|Rocky T Lee|
In a circular issued on December 10 2009, the State Administration of Taxation (SAT) made clear its intention to target offshore transactions involving the indirect transfer of PRC enterprises (Notice on Strengthening the Management of Enterprise Income Tax Collection of Proceeds from Equity Transfers by Non-Resident Enterprises Circular 698).
Circular 698 requires foreign (ie offshore) companies and funds, which are non-China Tax Resident Enterprises (Non-TRE), to pay taxes in the PRC when selling or transferring equity of an intermediate offshore company where the underlying intermediate offshore company directly or indirectly holds an interest (any assets, subsidiary, business operations) in the PRC.
Given Circular 698's broad language and lack of detailed guidance, there has been a rise in concern on the part of foreign investors.
Whether or not a transfer by way of a holding company is classified by PRC tax authorities as directly or indirectly holding an interest in a PRC entity is subject to whether the intermediate holding company has a "reasonable commercial purpose", which Circular 698 does not define.
There is guidance in the form of the implementing regulations of the Enterprise Income Tax Law, which provides that an arrangement will not be considered to have a reasonable commercial purpose if the main purpose of such arrangement is to reduce, exempt or defer tax.
It remains uncertain whether the breadth of the term "reasonable commercial purposes" has a wide or narrow meaning. Presumably, the SAT would adhere to a narrow meaning, contending that "business" requires the purpose to be reasonable in the context of the business operations of the PRC resident enterprise.
A wider interpretation would favour the approach that any transaction that a company engages in will be conducive to furthering a commercial objective for the company or its shareholders.
Where a non-TRE seller transfers multiple holding companies at the same time, the underlying PRC subsidiary must submit both the master transfer agreement and the local transfer agreement involving the PRC subsidiary to the PRC tax authorities. If the price allocation among the onshore and offshore subsidiaries is found to be unreasonable, the PRC tax authorities can adjust the purchase price allocation.
Further, where a non-TRE transfers the shares of a PRC subsidiary to its related parties for a non-arm's length price, the PRC tax authorities may make valuation adjustments they deem appropriate.
The Non-TRE seller is required to disclose an indirect transfer of a PRC subsidiary to the PRC tax authorities within thirty days of signing any such agreement. It is quite likely that a deal will not have been completed within this time period. As a result, there are confidentiality concerns for situations in which a disclosure must be made before the closing date of a transaction.
Given that the effective date of Circular 698 is January 1 2008, there are questions regarding whether or not the thirty-day disclosure period implies that the reporting obligation is only applicable for transactions concluded after December 10 2009, the issue date of Circular 698.
Rocky T Lee