World Tax Advisor May 1, 2009

Transcription

1 International Tax World Tax Advisor In this issue: China s SAT issues guidance on tax residence status of Chinese-controlled offshore companies... 1 Azerbaijan: New preferential treatment of certain oil and gas activities... 4 European Union: ECJ finds Greek rules on inbound and outbound dividends violate EC Treaty... 4 Italy: Guidance issued on interest deduction rules... 5 Venezuela: VAT rates increased... 6 In Brief... 7 Are You Getting Your Global Tax Alerts?... 7 China s SAT issues guidance on tax residence status of Chinese-controlled offshore companies The Chinese State Administration of Taxation (SAT) issued a Notice on 22 April 2009 that provides guidance on the determination of the tax residence status of Chinese-controlled offshore companies under the new place of effective management and control rule in the 2008 Enterprise Income Tax Law (EIT Law) [Guoshuifa [2009] 82]. The Notice may have a significant impact on certain Chinese companies, including those listed on a foreign stock exchange. Background Chinese tax residents pay EIT on worldwide income. The EIT Law defines a Chinese tax resident enterprise as either an enterprise that is incorporated in China or an enterprise that is incorporated outside China but that has its place of effective management and control in China. The EIT Implementation Rules (Regulations) define the place of effective management and control as the place where the overall management and control over manufacturing and business operations, personnel, accounting and property [etc.] of an enterprise are, in substance, exercised. Under this rule, an enterprise incorporated in a foreign country or territory would be regarded as a Chinese tax resident and thus be required to pay EIT in China on its worldwide income if it is effectively managed and controlled in China. The Notice sets out detailed rules for determining whether a Chinese-controlled offshore incorporated enterprise is a tax resident of China, describes the tax implications of being regarded as a tax resident and sets out the procedures for an assessment of residence status by the relevant local tax bureau. The provisions of the Notice apply retroactively as from 1 January World Tax Advisor 1 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

2 Key points of the Notice Definition of a Chinese-controlled offshore incorporated enterprise Article 1 defines a Chinese-controlled offshore incorporated enterprise as an enterprise that is incorporated under the laws of a foreign country or territory and has a domestic (i.e. a Chinese) enterprise or enterprise group as its primary controlling shareholder. Criteria for determining the place of effective management and control Article 2 provides that a Chinese-controlled offshore incorporated enterprise will be regarded as a Chinese tax resident by virtue of having a place of effective management and control in China and it will be subject to EIT on its worldwide income if all of the following conditions are satisfied: The primary location of the day-to-day operational management is exercised in China; Decisions relating to the enterprise s financial and human resource matters are made or are subject to approval by organizations or personnel in China; The enterprise s primary assets, accounting books and records, company seals, board and shareholder meeting resolutions are located or maintained in China; and 50% or more of voting board members or senior executives habitually reside in China. Article 3 further provides that the substance-over-form principle will be applied in determining the place of effective management and control. Tax implications of Chinese tax residence status: According to article 4 of the Notice, dividends distributed by a Chinese tax resident are exempt from income tax in the hands of an offshore incorporated Chinese tax resident under article 26 of the EIT Law and article 83 of the Regulations. Also according to article 4, dividends distributed by an offshore incorporated Chinese tax resident are deemed to be China-source income under article 7(4) of the Regulations. According to article 5 of the Notice, a Chinese subsidiary of an offshore incorporated Chinese tax resident retains its status as a foreign-invested enterprise. According to article 6 of the Notice, an offshore incorporated Chinese tax resident will not be treated as a controlled foreign company under the EIT Law; however, the status of the foreign subsidiaries it controls will be determined separately. Assessment of Chinese tax resident status Article 7 of the Notice provides that a Chinese-controlled offshore incorporated enterprise may apply to the local tax bureau in charge of its main Chinese shareholder for a determination of its status. In the absence of a request, that tax bureau reserves the right to make a determination of the status of a Chinesecontrolled offshore incorporated enterprise based on the information available to the bureau. In both instances, a final determination is made by the SAT. Determination of tax residence status under a tax treaty Article 8 of the Notice stipulates that the status of a dual resident company is to be determined in accordance with the provisions of an applicable tax treaty. Analysis Purposes of the Notice It is interesting that the Notice only covers Chinese-controlled offshore incorporated enterprises. The Notice defines such enterprises as those that are themselves controlled by Chinese enterprises. It is unclear whether foreign-incorporated enterprises that are controlled by Chinese individuals or foreign-incorporated enterprises that are controlled by foreign companies also fall within the scope of this Notice. Based on the language of the Notice, it seems that the SAT does not intend for it to apply to these categories of companies. On the surface, it would appear that many Chinese-based companies with offshore investments would be subject to the Notice because the ultimate decision-making resides in the headquarters in China. However, a careful reading shows that the rules are flexible, allowing the SAT considerable discretion to interpret the Notice and select which types of Chinese companies to target. On the other hand, the rules do not unduly constrain companies in relation to the organization of their governance and management structures. Companies also have reasonable room for maneuver in this regard. World Tax Advisor 2 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

3 Determining the primary controlling shareholder As noted above, a Chinese-controlled offshore incorporated enterprise is defined as an enterprise that is incorporated under the laws of a foreign country or territory and that has a Chinese enterprise or enterprise group as its primary controlling shareholder. The question thus arises as to what constitutes a primary controlling shareholder. Would control be determined by the ownership percentage, voting rights or de facto control? Many offshore listed Chinese groups comprise an offshore special purpose listed parent that holds the group s Chinese operations through Chinese subsidiaries. Would the listed parent be viewed as a Chinese-controlled offshore incorporated enterprise if Chinese investors retain management control or remain significant shareholders in the group? The answer is unclear based on the language of the Notice. Lack of measurable conditions for determining Chinese tax residence status According to article 2 of the Notice, if an enterprise fails to satisfy one of the conditions set forth above, it will not be regarded as a Chinese tax resident. This disqualification is provided for despite the obvious lack of measurable criteria in the Notice. For example, it is unclear what constitutes the primary location for exercising the day-to-day operational management, what constitutes habitually resides in China and what factors are to be used to determine whether an enterprise s primary assets are located in China. For an offshore holding company whose only activity is to hold the investments in China, would its assets (being the shares in the Chinese subsidiaries) be viewed as entirely located in China? Despite these ambiguities, it would seem that SAT s intention is to avoid being too specific so that it would have more discretion to apply the substance-over-form principle. Tax consequences for dividend distributions received by a foreign shareholder of the offshore incorporated Chinese tax resident According to the Notice, dividends received by a foreign shareholder of the offshore incorporated Chinese tax resident would be subject to Chinese withholding tax, which could result in adverse tax consequences for a foreign shareholder if the dividends would otherwise not be subject to tax. Tax treatment of capital gains derived by a foreign shareholder from the disposition of shares in the offshore incorporated Chinese tax resident The Notice is silent on how capital gains derived by a foreign shareholder from the disposition of shares in the offshore incorporated Chinese tax resident should be taxed. Following the logic of article 4 (treatment of dividends), it is reasonable to conclude that such gains would be treated as China-source income and, therefore, subject to capital gains tax under the EIT Law. Recommendations The first step that a company should take is to determine whether it is a Chinese-controlled offshore incorporated company that is covered by the Notice. Being a Chinese tax resident may not necessarily result in negative tax consequences. A company should evaluate the tax implications based on its own circumstances before taking any action with regard to the Notice. The provisions of the Notice are effective from 1 January 2008; accordingly, a company that is covered by the Notice should not only review its position going forward, but also its status in respect of the 2008 year. The objective of the review is to determine whether the company has any exposure resulting from the Notice which requires a provision in its financial statements for that year. For example, if a company is found to be a tax resident of China, it would be subject to tax in China on its non-china-source income. That income would not otherwise be subject to tax in China. All companies should ensure that procedures and controls are put in place so that tax status (tax resident in China, or nonresident) is not inadvertently affected by actions of the company s shareholders, board, management and employees. It should be noted that the determination concerning the status of a company is made by reference to substance and not form. Nonetheless, in setting up such procedures and controls, particular regard should be paid to the factors set out in the Notice: The composition of the board and the locations in which board members and senior management of the company reside; Locations at which board and management functions are exercised and decisions made; and Locations at which the company seals, books and records are kept. Procedures and controls should be clearly documented, and regular reviews be carried out to ensure that they are adhered to. World Tax Advisor 3 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

4 Companies also should look ahead and consider what evidence they would have to substantiate as to who exercises board, management and other relevant functions, makes relevant decisions, and locations in which such functions are exercised and decisions are made. All companies should ensure that they are able, if questioned or challenged, to produce compelling evidence to support their respective preferred positions concerning their tax status. Leonard Khaw (Shanghai) Partner Deloitte China +86 (21) Qiang Lu (Shanghai) Senior Manager Deloitte China +86 (21) Hong Ye (Shanghai) Senior Manager Deloitte China +86 (21) Azerbaijan: New preferential treatment of certain oil and gas activities A new special economic regime took effect 17 April 2009, providing benefits for export-oriented activities conducted in Azerbaijan for oil and gas projects outside Azerbaijan. The government enacted the regime to further enhance the appeal of Azerbaijan s shipyard facilities on the Caspian Sea for investors intending to build oil platforms to take outside Azerbaijan. The regime is designed to encourage foreign customers of Azerbaijan shipyards, as well as the Azerbaijan shipyards themselves, to bring materials into the country to construct oil rigs and then export the rigs with minimal administrative tax burdens. The law provides favorable tax, customs, currency and employment rules for companies engaged in export-related operations. Specifically, the profit tax of contractors (as defined by the law) and foreign subcontractors may be paid by way of a deduction of 5% from gross revenue. The law also provides for the possibility of a VAT refund for contractors within 20 days without the tax authorities having to carry out a full-scale tax audit. Contractors and subcontractors are exempt from import duties and VAT with respect to the import of items to be used for export-related oil and gas operations. It should be noted that the new regime does not apply to activities carried out in connection with production sharing agreements, agreements relating to main export pipelines or oil and gas operations carried out within the territory of Azerbaijan. Nuran Kerimov (Baku) Partner Deloitte Azerbaijan +994 (012) nkerimov@deloitte.az Nasir Ali (Baku) Partner Deloitte Azerbaijan +994 (012) nali@deloitte.az European Union: ECJ finds Greek rules on inbound and outbound dividends violate EC Treaty The European Court of Justice (ECJ) ruled on 23 April 2009 that Greek tax legislation that provided a tax exemption aimed at avoiding the double taxation of company profits distributed to shareholders, but which applied only to domestic dividends, violates the EC Treaty. Under the tax regime that applied to dividends before 1 January 2009, dividends distributed by Greek companies were exempt from further taxation in the hands of individual shareholders. However, foreign-source dividends were added to the annual taxable income of the Greek tax resident individual shareholder and taxed accordingly, pursuant to the applicable World Tax Advisor 4 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

5 tax bracket. A limited foreign tax credit was granted for the tax paid abroad. According to the ECJ, the tax treatment of foreign-source dividends in the hands of Greek shareholders violated the free movement of capital and freedom of establishment principles in the EC Treaty because the regime could discourage investors from purchasing shares of companies seated abroad and encourage investments in domestic entities. It should be noted that Greece amended this regime in September 2008 to unify the tax treatment of inbound and outbound dividends as follows: Foreign-source dividends received after 1 January 2009 are not added to the annual taxable income of the Greek individual tax resident, but a final 10% withholding tax is imposed on the net amount of dividend income received, e.g. after any tax withheld by the source country; and Dividends distributed by Greek companies to domestic or foreign shareholders, individuals or legal entities are subject to a 10% withholding tax (subject to a lower rate provided in an applicable tax treaty or if the EC Parent- Subsidiary Directive applies). Ioannis Tentes (Athens) Partner Deloitte Greece +30 (210) itentes@deloitte.gr Konstantinos Roumpis (Athens) Senior Consultant Deloitte Greece +30 (210) kroumpis@deloitte.gr Italy: Guidance issued on interest deduction rules The Italian tax authorities issued Circular No. 19/E on 21 April 2009, which clarifies the interest deduction rules under article 96 of the Income Tax Consolidation Act that were introduced in Background Italy s thin capitalization rules were replaced with new rules on 1 January 2008; under the new regime, interest expense that exceeds interest received may be deducted up to 30% of EBITDA (earnings before interest, taxes, depreciation and amortization) resulting from the borrower s profit and loss (P&L) account for the tax year. The nondeductible portion ( excess interest ) may be carried forward without limit and deducted in future years. Beginning 1 January 2011, 30% of EBITDA exceeding the net payable interest ( excess EBITDA ) may be carried forward without limit and added to the EBITDA of future tax years if the net payable interest exceeds 30% of EBITDA. For Italian tax consolidated groups, the excess EBITDA of one member can be transferred to another member of the group and used to deduct that member s net payable interest. The same rule also applies to excess EBITDA of a foreign company that is owned by a member of the tax consolidated group, provided certain requirements are met (e.g. the Italian company holds more than 50% of the voting rights or profit participation rights of the nonresident company, both companies use the same tax year and the financial statements of the nonresident company are audited). Certain entities are not subject to the above rules banks, insurance and other financial companies are allowed an interest deduction of up to 96% (97% for 2008) of the interest payable incurred by the company during the year before the new rules became effective. Partnerships can fully deduct payable interest provided the payments are inherent to the business activities carried out (with an exception made for tax-exempt activities). Circular No. 19/E Circular No. 19/E clarifies that the term payable interest must be considered in a broad sense and it includes all payments made by a company under any contract or operation involving financing. The Circular specifically mentions as among the items covered by the limited deductibility: Interest due under a notional cash pooling agreement; Interest included in the periodic installments of a finance lease; and World Tax Advisor 5 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

6 Losses from derivative instruments covering the interest rate risk. With respect to the payable interest element of payments under a finance lease, companies that do not use IAS (and thus do not separately show such interest in the P&L account) are authorized to determine the notional interest amount of such interest using the default method provided for purposes of the regional tax on productive activities (IRAP). (Under this method, the interest amount is equal to the difference between the leasing installments accrued in the tax year and the cost of purchase of the leased asset incurred by the leasing company (the latter amount being divided by the days covered by the leasing contract and multiplied according to the days in the tax year).) The Circular also clarifies that EBITDA must be calculated according to the amounts shown in the P&L account. The excess EBITDA of one year can be carried forward indefinitely. To avoid the possibility of refreshing prior year net operating losses, however, the tax authorities specify that the excess EBITDA must be used in the first year with payable interest exceeding the 30% threshold; otherwise, the benefit is lost (i.e. no further carryforward for the unused excess EBITDA amount). The same principle applies to the excess EBITDA transferred to the tax consolidated group the amount not used in the first year during which one of the consolidated companies has payable interest exceeding the 30% threshold may not be carried forward. In all cases, only the excess EBITDA (or excess interest) accrued after the tax consolidation election was effective can be transferred to the tax consolidated group. The excess EBITDA of a foreign subsidiary of an Italian company may be taken into account for purposes of calculating the interest deductibility limitation, provided the Italian company belongs to an Italian tax consolidated group. The entire amount of the foreign subsidiary s excess EBITDA is taken into account, even if the participation held by the Italian company is less than 100%. Finally, the tax authorities clarified the limitations applicable to the excess EBITDA (or excess interest) carried forward by companies involved in extraordinary operations such as mergers and demergers. Like tax losses from previous years, excess interest can be carried forward by the companies involved only if the revenues and labor costs resulting from the profit and loss account of the year preceding the extraordinary operation are higher than 40% of the average amounts of the two prior years. The tax losses and the excess interest can be carried forward up to the book value of the net equity shown in the last financial statement of the company (or, if lower, in the asset and liabilities statement specifically drafted for the merger/demerger), reduced by the contributions and payments in the capital account made by the shareholders during the prior 24 months. If the amount of the tax losses plus the excess interests exceeds the above-mentioned limit, the company can freely choose, based on its specific tax position, to carry forward the tax losses or the excess interest. Stefano Schiavello (New York) Client Service Executive Deloitte Tax LLP +1 (212) sschiavello@deloitte.com Olderigo Fantacci (New York) Client Service Executive Deloitte Tax LLP +1 (212) ofantacci@deloitte.com Venezuela: VAT rates increased On 26 March 2009, the Venezuelan Parliament published a partial amendment to the 2009 Budget Law, which increased the standard VAT rate from 9% to 12%. The standard rate applies to the sale of tangible property, the import of movable property and services provided or used in Venezuela, including services provided from overseas. The partial amendment also established a reduced VAT rate of 8% for certain imports and sales of food, services provided to the government (as established by the VAT Law) and air transport of passengers. The new rates, which are effective as from 1 April 2009, do not apply to free zones, free ports and other special tax regimes. Massimo Melone (Caracas) Socio Deloitte Venezuela +58 (212) mmelone@deloitte.com Romina Siblesz Viso (Caracas) Abogado Asociado Deloitte Venezuela +58 (212) rsiblesz@deloitte.com World Tax Advisor 6 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

7 In Brief Canada The Crown has decided not to seek leave to appeal to the Supreme Court of Canada the Federal Court of Appeal (FCA) decision in Prévost Car Inc., issued on 26 February 2009, which unanimously dismissed the Crown s appeal. The FCA held in Prévost Car Inc. that a Dutch holding company was the beneficial owner of the dividends received from its Canadian subsidiary (Prévost) for purposes of the Canada-Netherlands tax treaty, despite the fact that substantially all of the dividends had been distributed to its shareholders resident in other countries. Therefore, the rate of withholding tax applicable to the dividends was 5% instead of the 25% rate used by the Minister in the reassessment of Prévost. Czech Republic The first-time totalization agreement between the Czech Republic and Japan enters into effect 1 June The agreement eliminates the 270-day exception period during which Japanese employers are not obligated to pay Czech insurance contributions. Czech-covered individuals who wish to continue contributing to the Japanese insurance system will need a new form (J/CZ 1) issued. European Union The new rules on the place of supply of services following from the EU VAT Package need to be implemented in the national legislation of the EU Member States by 1 January The following Member States have already published their draft legislation Belgium, France, Germany, Greece, Ireland, Lithuania, Luxembourg, Netherlands, Poland, Sweden and the U.K. Are You Getting Your Global Tax Alerts? Throughout the week, Deloitte provides commentary and analysis on developments affecting cross-border transactions on a free subscription basis delivered straight to your . Read the recent alerts below or visit the archive. Subscribe: Archives: Iceland Parliament approves new CFC regime The Parliament has passed a major amendment to the Income Tax Act, which introduces a controlled foreign company regime in Iceland for the first time. [Issued: 28 April 2009] URL: URL: World Tax Advisor 7 of 8 Copyright 2009, Deloitte Touche Tohmatsu.

8 Talk to Us If you have questions or comments about the content of World Tax Advisor, contact one of the tax professionals at a Deloitte Touche Tohmatsu office in your area or: Susan Lyons, Director Washington International Tax Services Deloitte Tax LLP +1 (202) slyons@deloitte.com - or - Connie Angle Washington International Tax Services Deloitte Tax LLP +1 (734) cangle@deloitte.com About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its member firms. Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in 140 countries, Deloitte brings world-class capabilities and deep local expertise to help clients succeed wherever they operate. Deloitte s 165,000 professionals are committed to becoming the standard of excellence. Deloitte s professionals are unified by a collaborative culture that fosters integrity, outstanding value to markets and clients, commitment to each other, and strength from cultural diversity. They enjoy an environment of continuous learning, challenging experiences, and enriching career opportunities. Deloitte s professionals are dedicated to strengthening corporate responsibility, building public trust, and making a positive impact in their communities. Disclaimer This publication contains general information only, and none of Deloitte Touche Tohmatsu, its member firms, or its and their affiliates are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. None of Deloitte Touche Tohmatsu, its member firms, or its and their respective affiliates shall be responsible for any loss whatsoever sustained by any person who relies on this publication. World Tax Advisor 8 of 8 Copyright 2009, Deloitte Touche Tohmatsu.