(This is an English translation of the Chinese article published in the Hong Kong Economic Journal Forum on March 26, 2018: https://manageyourtax.com/HKEJ Forum 8)
[Tax Tips (7) is a recommended pre-reading to facilitate reader’s understanding of certain terms used in this article. Readers who are familiar with the history leading up to PN9 may jump directly to Tax Tips (9)]
Hong Kong enterprises with investments in the Mainland should be familiar with the term “Beneficial Ownership”. With the introduction of the new Enterprise Income Tax Law in 2008, dividend payment from Mainland enterprises to overseas jurisdictions is subject to 10% Withholding Tax. The Double Tax Treaties or Arrangements (collectively referred to as “DTA” below) between the Mainland and the overseas jurisdictions have become important: Dividend Withholding Tax is reduced to 5% for payment to a number of countries (e.g. Singapore) or region (e.g. Hong Kong).
To many investors who entered the Mainland market early, they would be earning stable and growing dividends from the investments, and an effective means of reducing the Withholding Tax would significantly dampen the negative financial impact. Treaty Shopping, as mentioned in the last Tax Tips, is commonly adopted by enterprises in lowering their tax burden. In order to combat Treaty Shopping which is an abusive use of the DTA, starting in 2009, the State Administration of Taxation of the Mainland (“SAT”) has issued several regulations to provide guidance in determining whether the income recipient is the Beneficial Owner, and thus entitled to DTA benefits. The latest regulation is the Public Notice No.9 of 2018 (“PN9”), titled “Public Notice Relating to “Beneficial Owner” Under Tax Treaties”, issued on 3 February 2018. In this article, we first review the regulations superseded by PN9, so that Readers would be better equipped in understanding PN9.
The SAT issued “Notice on the Interpretation and Recognition of Beneficial Ownership under Tax Treaties” (Circular (2009) No.601, “Cir 601”) in October 2009, which is well-known by Hong Kong enterprises, to help local tax bureaus to determine if the foreign recipient is the Beneficial Owner of the relevant income. Article 1 of Cir 601 stated the key principle: “Beneficial Owner” refers to a person who has both the ownership and right of control over the income or assets or rights generating the income, is generally engaged in substantive business activities, and exclude persons such as nominees and conduit companies. Cir 601 defined a conduit company as “a company established for the purpose of avoidance or reduction of taxes or the transfer or accumulation of profits”. The definition of Beneficial Owner is basically in-line with the OECD Model Tax Convention but raised the bar somewhat (see the last Tax Tips).
Paragraph 2 of Cir 601 requires local tax bureaus to take a holistic approach in assessing the Beneficial Ownership qualification taking into account the primary aim of DTA (i.e. avoidance of double-taxation and prevention of tax evasion), consider “substance over form”, understand the facts and circumstances of each case, and analyse with the assistance of the seven “Unfavourable Factors”. Through a comprehensive analysis of the Unfavourable Factors, if the applicant of treaty benefits claim (the “Applicant”) does not satisfy Article 1 of the Circular (does not have both the ownership and right of control over the income or assets or rights generating the income / is not engaged in substantive business activities / possess the characteristics of a nominee or conduit), the tax bureau should not recognise the Applicant as the Beneficial Owner. The five Unfavourable Factors relating to dividend are:
(1) The Applicant is obliged to pay or distribute all or most of (such as more than 60%) the income to a resident of a third country (region) in a stipulated time period (such as twelve months upon receipt of income);
(2) The Applicant does not or barely engages in other operating activities except for holding the assets or rights that generated the income;
(3) In case the Applicant is an entity such as a company, the Applicant’s assets, business scale and number of personnel are relatively small and could not reasonably match with the amount of income;
(4) 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;
(5) The income is non-taxable or tax-exempt in the other contracting state (region), or even if it is taxable, the tax rate is extremely low.
As the amount of dividend Withholding Tax is often very large and have a significant impact on tax bureaus in meeting their revenue collection budget, many local tax bureaus tended to reject applications on the basis that the Applicant failed to meet one or two of the Unfavourable Factors under Cir 601. Since Cir 601 stated that “local bureaus shall consolidate experience and uncover problems, and may report uncertain cases upwards towards the SAT (International Tax Department) for resolution”, many cases became uncertain cases when the Applicants disputed upon being rejected, and the SAT was flooded with cases to be resolved. On the other hand, as the Applicants did not want to deal with the typically-problematic tax refund procedure, they decided not to remit dividend in order to avoid paying excessive amounts, until the SAT has concluded on their cases. Both the tax authorities and taxpayers faced tremendous pressure while their cases were being studied.
Public Notice 30
The SAT is not an arbitration organisation for resolving disputes. In order to reduce the number of cases reaching the SAT and encourage local tax bureaus to close cases at local levels, the SAT issued the “Notice on the Recognition of “Beneficial Owner” under Tax Treaties” (Public Notice No.30 of 2012, “PN30”). PN30 reiterated that tax bureaus should analysis and determine each case based on the Unfavourable Factors set out in Cir 601 on a collective basis, and a decision to grant or reject an application should not be made simply because an Unfavourable Factor exists, or “the purpose of avoidance or reduction of taxes or the transfer or accumulation of profits” cannot be identified. The Notice provided further specific guidance to help the tax bureaus, which include:
- Documents that should be reviewed;
- Safe-harbour Rule – If the Applicant is a company listed on the stock exchange of the contracting state, or is 100% held directly or indirectly by that listed company via companies that are residents of the same contracting state, the Beneficial Owner status can be granted directly to the Applicant;
- Approval at the Provincial-level tax bureaus – local tax bureau shall seek approval from the in-charge Provincial-level tax bureau for rejection cases, and the Provincial-level tax bureau shall file a report of such determination to the SAT for records.
As the applicability of the Safe-harbour Rule is somewhat narrow, PN30 has limited effect in relieving the pressure in the system, and the SAT had to be involved in assisting the decision making in many cases.
Circular (2013) No.165 (“Cir 165”), titled “Views on the Treatments of Beneficial Ownership Cases involving the Dividend Article of the DTA between the Mainland and Hong Kong raised by HuBei and other Provincial and Municipal State Tax Bureaus”, was issued by the SAT in April 2013 as a collective reply to several cases raised by a number of local tax bureaus to provide SAT’s view on such cases. Cir 165 has considered the actual situations of many Hong Kong enterprises and has established several viewpoints that are advantages to Hong Kong Applicants, such as:
- If the Applicant has not distributed profits to any non-Hong Kong enterprise, it is not considered to be an Unfavourable Factor;
- Investment activities should be regarded as business activities
- Beneficial Ownership status should not be denied simply because the investing entity was set up for a single project only;
- Registered capital should not be considered equivalent to “Assets”
- No case should be decided based only on the number of employees or amount of employee expense
- The Applicant’s right of control and disposal of income should not be nullified simply because the shares of the Applicant is controlled by its immediate parent company
- The territorial concept of taxation adopted in Hong Kong which does not impose tax on profits sourced outside of Hong Kong should not be considered a key factor in deciding against the granting of the Beneficial Ownership status
- Article 3 of PN30 (the Safe-harbour Rule) should not be interpreted as the basis for rejecting the Beneficial Ownership status in the following situations:
– The Applicant is 100% directly or indirectly held by Hong Kong resident that is not a listed entity;
– There are overseas incorporated companies in the holding structure between the Applicant and the Hong Kong ultimate parent entity.
However, as Cir 165 was a response specifically addressed to certain tax bureaus, other tax bureaus may make reference to the views stated therein but such views would not be binding on them.
From Tax Office Approval to Taxpayer Self-Assessment
Probably partly due to the pile-up of cases, the SAT issued the “Administration Rules on Non-Resident Taxpayer DTA Benefit Claim” (Public Notice No.60 of 2015, “PN60”). PN60 is not an amendment of the Beneficial Owner definition but amended the procedure on DTA benefits claim. The key change is that instead of pre-approval by the tax bureaus, Applicant shall provide the supporting information if DTA benefit claim is to be lodged. Tax bureaus would allow the claim upon receipt of the required information, and cases will be reviewed afterwards. In other words, taxpayers can enjoy the benefits upfront knowing that they may be required to substantiate their claims when subsequently reviewed by tax bureaus. The new arrangement has substantially reduced the tension between taxpayers and tax bureaus, and the tax bureaus could select cases for follow-up review by deploying risk assessment tools, which improved the efficiency in countering the abusive use of DTAs.
The Latest Guidance on Beneficial Ownership – Public Notice No.9
The newly-issued PN9 and its Explanatory Notes are applicable to DTA benefit claims on liabilities to tax or withholding arising on or after 1 April 2018, and replaced both Cir 601 and PN30. PN9 is silent on Cir 165.
Please note that as the discussion on PN9 is over 4,400 words long, it will be covered in the next issue of Tax Tips, to be issued on 9 April 2018.
Tax Tips: The Author always encourage friends who are concerned about how new tax rules would affect them to first read the rules themselves, then study the Tax Flash/Alert issued by the large firms in order to do a preliminary assessment of the impact, which can then be verified with tax consultants in order to determine the appropriate course of action for implementation. Since PN9 comes with a detailed Explanatory Notes (with six examples), Readers who have studied the last Tax Tips and this article should find PN9 not too difficult to understand.
Author: Edwin Bin
Ref (all in Chinese)
2018 Notice 9 Explanatory Notes: http://www.chinatax.gov.cn/n810341/n810760/c3278984/content.html