China Tax & Investment News. The long-awaited tax agreement between the China Mainland - Taiwan Straits was signed. Background

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1 Issue No.CTIN Sep 2015 China Tax & Investment News The long-awaited tax agreement between the China Mainland - Taiwan Straits was signed Background A bilateral tax treaty, known as an agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, refers to an agreement that is entered into between two jurisdictions to allocate their taxing rights on revenues as well as other tax-related matters. Due to differences in political, economic and cultural environments, plus the gap in their tax systems, to protect the interests of respective jurisdictions, bilateral negotiations between two jurisdictions would be relatively efficient and can reach the purposes of providing tax residents with relief from double taxation; appropriate distribution of taxing rights and tax revenue; saving administrative costs as well as prevention of tax evasion. In addition to tax treaties, the bilateral tax arrangements entered into under specific circumstances, e.g., the agreements between Mainland China (the Mainland) and the special administration regions (SARs), have similar functionality to the double tax treaties (hereby collectively referred as DTA). The DTA plays a key role in international taxation coordination and cooperation and is a significant regulatory framework to promote and facilitate cross-border business activities. Nevertheless, the Mainland and Taiwan had never entered into a DTA due to historical reasons; this inevitably resulted in double taxation on cross-strait economic activities, impeding the cross-strait trading flows and economic development. China Tax & Investment News 1

2 After years of negotiations, Chairman Chen Deming of the Association for Relations across the Taiwan Straits (ARATS) and Chairman Lin Join-sane of the Straits Exchange Foundation (SEF) finally signed the Agreement on Avoidance of Double Taxation and Improvement of Tax Cooperation across the Taiwan Straits (hereinafter referred to as the Cross-strait DTA ) on 25 August Mr. Zhang Zhiyong, the vice-minister of the State Administration of Taxation (SAT) was invited to witness the signing ceremony. The Cross-strait DTA 1, according to its claims, aims to further improve cross-strait economic and trade cooperation, as well as reduce or eliminate double taxation. The Cross-strait DTA shall be ratified upon the completion of the respective internal procedures required by both the Mainland and Taiwan and shall take effect on the day following to the relevant notes being exchanged from both sides. It will apply to income derived on or after 1 January of the calendar year following that in which the Cross-strait DTA enters into force. The Cross-strait DTA stipulates the taxing jurisdictions over various incomes derived from cross-strait economic activities and available DTA relief mechanisms. It also clarifies the approaches to eliminate double taxation and promises a non-discrimination tax treatment for residents from both sides. It is expected that the DTA would reduce the tax burden of enterprises doing business across the Strait, enhance the competitiveness of both jurisdictions and facilitate investments between the Mainland and Taiwan. This issue of China Tax and Investment News is to discuss the Cross-strait DTA in detail. The Cross-strait DTA The Cross-strait DTA is similar to some standard DTAs and covers matters related to scope, permanent establishment, income derived from business and etc. We summarize certain key contents of the Cross-strait DTA as follows: Table 1 Note: 1. You can click this link to access the full content of the Cross-strait DTA: China Tax & Investment News 2

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4 Our observations The Cross-strait DTA aims to reduce the tax burden of enterprises and individuals participating in cross-strait economic activities by taking into consideration the special cross-strait economic relationships and the respective tax schemes. The goal of the Cross-strait DTA is to create a certain and transparent tax environment for cross-strait investors with appropriate tax relief so as to improve the development of economic and trade across the Taiwan Strait. According to the official website of the SAT, as of the end of May 2015 China has entered into 100 DTAs with other jurisdictions, among which, 97 DTAs already became effective. On top of that, the Mainland has entered into double tax arrangements with the Hong Kong SAR and Macau SAR in 2006 and 2003 respectively. In the absence of a similar tax agreement/arrangement, enterprises and individuals of the Mainland and Taiwan engaging in cross-strait investments or trading were placed in comparatively disadvantageous positions. Based on the statistics released by the competent finance department of Taiwan, for the past 20 years, the accumulated investments in the Mainland from Taiwan have reached USD147 billion which accounts for 62% of total Taiwan s outbound investments. The conclusion of the Cross-strait DTA would not only reduce the tax burden of Taiwan enterprises investing in the Mainland but also encourage more Mainland enterprises to invest in Taiwan. Upon the ratification of the Cross-strait DTA, it is anticipated that positive impacts would arise in the following areas: 1. Elimination of double taxation Before the conclusion of the Cross-strait DTA, it is not impossible that some cross-strait economic activities may be double taxed. Within the effectiveness of the Cross-strait DTA, such a problem could be effectively addressed. For instance, where a Mainland/Taiwan enterprise engages in businesses with the other side without the constitution of a PE, then the relevant business profits derived shall not be taxable on the sourcing side. According to the Cross-strait DTA, where a resident of the Mainland/Taiwan does not constitute a PE in the other jurisdiction, this resident shall not be taxed on the other side (i.e. for a construction project, if the activities do not continue for a period of more than 12 months; or, for a service project, if the provision of services by an enterprise through employees or other personnel engaged by the enterprise does not continue for a period or periods aggregating more than 183 days within any 12-month period, no PE is constituted). 2. Indirect investment made by Taiwan Investors through a third jurisdiction may also enjoy benefits under the DTA In general, a DTA is not applicable to a situation where a resident of one jurisdiction invests in another jurisdiction through an entity incorporated under laws of a third jurisdiction. However, according to the statistics released by the competent finance department of Taiwan, 75% of investments in the Mainland by Taiwan investors are through their entities incorporated in a third jurisdiction. In this respect, the Cross-strait DTA specifically adds the provision that any entity incorporated under the law of a third jurisdiction which has its place of effective management in one of the jurisdictions, is regarded as resident for the purposes of this agreement, and hence any entity incorporated under the law of third jurisdiction may be deemed as residents of the Mainland/Taiwan and would therefore be eligible for enjoying benefits under the Cross-Strait DTA in future, as long as the places of effective management (PEM) of such an entity are in the Mainland/Taiwan. Pursuant to the Cross-strait DTA, the aforesaid places of effective management refer to enterprise which satisfies ALL of the following criteria: Substantial operation management, financial and human capital decisions are made or approved by personnel/head offices/organizations located in the Mainland/Taiwan. China Tax & Investment News 4

5 Financial statements, accounting records, board resolutions or shareholders resolutions are recorded or maintained in the Mainland/Taiwan. Organizations in charge of the major operation activities are located in the Mainland/Taiwan. 3. Reduction of withholding tax rates According to the prevailing PRC CIT Law, dividends, interests and royalties derived from the Mainland by Taiwan enterprises are subject to CIT at 10%. After the Cross-strait DAT becomes effective, the relevant withholding tax rates could be substantially reduced. The preferential tax treatments among the Cross-strait DTA, the Mainland - Hong Kong DTA and the Mainland Macao DTA are generally in line and details are laid out for your reference: Table 2 China Tax & Investment News 5

6 Upon the ratification of the Cross-strait DTA, it is anticipated that positive impacts would arise in the following areas: 1. Elimination of double taxation For dividends, interests and royalties, the preferential withholding tax rates as prescribed in the Cross-strait DTA are the same as that of the Mainland Hong Kong DTA and the Mainland Macau DTA. After the effectiveness of the Cross-strait DTA, the treaty relief would enhance the willingness of domestic enterprises to invest in Taiwan. Note: 2. According to Guishuihan [2008] No. 685, when implementing this provision, where a Hong Kong resident has directly or indirectly owned not less than 25% capital of the Mainland enterprise at any time within the 12 months before the alienation, the supervising tax authority in the Mainland is empowered to impose tax. China Tax & Investment News 6

7 For capital gains, prior to the effectiveness of the Cross-strait DTA, if a Taiwan enterprise directly transfers shares of a Mainland enterprise, the Taiwan enterprise shall be subject to CIT at 10% according to the prevailing PRC CIT Law and its Implementation Rules, regardless the percentage of ownership or other conditions. However, under the Cross-strait DTA, a resident of one jurisdiction derives gains from the alienation of shares or other rights of the resident company of the other jurisdiction may only be taxed in the jurisdiction where the transferor resides. For example, for non-land-rich equity transfer, unless such gains are exempt from tax in the jurisdiction where the transferor resides and such transferor directly or indirectly holds 25% capital of the company of the other jurisdiction at any time during the 12-month period preceding such alienation, upon the effectiveness of the DTA, gains so derived by a Taiwan resident may only be taxed in Taiwan and are exempt from tax in the Mainland. The same tax treatment will apply to a Mainland resident disposing shares of a Taiwan company. In addition, as aforesaid, if a Taiwan enterprise transfers shares of their Mainland subsidiaries through an intermediate company incorporated in a third jurisdiction, the relevant capital gain provisions in the Crossstrait DTA may also be applied, provided its PEM is located in Taiwan. 4. Improvement of cooperation Before announcement of the Cross-strait DTA, it was not rare that tax authorities of both sides could not agree on a transfer price for RPT by mutual consent, which accordingly may have lead to double taxation. Under the effectiveness of the DTA, the tax burden of taxpayers, especially for the business group, can be reduced and double taxation can be eliminated by adopting the mutual BAPA and signing an APA. When encountering any disputes, the Mainland domestic enterprises or Taiwan enterprises can take advantage of the Cross-strait DTA to protect the respective benefits. In the meantime, although the automatic EoI system has not been specified in the Cross-strait DTA, it is expected that tax authorities of both sides would work closer for the exchange of tax related information and would therefore disallow structure or actions that would abuse provisions under Cross-strait DTA. Conclusions Although the Cross-strait DTA was signed on 25 August 2015, it will not be effective until the respective ratification procedures are completed. The DTA shall then apply to income derived on or after 1 January of the calendar year when this Agreement enters into force. After the Cross-strait DTA is ratified successfully, it will bring about far-reaching positive impacts for thecross-strait investment environment. It is an encouraging change that the tax systems can finally catch up with the rapid business development driven by cross-strait entrepreneurs. It will clearly benefit entrepreneurs who ve been aiming atoptimizing their business operation structure in the globalized economy. Taiwanese enterprises that already have investments in the Mainland or intend to invest in the Mainland should review their existing or planned investment structures and transactional flows to determine whether proper adjustments need to be made to enhance operational and financial synergy. Meanwhile, it is important to note that the legislative ratification may not necessarily be a straight-forward process, especially considering the fact that the Service Trade Agreement between the Mainland and Taiwan signed in 2013 has not yet become effective due to unresolved legislative debates in Taiwan. The business community is advised to be patient and wait for the effective date of the Cross-strait DTA to be confirmed.. We will aim to always keep you abreast of the developments regarding this important Cross-strait Agreement. Analysis related to individual services as prescribed in the DTA shall be released separately in due course. If in doubt, consultations with tax professionals are recommended. China Tax & Investment News 7

8 Contact us For more information, please contact your usual EY contact or one of the following of EY s China tax leaders. Office Tax Leaders Margin Ngai (Beijing) martin.ngai@cn.ey.com Fisher Tian (Tianjin) fisher.tian@cn.ey.com Samuel Yan (Dalian/Shenyang) samuel.yan@cn.ey.com Lucy Wang (Qingdao) lucy-c.wang@cn.ey.com Joanne Su (Xi an) joanne.su@cn.ey.com Vickie Tan (Shanghai) vickie.tan@cn.ey.com Raymond Zhu (Wuhan) raymond.zhu@cn.ey.com Audrie Xia (Suzhou) audrie.xia@cn.ey.com Andrew Chen (Nanjing) andrew-jp.chen@cn.ey.com Patricia Xia (Hangzhou) patricia.xia@cn.ey.com Chuan Shi (Chengdu) chuan.shi@cn.ey.com Clement Yuen (Shenzhen) clement.yuen@cn.ey.com Rio Chan (Guangzhou/Changsha) rio.chan@cn.ey.com Jean Li (Xiamen) jean-n.li@cn.ey.com Tracy Ho (Hong Kong) tracy.ho@hk.ey.com Heidi Liu (Taipei) heidi.liu@tw.ey.com Service Line Tax Leaders Andrew Choy (International Tax & Transfer Pricing) andrew.choy@cn.ey.com Paul Wen (Human Capital) paul.wen@hk.ey.com Kenneth Leung (Indirect Tax) kenneth.leung@cn.ey.com Becky Lai (Tax Policy) becky.lai@hk.ey.com David Chan (Transaction Tax) david.chan@hk.ey.com Samuel Yan (Global Compliance & Reporting) samuel.yan@cn.ey.com Sector Leaders Henry Chan (Financial Services) henry.chan@cn.ey.com Alan Lan (Energy & Resources) alan.lan@cn.ey.com Martin Ngai (Technology, Media, Telecommunications) martin.ngai@cn.ey.com Vickie Tan (Life Science) vickie.tan@cn.ey.com Gary Chan (Real Estate) gary.chan@cn.ey.com Audrie Xia (Consumer Products) audrie.xia@cn.ey.com Walter Tong (Automotive & Transportation) walter.tong@cn.ey.com Raymond Zhu (Government& Public Sector) raymond.zhu@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 8

9 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 not 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 not 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 9