China’s crack down on tax anti-avoidance took another major step forward with the release of a new Circular by the SAT which may severely restrict the ability of offshore holding companies to take advantage of tax treaty benefits. The SAT’s “Notice on Interpretation and Determination of Beneficial Owner under Tax Treaties” (Guoshuihan  No. 601, or “Circular 601”), directs local tax authorities to investigate whether an applicant satisfies the requirements to qualify as a beneficial owner, which is a pre-requisite to enjoy the benefit of a reduced withholding tax on dividends, interest, royalties or capital gains under a double tax arrangement.
According to Circular 601, a beneficial owner refers to a person or any organization that has both ownership and right of control over the income or the assets or rights generating the income. An agent or a conduit company is not regarded as a beneficial owner. A conduit company is defined as a company established in a tax-exempt or low tax rate jurisdiction for the purpose of avoidance or reduction of taxes or the transfer or accumulation of profits, and where the company does not engage in substantive business activities like manufacturing, distribution or management. No further guidance is provided as to what constitutes management activities and whether such activities must be carried out by personnel or may be conducted at board level.
The determination of beneficial owner is to be conducted on a case-by-case basis, based on information provided by the taxpayer when applying for treaty benefits. The Circular further states that the following factors would be unfavorable in determining whether a company is the beneficial owner of an item of income, without indicating how these factors are to be weighed:
- (a) The applicant is obligated to transfer all or most of (such as more than 60%) income to a resident of a third country (region) in the stipulated time period (such as twelve months upon receipt of income);
- (b) The applicant does not or barely engages in other operating activities except for holding the income derived from the assets or rights;
- (c) When the applicant is a company, the applicant’s assets, business scale and personnel could not reasonably match the income;
- (d) The applicant has no or little right of control or disposal of the income or its underlying assets or rights; nor does it assume any or hardly any risks;
- (e) The income is non-taxable or tax-exempt in the other contracting country (region), or even if it is taxable, the tax rate is extremely low;
- (f) The lender to a loan agreement that generates interest income has another loan agreement or deposit contract with a third party; the amount, interest rate, and the time of conclusion with respect to the third-party contract are similar to those of the first loan agreement.
- (g) The licensor to an agreement on copyright, patent, and technology licensing or transfer has a contract to obtain the rights by license or transfer from a third party.
It appears clear that a single purpose vehicle (SPV) set up for a single Chinese investment will not satisfy the requirements for beneficial ownership under the Circular. It is less clear whether a holding company that holds several investment subsidiaries, but does not have its own management personnel, would qualify as a beneficial owner. The local tax authorities appear to have considerable discretion to make that determination, given the broad statement in the notice that a beneficial owner should have substantive business operations, the lack of any weighting in the identified negative factors, and the fact that even a multi-investment holding company would trigger at least two of the criteria set out above, and perhaps one or two more, depending on how these criteria are interpreted.
Companies are well-advised to review their holding company structures immediately, and consider restructuring out of SPVs, assuming they need to take advantage of the dividend withholding tax exemption. Companies with multiple investment holding companies need to exercise caution before applying to distribute dividends, and may consider injecting personnel and operating assets into their holding companies, if feasible, while keeping alert to further developments in the actual enforcement of Circular 601.