China Tax & Investment News. New implementation guideline on indirect transfers of China assets has just been issued. Background

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1 Issue No.CTIN Jun 2015 China Tax & Investment News New implementation guideline on indirect transfers of China assets has just been issued Background In 2009, the State Administration of Taxation (SAT) promulgated Guoshuihan [2009] No. 698 (Circular 698) that addressed tax treatments on China equities transferred by non-residents. With the promulgation of Circular 698, China tax authorities have been empowered to disregard interposed entities if they are considered as lacking reasonable commercial purpose and the whole indirect share transaction will be treated as a direct share transfer with PRC capital gain tax liabilities arising. Circular 698 only laid down general guiding principles, leaving room for local authorities' interpretations. SAT Announcement [2011] No. 24 (Circular 24, subsequently released in 2011) provided certain clarifications following to Circular 698. About two months ago, the SAT Notice [2015] No. 7 (Announcement 7) preceded by Circular 698 was released. Instead of taking it as a supplement to Circular 698, Announcement 7 is actually an advanced version of Circular it broadened the scope cover China taxable assets (instead of shares only), provided safe harbor rules, abolished some articles in Circular 698 and Circular 24 by replacing them with other new requirements. However, uncertainties still remain in some areas, e.g., tax basis, reviewing time line, written confirmation, etc. An internal implementation guideline, Shuizongfa [2015] No. 68 (Circular 68), has just been issued by the SAT to clarify the respective responsibilities of tax authorities at different levels and detailed administrative procedures on the implementation of Announcement 7. This issue of China Tax and Investment News is to discuss this circular in detail. China Tax & Investment News 1

2 New internal implementation guidelines Circular 68 has delivered four key messages and each of them carries certain merits but may be able to resolve all issues involve in the reporting of indirect transfers. 1. Encourage concerned parties to do voluntary reporting Whether China tax authorities really have the right to require nonresident sellers of offshore transfers to follow a PRC tax reporting requirement and related tax administration procedures before they are concluded as having any China tax obligations the answer is likely no and thus, China SAT does overtly say it has such authority. Follow the same logic, Announcement 7 stipulates a voluntary reporting scheme and a compulsory filing requirement, respectively. The relevant parties, including sellers, buyers, and the related China targets (Chinese resident enterprises whose equities were indirectly transferred) in an indirect transfer MAY choose to report to the in-charge tax authority with the relevant documents submitted. What does Circular 68 say? In Circular 68, the SAT further emphasizes that Chinese tax authorities should provide guidance and encourage all concerned parties in a transaction, including sellers, buyers, and the Chinese targets to do voluntary reporting. In general, voluntary reporting could apply to the two scenarios: a qualifying safe harbor transaction; or a transaction with concerned parties who would like to voluntarily disclose the related information to China tax authorities in order to gain certainty on PRC-tax position. Take away voluntarily report or? Safe harbor provisions have been provided in Announcement 7, which states that qualifying group restructurings would be re-characterized under the looking-through approach but will be regarded as having reasonable commercial purpose. Announcement 7 does state a compulsory requirement for a qualifying group structuring to report. However, if no reporting is done, who has the say if a transaction is safe or? If the answer is only the China tax authorities in charge, it would be unreasonable to infer that related documentation should still be submitted by relevant parties for authorities formal endorsement, so as to make it totally safe. In this regard, voluntary reporting along with proactive communication with in-charge tax authorities may be a wise approach for a safe harbor transaction. The Announcement stipulates that if a non-resident seller provides the required documentation within 30 days from the date on which a contract is signed, the additional 5% penalty interest may be waived. The sellers of indirect transactions (include those transactions that may be directly deemed as without commercial purpose) may then wish to voluntarily report and conclude their case sooner in order to mitigate any late payment interest. In addition, Announcement 7 imposes withholding obligation on buyers and states that a penalty may be waived if buyers report to tax authorities within 30 days from signing for this reason, buyers may have greater motivations to perform voluntary reporting or to force the sellers to file earlier than later. Nevertheless, from foreign tax credit claim perspective, some investors may have a concern about whether voluntary reporting would be construed as a voluntary tax payment that makes the tax payment eligible for foreign tax credit claim. While this risk is real, the definition of voluntary tax may vary in different countries. Detailed analysis by respective local country tax experts or international tax professional should be sought before any action. China Tax & Investment News 2

3 2. Written documentation from tax authorities Previously, all related rules were silent about written acknowledgement from tax authorities upon voluntary reporting; this has created difficulty for sellers to prove themselves on compliance unless they have filed the tax return or paid the tax. What does Circular 68 say? In Circular 68, the SAT specifically requires its subordinates to issue written acknowledgement to the reporting parties upon receipt of the reporting package. Take away good news or? With no doubt this is a good move for the business community as once you report at least you would get paper evidence to support that you have done it. However, the written acknowledgement is only for the reporting activity itself NOT for the result. Based on Announcement 7, a nonresident s indirect transfer of China taxable assets will receive a formal ice regarding the related tax treatments (with China tax liabilities or ) only if a formal GAAR investigation is launched. Announcement 7 does mention if a qualifying safe-harbor transaction could obtain a formal written confirmation, or if a transaction which is pre-assessed as having commercial purpose by local in-charge tax authorities would get any clearance letter. Circular 68 does address these either. From a technical perspective, for a transaction that qualifies for the safe harbor provision or is pre-assessed as having commercial purpose, the tax authority does have a legal obligation to issue a written confirmation to such a reporting party, this is on the basis that such taxpayer would be seen as a non-prc-taxpayer, somebody outside of Chinese tax jurisdiction, thus, are qualified for receiving Chinese tax authorities formal administrative ice for tax treatments. Unless further ice is issued, the related applicants should always negotiate with in-charge tax authorities for an official feedback. 3. Re-introduce centralized reporting option for transfers involving multiple PRC targets For a deal that indirectly transfers multiple PRC target companies, the seller was allowed to choose to file with the tax authority in charge of one selected PRC target company according to Circular 24. In other words, multiple documentation filings would be needed under this offer. However, Announcement 7 abolished this protocol and requires a seller to file with tax authorities in multiple locations. It is unreasonable to anticipate that differences in technical positions of the different tax authorities in charge on the same transaction may arise; especially on the price and cost allocation that will directly affect the tax revenue of the respective tax authorities. What does Circular 68 say? Circular 68 brings along the good news that the centralized reporting system is being reintroduced. Pursuant to Circular 68, for a deal that involves multiple PRC target companies, the sellers, the buyers, or the underlying Chinese targets may choose to report to the tax authority in charge of a selected PRC target company. China Tax & Investment News 3

4 Circular 68 also clarifies the general process for tax authorities at different levels to deal with an indirect transfer involving multiple PRC targets. The procedures are illustrated below for your easy reference. Take away certainly a good move The centralized reporting is a well-received administrative rule which could significantly reduce taxpayers compliance costs and avoid controversy that may arise from the different views of different tax authorities. Relevant reporting parties with Chinese targets all over the place should therefore proactively communicate with a user-friendly tax authority for the discussions on the option of centralized reporting. It is worth ing that the provision of multiple tax filings stipulated in Announcement 7 is still valid, i.e. upon basis of tax filing is agreed with that single tax authority, tax returns should still be submitted and tax payments should still be made to the respective tax authority in charge of each PRC target. Further, previous Circular 24 also offered centralized reporting and filing options for indirect share transfer involving multiple offshore sellers. That is to say, one offshore representative party was allowed to complete information filing for all sellers for an indirect transfer. This article has also been abolished by Announcement 7 but Circular 68 did bring it back, which means all nonresident investors should now conduct their own reporting and filing even if they are doing one single transaction together. 4. Reiterate case-conclusion timing to be in line with GAAR procedures Announcement 7 prescribes that relevant GAAR provisions shall be applied if in-charge tax authorities decide to launch a tax investigation on an indirect transfer of a China taxable asset. Set-up and conclusion of a GAAR case are both subject to the SAT s final approval. What does Circular 68 say? Circular 68 demands local tax authorities to identify indirect transfer cases from their daily work like corporate income tax clearance, tax assessments, contemporaneous documentation reviews, tax clearance for outbound payments and from other news reports. Where a local tax authority suspects a tax avoidance case, it shall report all the way up to the provincial-level tax authorities for their review and approval; these authorities would then submit the same to the SAT for approval before initiating a case for GAAR examination. From the date of a GAAR case initiation being approved, local tax authorities shall reach a conclusion and escalate to the provincial tax authority for approval within 9 months. The case conclusion should finally be endorsed by the SAT. China Tax & Investment News 4

5 Take away how long it would really take? By reading the description for the 9 months counting, the in-charge tax authority s decision to launch a tax investigation is a prerequisite. The tricky thing is, no rule has mentioned within how long a local tax authority should make such a decision. The 9-month timeline neither includes the above thinking time, nor the provincial tax authorities and the SAT s review time either. Thus, the final conclusion may indeed take much longer than this 9-month timing due to complications of each case. The below diagram illustrates the procedures with and without time line in the whole investigation and assessment procedure for an indirect transfer case. Documents received by incharge tax authority Approval on initiating a GAAR case by provincial tax authority SAT approval on initiating a GAAR case In-charge tax authority reaching a conclusion 9 months Approved by Final approved provincial tax by the SAT authority As an internal protocol, Circular 68 aims to provide procedural and administrative guidance for the local tax authorities to implement Announcement 7 consistently. It does have any technical answers like cost basis for tax calculation. It may also lead to different interpretations among different locations, especially for the centralized reporting possibility. Apart from reviewing current structure to assessing tax exposure arising from transaction plans, multinational companies are highly recommended to stay close with their tax consultants and proactively communicate with tax authorities to understand their local practice; and their views and positions. We shall keep you posted if there is any further development. China Tax & Investment News 5

6 Contact us For more information, please contact your usual Ernst & Young contact or one of the following of Ernst & Young s China tax leaders. Office Tax Leaders Henry Chan (Beijing) henry.chan@cn.ey.com Alan Lan (Tianjin) alan.lan@cn.ey.com Samuel Yan (Dalian) samuel.yan@cn.ey.com Andy Chen (Qingdao) andy.chen@cn.ey.com Vickie Tan (Shanghai / Wuhan) vickie.tan@cn.ey.com Audrie Xia (Suzhou) audrie.xia@cn.ey.com Patricia Xia (Hangzhou) patricia.xia@cn.ey.com Chuan Shi (Chengdu) chuan.shi@cn.ey.com Rio Chan (Guangzhou / Xiamen) rio.chan@cn.ey.com Lawrence Cheung (Shenzhen) lawrence-f.cheung@cn.ey.com Clement Yuen (China South) clement.yuen@cn.ey.com Service Line Tax Leaders Andrew Choy (International Tax and Transfer Pricing) andrew.choy@cn.ey.com Becky Lai (Tax policy) becky.lai@hk.ey.com David Chan (Transaction Tax) david.chan@hk.ey.com Paul Wen (Human Capital) paul.wen@hk.ey.com Robert Smith (Indirect Tax) robert.smith@cn.ey.com Greater China Tax Leader Walter Tong walter.tong@cn.ey.com Author China Tax Center Jane Hui jane.hui@hk.ey.com China Tax & Investment News 6

7 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does provide services to clients. For more information about our organization, please visit ey.com Ernst & Young (China) Advisory Limited All Rights Reserved. APAC no ED None. This material has been prepared for general informational purposes only and is intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/china China Tax & Investment News 7