According to the Double Taxation Treaties (“DTA”) entered into by the PRC and other countries / regions, the non-resident recipient in other contracting state may apply for the treaty benefits available for dividend, interest and royalties only if it qualifies as the beneficial owner of the mentioned passive income.
On October 2009, the State Administration of Taxation (“SAT”) issued the Guo Shui Han [2009] No. 601 (“Circular 601”) to lay down the basic principle on the identification of the beneficial owner of the applicant. Circular 601 emphasizes that the identification of the beneficial owner shall comply with the principle of “substance over form”, and lists seven negative factors that unfavorable for the identification of the beneficial owner. The provisions of Circular 601 are generally in line with the principle as set out in the OECD Tax Treaty Commentary. However, the provisions of Circular 601 are too general and lead to different interpretation and tax treatment by the tax authority in certain extent, and give rise to a lot of uncertainty to the taxpayer. For example, in practice, the same taxpayer may get different results for the application of the beneficial owner status from different tax authorities, under which one tax authority may deny its application on the grounds of lack of the beneficial owner status and the other tax authority may confirm its beneficial owner status.
In response to the issues encountered in practice, the SAT issued an Announcement titled as the “Announcement on the Identification of the Beneficial Owner in the DTA (“Announcement [2012] No. 30”), to provide further guidance for the identification of the beneficial owner. We below summarized the key points of Announcement [2012] No. 30 and shared our observation and opinion to the relevant issues.
1. Key points of Announcement [2012] No. 30
(a) More stringent criteria on the identification of the beneficial owner shall be adopted
Announcement [2012] No. 30 stresses that the identification of the beneficial owner shall take all factors into account to make a comprehensive analysis, and shall not deny the beneficial owner status of the applicant only because of the existing of any of the negative factors, or grant the beneficial owner status for the applicant only due to the non-existing of purposes to “evade or reduce tax, transfer or accumulate profits”.
Meanwhile, Announcement [2012] No. 30 listed some common documents required when assessing the beneficial owner status of the applicant, including articles of association, financial report, board meeting minutes, board meeting resolution, statement on the function and relevant situation of the applicant, legal contract, and the ownership certificate of the relevant assets , the designated collection contract and so on.
(b) Setting safe harbor rule to simplify the identification of the beneficial owner for the applicant’s dividend income
In order to simplify the identification of the beneficial owner for applicant’s dividend income, Announcement [2012] No. 30 provides the safe harbor rule with stringent application conditions. According to the safe harbor rule, if an applicant is a listed company or 100% directly or indirectly owned by a listed company located in the same country / region, the applicant shall be qualified as the “beneficial owner”.
(c) The non-resident partnership and trust may benefit from the “agent rule”
Announcement [2012] No. 30 provides that if an applicant collects such passive income as dividend, interest and royalties through an agent (or a designated person), the tax residency of the agent shall not affect the applicant’s beneficial owner status, but at the same time the agent shall file a declaration to the tax authority stating that it is not a beneficial owner. This is the so-called agent rule. However, if the Chinese tax authority subsequently discovers that the agent is in fact the beneficial owner, the tax authority can change the original decision, claw back the treaty benefits, and the later payment surcharge shall also be imposed.
This may be good news for the non-resident partnership and trust with investment in China. In the context of the DTA, the partnership and trust are deemed as “person”, i.e., “non-resident taxpayer”. In the past, the partner of the partnership cannot apply for beneficial owner status on its own name instead of the partnership. The agent rule of Announcement [2012] No. 30 may open a door for the partners of the partnership or the investors of the trust or OFII to apply for the beneficial owner status on their own names rather than the name of the partnership or trust.
Unfortunately, Announcement [2012] No.30 does not provide a definition of the “agent” or the “designated recipient”. Therefore, it remains to be seen whether the partners or investors of the partnership and trust can really benefit from the agent rule, through which the partners or investors can apply for the treaty benefits on their own name.
(d) Tax administration
Announcement [2012] No.30 states that, if the competent tax authority intends to deny the application of the tax treaty benefits based on thenon-qualification of the beneficial owner status, it shall submit its decision in advance to the provincial tax authority for final decision. Meanwhile, the provincial tax authority shall file the decision with the SAT.
Moreover, if the same taxpayer needs to apply for the DTA benefits with more than one tax authorities, it can report it to the relevant tax authorities, and these tax bureaus shall team up to reach a unanimous decision. If a consensus cannot be reached, the case should be escalated to the next Chinese tax authority level that is in charge of all these tax authorities involved in the decision.
The two points above showed the efforts made by the SAT to unify the tax law’s practice.
2. MinterPKU’s Opinion
As an overview, we are of the opinion that Announcement [2012] No. 30 shows that the Chinese tax authority intends to tighten the examination for the application of the beneficial owner status. Therefore, non-resident taxpayer shall prepare more detailed documents in place to demonstrate its beneficial owner status when applying for the tax treaty benefits. This requires the taxpayer to improve its internal control procedures and make sure that the relevant documents are prepared and maintained for future reviews by the tax authorities.
It is no doubt that the “safe harbor rule” would be good news for the taxpayer with the “safe harbor”. However, it is worth noting that, although Announcement [2012] No.30 specifies an effective date of 29 June 2012, it remains unclear on whether the provisions of Announcement [2012] No.30 can be applied retroactively to the cases that remained open as of 29 June 2012. Therefore, it is advisable for the taxpayer to actively communicate with the competent tax authority to pursue a favorable interpretation and enforcement of the law.
The provision of agent rule will be of particular interest. The agent rule may have significant impact to the QFII that remain large amount of undistributed profits in China. As such, for the non-resident VC or PE, the agent rule may also impact the ultimate interests of the partners or investors. MinterPKU will take a close look to the latest development and practices of the agent rule under Announcement No.30, and keep you posted on these.
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