HOW TO VERIFY WHETHER YOUR ORGANIZATION IS ELIGIBLE FOR DTA BENEFITS
16 April 2020 | Foreign Investment, DTA | Written by Dr. Richard van Ostende | Reading time: 8 minutes
Many multinational companies have established China-based subsidiary companies with active business operations in China. Depending on the bilateral agreements between China and the other countries or non-state tax jurisdictions, generating income in China has tax implications which might affect the overall tax burden of both the China-based subsidiary company and the foreign parent company.
Double Taxation Agreements (DTAs) aim to prevent income from being taxed by two or more states through providing tax credits, exemptions, and/or reduced tax rates for specific income types such as interests, royalties, and dividends. DTAs further provide certainty by defining the taxation right of each jurisdiction on various types of income arising from cross-border economic activities.
In this article the steps which entrepreneurs should take to confirm whether their organizations are eligible for DTA benefits are discussed in detail.
A non-resident enterprise refers to
a company established in accordance with the law of a foreign country or
region whose actual administration institution is located outside the territory of the People’s Republic of China but with “organizations or establishments” within the territory of the People’s Republic of China; or without organizations or establishments within the territory of the People’s Republic of China but which have income derived from the territory of the People’s Republic of China.
The term “organizations or establishments” part of the definition of “non-resident companies” refers to the establishments and places in China engaging in production and business operations, including:
Management organizations, business organization and representative offices;
Factories, farms and places where natural resources are exploited;
Places where labor services are provided;
Places where contractor projects such as construction, installation, assembly, repair and exploration are undertaken; and
Other establishments or places where production and operation activities are undertaken.
If a non-resident enterprise entrusts a business agent to carry out production and business activities in the territory of China, including entrusting a company or individual to regularly sign contracts, store or deliver goods on its behalf, such business agent shall be considered as the establishment or place of the non-resident enterprise in China.
BENEFICIAL OWNERSHIP GENERAL TEST
In many of the DTAs concluded between China and foreign countries, non-state tax jurisdictions or regions, preferential tax rates for income sourced from China are only applicable when the recipient holds a beneficial ownership status over the relevant income. A “Beneficial Owner” (BO) refers to a person who has ownership over and the right to control income, or the rights or properties that generate such income.
In order to determine whether a non-resident enterprise qualifies for beneficial ownership, five unfavorable principles are assessed. The principles have been listed in table 1 below. The presence of unfavorable factors negatively influence the possibility to enjoy the relevant treaty benefits.
Chinese authorities have created the “safe harbor rule”, where the recipient of dividend income can be determined as a beneficial owner without assessment of the unfavorable factors of the beneficial ownership general test. Under the safe harbor rule, the following companies are deemed eligible for beneficial ownership status for receiving dividend income from a China-based subsidiary company which is a tax resident in China.
Listed companies, foreign government or an individual who is a tax resident of a tax treaty jurisdiction; or
A company wholly owned directly or indirectly by such listed company, foreign government or individual.
BENEFICIAL OWNERSHIP ATTRIBITION TEST
In the event the imminent dividend recipient is neither eligible for the safe harbor rule nor qualifies as a beneficial owner assessed based on the unfavorable factors, the applicant from China cannot enjoy the relevant treaty benefits.
If the immediate shareholder of the China-based subsidiary company which is a tax resident in China can be considered as the Beneficial Owner of the dividend received from China, it will be still able to enjoy treaty benefits. Despite not meeting the conditions described above, shareholding companies will be considered eligible to enjoy tax treaty benefits if the conditions of the Same Country Scenario and Non-Same Country Scenario below apply.
(1) Same Country Scenario
In the same country scenario company 1 directly owns 100% of the equity of company 2. Both company 1 and 2 are tax residents in country A. Between country A and China a Double Taxation Agreement has been concluded.
Company 2 holds an equity interest in company 3 which is based in China and receives dividend income from company 3, but does not qualify for Beneficial Ownership status due to a lack of local substance in country A. This situation has been illustrated in figure 1.
However, if company 1 had directly invested into company 3 and received the dividend income, it would have qualified for Beneficiary Ownership. Therefore, company 2 will be granted beneficial ownership status and will qualify for the withholding tax rate on dividend included in the DTA.
Further, this result will remain the same in the event company 1 indirectly holds 100% of the equity of company 2, regardless whether these intermediate legal entities are tax residents of country A or from other jurisdictions, foreign countries or regions.
(2) Non-same Country Scenario
In the non-same country scenario company 1 directly owns 100% of the equity of company 2. Company 1 is a tax resident of country A. Company 2 is a tax resident of country B and holds an equity interest in company 3 which is based in China. Company 2 does not qualify for Beneficial Ownership status due to a lack of local substance in country B. This situation has been illustrated in figure 2.
Company 2 can still be treated as a beneficial owner if company 1 meets the conditions listed in the Beneficial Ownership General Test and is a “qualified person”. To constitute a qualified person company 1 must:
Be a tax resident in a jurisdiction, foreign country or region; and
Be eligible to enjoy the same or a lower withholding tax rate under the DTA between Country A and China, compared to the withholding tax rates under the DTA between Country B and China.
For both scenarios the beneficial ownership safe harbor and the beneficial ownership attribution test, the 100% ownership requirement must not only be satisfied at the time of application for the DTA benefits, but also continuously during the preceding twelve months.
CHECKLIST SUPPORTING DOCUMENTS FOR BENEFICIAL OWNERSHIP APPLICATION
In connection with an application for beneficial ownership status based on the general test, the beneficial ownership safe harbor or the beneficial ownership attribution test, the supporting documents listed in table 3.4 must be provided to the tax authorities for review and approval.
* The Tax Certificate or the Certificate of incorporation should be issued within one (1) calendar year of submitting the application for tax treaty benefits to China’s tax authority.
Van Ostende, R.A. (2019). Profit repatriation via dividend payments from China, KDP Select, ISBN: 978-167-053-1377
The information in this article is intended for general information on the subject matter. The content of this article is not intended to replace professional advice on the subject matter in relation to your specific circumstances.
Copyright © 2020 R.A. van Ostende. All rights reserved.