Background of Shanxi Case
On 6 April 2012, the China Taxation News reported a recent real case titled as “Single largest tax in an offshore indirect share transfer had been collected recently” (“Shanxi Case” or “Report”)). According to the Report, the Jincheng State Tax Bureau (“Jincheng STB”) in the Shanxi province recently collected withholding tax in the amount of RMB 403 million from the indirect transfer of shares in a Chinese coal enterprise, by a BVI company (“the Transferor”). The tax amount imposed is the single largest tax in the offshore indirect share transfer case to date since the issuance of Circular 698 on December 2009.
The Report states that, in order to accurately quantify the share transfer price, the deductible cost, how to impose late payment surcharges and other penalties, the Jincheng STB made the following efforts: (1) carefully examined the available documents and information of the transaction; (2) approached the Chinese coal enterprise to acquire more detailed information of the transaction and the shareholders change; (3) issued the Notice of Tax Matters requiring the parties to provide the transaction materials.
Over several rounds of negotiation with the representative of the Transferor, no substantial achievement was made. In light of this, the Jincheng STB actively negotiated with the Transferee, and requested it to withhold the payable tax of the Transferor from the outstanding payment to the Transferor. In the joint efforts of various sides, the Transferee finally agreed with the in-charge tax authority on the share transfer price, the deductible cost, and paid the withholding tax.
MinterPKU Insights
Circular 698 makes it clear that the Chinese tax authority shall have the taxation jurisdiction to the indirect share transfer of a Chinese enterprise by non-resident enterprises. And the non-resident enterprises shall have to perform transaction disclosure liability and tax liability as requested under Circular 698.
Following the issuance of Circular 698, the tax amount from the indirect share transfer by non-resident enterprises has increasing year by year, and the single largest amount also strikes the new highs over and over again. The single largest tax amount from the indirect share transfer by non-resident enterprises is RMB 173 million and RMB 306 million in 2010 and 2011 respectively. This indicates that the administration of the non-resident enterprise has been one of the priorities of the tax authorities’ work.
Based on this Report, we below share with you our observation and insights on three salient points, which are worthy of drawing the attention of the Transferor and the Transferee of the indirect share transfer.
- Timing of tax liability arising
The arising of tax liability of the non-resident enterprises under Circular 698 is on the premise of re-characterizing of the share transfer transaction from the economic substance perspective and denying of the existence of the intermediate SPV. Meanwhile, the re-characterizing of the share transfer transaction by tax authority is based on the documents and information provided by the involved parties for filing purposes under Circular 698, or the information obtained by the tax authority from other sources. Therefore, theoretically, the tax liability of the Transferor shall arise following the issuance of the tax imposition notice by the tax authority. The arising of the tax filing liability does not mean the arising of the tax liability.
Based on the this logic, if the Transferor fails to perform its transaction filing liability and the tax authority does not become aware of the share transfer transaction, the tax liability of the Transferor under Circular 698 may be indefinitely delayed. Meanwhile, if the Transferor is found not to make any transaction disclosure, it may only be imposed small fine (usually not more than RMB 10,000 yuan). This is obviously not conducive to the implementation of Circular 698 and the tax collection.
- whether the late payment surcharges shall be imposed on the indirect share transfer case by non-resident enterprises
The Reports sets out that the Jincheng STB made in-depth investigation to the transaction in order to determine whether the late payment surcharges and any penalty shall be imposed. However, the media reported cases involved the indirect share transfer of a Chinese enterprise did not expressly indicates whether the tax authority once imposed any late payment surcharges (and /or any other penalties) or not.
From the perspective of the nature of the indirect share transfer activity, it is one of the common ways of tax avoidance regulated by the general anti-avoidance rules as provided in the Enterprise Income Tax Law (“EIT Law”), the Implementation Regulations of the EIT Law, as well as the Administrative Regulations of Special Tax Adjustments (Trial) (“Regulations of STA”). The Regulations of STA do not have any late payment surcharges provision, but provide the articles regarding the additional interest, i.e, “if the tax authorities make a special tax adjustment for the enterprise pursuant to the provisions of the EIT Law and the Implementation Regulations of EIT Law, and additional interest payment should be charged for additional tax levied on transactions after 1 January 2008”. Therefore, we are of the view that the indirect share transfer shall not be imposed any late payment surcharges. However, if the Transferor fails to pay the due tax within the stipulated period when the tax authority issues a tax payment notice, the late payment surcharges may be still applied.
Though the publicly reported cases do not explicitly mention the imposition of the late payment surcharges on the non-resident enterprises, we are aware that the tax authorities may take the imposition of the late payment surcharges as a leverage to push the non-resident Transferor to pay the tax.
- Whether the Transferee has the statutory withholding liability
In shanxi case, it is reported that Jincheng STB requested the Transferee to withhold the tax payable by the Transferor.
There have always been different views on whether the Transferee has the statutory withholding liability for the tax payable by non-resident for the indirect share transfer.
Most tax specialists hold the view that if the Transferee in the indirect share transfer is also a non-resident enterprise, it falls within the circumstances under which the withholder cannot perform the withholding liability. According to the Interim Regulations on Source Withholding of Non-residents’ Enterprise Income Tax (Guo Shui Fa [2009] No. 3) (“Circular 3”), the Transferor shall declare the payable tax by itself or through an agent authorized by the Transferor. Meanwhile, Circular 3 provides that the Chinese enterprise transferred shall assist the tax authority to collect the withholding tax payable by the non-resident Transferor, without any provisions concerned the Transferee’s assistance liability.
In practice, some tax officials, however, took the opinion by reference to Article 3 of Circular 3 that even if the Transferee is also a non-resident enterprise, the Transferee shall bear the statutory withholding tax liability. Article 3 of Circular 3 set out a general principle on withholding liability, providing that, non-resident enterprises’ China sourced income in the form of dividend, interest, rental, royalties and capital gains etc., shall be subject to withholding tax, and the tax payable shall be withheld by the Transferee. If the Transferee fails to withhold the tax, it may be imposed a fine in the range of 50% ~ 300% of the underpaid tax.
According to the Report, it seems that the Jincheng STB held the views that the Transferee shall be subject to the withholding liability for the tax payable by the non-resident Transferor. However, this Report does not shed some lights on whether the tax is paid by the Transferor or withheld by the Transferee.
In light of the above potential risks, the Transferee may consider to include a separate article to stipulate the Transferor’s disclosure and tax liability, as well as the corresponding penalty rules upon the failure of the fulfilling of the stipulated liability, in order to alleviate its potential tax risks in the transaction.
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