Compliance executives should take note of a spate of new tax rules from the Chinese government for two reasons: first, the nuts-and-bolts headache of obeying the laws; and second, for the deeper message Chinese regulators are telegraphing about how they will handle U.S. companies doing business there.
And get this: That deeper message might actually be one that companies like.
At the top of the list is a document called Caishui 59, issued April 30 and known in English as the “New Reorganization Rules.” The document bars tax-deferred restructurings within a group. That’s bad news for companies active in China, which often must adjust the set up of their activities on the mainland in the course of business. They frequently find it necessary to sell one subsidiary to another, consolidate subsidiaries, or move assets between their various entities within the country.
“Obviously, the circular is important to a lot of multinationals, especially for those who have substantial operations in China,” says Fuli Cao, a lawyer at the law firm Jones Day in Beijing. “People buy and sell from time to time, sometimes for tax reasons and sometimes for business reasons.”
Another rule comes from Guoshuifa 82, also published in April. The document addresses possible taxation of the worldwide income of corporations based outside China, and at first glance it suggests that revenue-hungry Chinese bureaucrats are trying to extend their reach outside the country.
At closer reading, however, both publications aren’t as alarming as they seem. Corporate tax experts say the new rules are fairly clear, approach international norms, and go a long way toward addressing previous uncertainties. While foreign corporations in China still have lots of homework in front of them to determine precisely how the rules apply to their companies, the legislation may ultimately be a reason for optimism.
“There was a black period from January 1, 2008, until now. Before, there was no guidance. There were no definite rules.”
— Fuli Cao,
Lawyer,
Jones Day
In addition to the new tax rules, other regulations also seem to indicate that China is working to simplify and clarify matters for foreign corporations. The recently issued Circular 7, for example, allows international companies making small investments in China, generally under $100 million, to avoid the Ministry of Commerce in Beijing and deal directly with the local branches of the same ministry. Lawyers and other professionals in China say that this is a significant change and will lead to faster and easier approvals.
Right away, Guoshuifa 82 falls by the wayside for most Western companies. It does indeed call for some offshore businesses to be taxed as Chinese companies, but it limits itself to corporations majority-owned by Chinese shareholders; that exempts the large majority of global corporations. The law is aimed at Chinese companies trying to pass themselves off as foreign businesses for tax benefits, and actually mimics legislation in many other countries intended to address the abuse of offshore tax havens. In that sense, China is following best practices.
Caishui 59, in contrast, is a rule that compliance, accounting, and legal departments will need to monitor. Because tax might now be charged at the time of a restructuring, and because that tax can be significant and material to a transaction, Caishui 59 could prevent international companies from engaging in the routine and beneficial reorganization of assets.
“It is more restrictive than in the past. Under the old rules, we could do the transfer at cost within the group,” says Alan Tsoi, a tax partner at Deloitte and Touche. “If you can’t move your holdings, the company’s structure becomes more rigid.”
TAX TREATMENT
The following excerpt from KPMG’s unofficial translation of Caishui 59 explains some provisions of special tax treatment:
Article 5: Where a corporate restructuring simultaneously satisfies the following conditions, the provisions in respect of special tax treatment shall apply:
(1) The corporate restructuring has reasonable commercial purposes and does not have as its main purpose the reduction, elimination or deferral of tax;
(2) The ratio in respect of the assets or equity interests that are acquired, merged, or demerged is in line with that stipulated in this circular;
(3) The original substantive operating activities in respect of the restructured assets do not change within the twelve consecutive months after the corporate restructuring;
(4) The amount of the equity consideration included in the consideration for the corporate restructurings is in line with the ratio stipulated in this circular;
(5) The original main shareholder(s) that obtain(s) the equity consideration in the corporate restructuring will not transfer the equity interests obtained within the twelve consecutive months after the corporate restructuring.
Article 7: Where enterprises are involved in equity and asset acquisition transactions that take place between the China and overseas territory (including the territories of Hong Kong, Macao, and Taiwan), not only shall the conditions stipulated in Article 5 of this circular be satisfied, the following conditions shall also be simultaneously satisfied in order to elect to apply the special tax treatment provisions:
(1) A non-resident enterprise which transfers its equity interest in a resident enterprise to another non-resident enterprise in which it holds a 100% direct interest, the withholding tax in respect of the gains from the alienation of that interest should not be affected. In addition, the transferor non-resident enterprise shall provide a written undertaking to the tax authorities that it shall not transfer the equity interests in the transferee non-resident enterprise within three years of the transfer;
(2) A non-resident enterprise transfers the equity interest in a resident enterprise to another resident enterprise with which it is 100% directly related in shareholding;
(3) A resident enterprise uses the assets or equity interest to invest in a non-resident enterprise in which it holds a 100% direct interest; or
(4) Other circumstances permitted by the Ministry of Finance or the State Administration of Taxation.
Source
KPMG Unofficial English Translation of Caishui 59 (April 30, 2009).
Tsoi
But the new rules for reorganization are also ultimately on the benign side, and many even regard them as a positive bit of rulemaking from Beijing. Above all, they say, Caishui 59 resolves an area of uncertainty in Chinese business law.
China imposed a new corporate income tax in 2008. Before that law, tax-deferred restructurings were generally allowed; after it, nobody was quite sure whether such deals were still permitted. Yes, Caishui 59 provides clarity that they are not allowed—but it also provides a dose of clarity in the often-opaque world of Chinese bureaucracy. Tax professionals are happy that they now have specific guidance about the taxation of reorganizations.
“There was a black period from January 1, 2008, until now,” says Cao from Jones Day. “Before, there was no guidance. There were no definite rules.”
And Caishui 59 itself is not so draconian. While it does forbid tax-deferred reorganizations, it also allows for “special tax treatment” for certain transactions. The upshot is that many restructurings can be done without being taxed immediately. They need to be undertaken for legitimate business purposes rather than tax purposes, and continuity of ownership must exist after the transaction. But broadly speaking, many reorganizations can proceed without being taxed right away.
Ni
“The bottom line is to ensure the restructuring is tax neutral,” says Peter Ni, a partner at the law firm White & Case in Shanghai. “Transactions should not be tax driven, but on the other hand, tax should not be a show-stopper for restructurings with bona fide business purposes.”
As with Guoshuifa 82, the new rules on reorganization closely match legislation in the West and suggest a new attitude on the part of the regulators. They appear to be working toward international standards. Rather than being too creative, Chinese regulators seem to have accepted the need to issue rules that align with what’s been developed elsewhere. Pragmatism is taking hold.
“These rules are built on the overseas model and tailored to the local context,” says Chris Xing, senior tax manager at KPMG China. “It is an indication of a trend that the [State Administration of Taxation] is issuing rules to allow for commercial tax planning.”
No comments yet