Foreign investors in China who want to obtain tax treaty benefits for withholding taxes on dividends need to understand the concept of beneficial ownership, communicate it effectively to tax authorities, and compile complete documentation to prove their case. Investors from certain countries that have tax treaties with China may be eligible to have the tax rate on dividend income reduced from 10 percent to 5 percent. However, many companies fail to obtain treaty benefits, because they do not convince tax authorities they are the “beneficial owner” of passive income such as interest, dividends, and royalties. The lower treaty rate is not applicable to US companies with direct investment in China. However may be applicable if the investment in China was structured through a country with the more favorable withholding rate.
Attention on Corporate Income Tax Revenue
China collected RMB 87.17 billion ($14 billion) in corporate income tax revenue from nontax resident enterprises in 2011, and more than half came from withholding tax on dividends. Public Notice No. 30, issued in June by China’s State Administration of Taxation (SAT) , clarified how China would assess beneficial ownership and “affected almost all foreign investors in China.” Notice 30 clarifies an earlier government document, Circular 601, which defines beneficial ownership and lays out seven unfavorable factors that tax authorities consider. To be deemed the “beneficial owner,” companies must show that they have “ownership and control” of the assets and dividends received.
Presenting a Case
Beneficial ownership is complicated, and sometimes tax authorities do not consider all aspects before making a decision. In some cases, tax authorities may “cherry pick one or two factors and ignore the others.” For example, they may apply a very narrow interpretation of the term “business activities,” equating it only with production and trading.
Companies may fail to convince tax authorities that they are entitled to the treaty benefits if they do not adequately review the facts and circumstances of their businesses and formulate technical arguments to help the tax officials understand their case. How the applicant presents the case, demonstrates beneficial ownership status of the company, and the way they approach the tax authority will make a big difference in the treaty application.
Companies also may run into trouble proving their case, because they cannot produce enough documentation. Notice 30 lists a number of documents that tax authorities may request in evaluating beneficial ownership status, including articles of association, record of cash flow, minutes of board meetings, and financial statements.