdens.
Suggestions for Chinese listed companies
It is also important for the Chinese listed companies, as the withholding agents, to be knowledgeable about this tax development. They have to ensure full compliance of the withholding obligations and make proper disclosures in their financial statements for year 2008.
Meanwhile, PwC will close monitor the development in this area and share with you our further insights once available.
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