In the August/September 2012 issue of Baker & McKenzie’s newsletter, China Tax Monthly, we reported that the State Administration of Taxation (SAT) will issue supplementary regulations to clarify the indirect transfer rules under Notice 698. More recently, it has been reported that these new regulations will be finalised and issued in the near future to replace the indirect transfer rules under Notice 698 (and other supplementary regulations) and will clarify some key issues under the existing regulations.
First, the new regulations will provide a safe harbour for internal reorganisations. One major criticism of Notice 698 has been that it is overly broad. Many legitimate transactions with reasonable commercial purposes, particularly internal reorganisations, have been caught by the notice.
The new regulations will address this over-breadth in part and provide a safe harbour for internal reorganisations. Qualified internal reorganisations will be exempt from enterprise income tax (EIT) and have reduced filing requirements, i.e. only the pre- and post-transaction organisational charts and a brief explanation of the reasonable commercial purpose of the reorganisation will need to be filed with the tax authorities.
[ihc-hide-content ihc_mb_type=”show” ihc_mb_who=”1″ ihc_mb_template=”2″ ]
Reportedly, an internal reorganisation will qualify for the safe harbour if:
- the shareholding relationship in the internal reorganisation meets one of the following conditions:
- the non-resident transferor holds, directly or indirectly, 80% or more of the shares of the transferee;
- the transferee holds, directly or indirectly, 80% or more of the shares of the non-resident transferor; or
- the same party or parties hold, directly or indirectly, 50% or more of the shares of the non-resident transferor and transferee; and
- the actual EIT burden for the transfer of the shares in the underlying resident company will not be reduced after the internal reorganisation.
Second, the new regulations will require tax authorities to issue a formal binding decision when declaring an indirect transfer non-taxable under Notice 698. Under existing rules, tax authorities have to issue a formal binding decision only if they determine an indirect transfer is taxable. If they determine that an indirect transfer is not taxable, they do not have to issue a formal binding decision.
By not being bound by their determination of non-taxability, the tax authorities can change their determination and tax the transaction at any time during the next 10 years (the statute of limitations on tax avoidance). The inability of taxpayers to rely on a formal binding decision of non-taxability has caused uncertainty and inconvenience for cross-border merger and acquisition transactions. The new regulations will help to increase certainty by requiring that a formal binding decision is issued on all taxability determinations, and that it is issued within a fixed period of time.
Third, the new regulations will provide guidance on how to determine the tax basis in a series of transactions. Reportedly, the new regulations will recognise the tax paid in prior indirect transfers when determining the tax basis in subsequent transactions to avoid double taxation.
[/ihc-hide-content]
Business Law Digest is compiled with the assistance of Baker & McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker & McKenzie by e-mail at: Zhang Danian (Shanghai) danian.zhang@bakermckenzie.com
