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TAX & FINANCE: Determination of “Beneficial Ownership”
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Determination of “Beneficial Ownership”

By Kelvin Lee, PwC Tianjin

BT 201804 Finance 05税务总局于2018年2月3日出台了期待已久的国家税务总局公告:2018第9号公告,废止了601号文和30号公告,大幅度更新了中国税务机关对于受益所有人的规定规则。与之前的文件和公告相比,9号公告对执行税收协定股息条款的解释作出了两项重大改进。一是扩大了股息条款适用安全港规定的范围,二是对存在境外多层控股的架构,在符合一定条件的情况下,可以使用“相同国家/相同协定待遇”规则,这些都增加了非居民纳税人享受股息的协定优惠待遇,是为广大非居民纳税人所欢迎的重大利好。同时9号公告收紧了601号公告中的第一和二项不利因素的判定标准,这可能会对部分非居民纳税人带来一定的挑战,造成受益所有人身份被否定,享受不到协定优惠待遇。为执行中华人民共和国政府对外签署的避免双重征税协定(简称“税收协定”),税收协定股息、利息、特许权使用费条款中“受益所有人”身份判定包含以下几点:一、“受益所有人”是指对所得或所得据以产生的权利或财产具有所有权和支配权的人。二、判定需要享受税收协定待遇的缔约对方居民(以下简称“申请人”)“受益所有人”身份时,应根据本条所列因素,结合具体案例的实际情况进行综合分析。三、申请人从中国取得的所得为股息时,申请人虽不符合“受益所有人”条件,但直接或间接持有申请人100%股份的人符合“受益所有人”条件,并有另两种情形之一的,应认为申请人具有“受益所有人”身份。另外,代理人或指定收款人等(以下统称“代理人”)不属于“受益所有人”。申请人通过代理人代为收取所得的,无论代理人是否属于缔约对方居民,都不应据此影响对申请人“受益所有人”身份的判定。同时,根据本公告第二条规定的各项因素判定“受益所有人”身份时,可区分不同所得类型通过公司章程、公司财务报表、资金流向记录、董事会会议记录、董事会决议、人力和物力配备情况、相关费用支出、职能和风险承担情况、贷款合同、特许权使用合同或转让合同、专利注册证书、版权所属证明等资料进行综合分析;判断是否为本公告第六条规定的“代理人代为收取所得”情形时,应根据代理合同或指定收款合同等资料进行分析。

9号公告于2018年4月1日起开始实施,在中国有投资的跨国集团应积极审视集团现有的投资架构和经营模式下,9号公告带来的变化,是否令其更容易享受税收协定待遇。如果需要的话,可以通过投资架构或经营模式的重整,以充分利用9号公告中的利好。如果无法使用安全港规定或“相同国家/相同协定待遇”规则,跨国集团应评估如何应对修改后的不利因素,同时应准备恰当充足的文件和证明材料,以应对税务机关的质疑。

BT 201804 Finance 02etermination of “Beneficial Ownership” (BO) status for non-tax residents who derive dividends, interests and royalties from China for the purpose of enjoying tax treaty benefits has always been a hot topic. Since 2009, the State Administration of Taxation (SAT) has released several circulars including Guoshuihan [2009] No.601 (Circular 601) and the SAT Public Notice [2012] No.30 (Public Notice 30). The former listed seven unfavourable factors for the determination of BO while the latter provided a safe harbour rule for qualified non-tax residents to enjoy treaty benefit on dividends. Nevertheless, taxpayers and local-level tax authorities in China have encountered numerous technical and practical problems when dealing with BO related cases and have been expecting further guidance from the SAT.
 

On 3rd February 2018, the SAT released the long-awaited SAT Public Notice [2018] No.9 (Public Notice 9). Public Notice 9 abolished Circular 601 and Public Notice 30. It comprehensively updates assessment principles for the determination of BO. Compared with Circular 601 and Public Notice 30, Public Notice 9 has brought about two major breakthroughs for claiming of tax treaty benefits on dividends: it extended the scope of non-tax residents who are eligible for the safe harbour rule with respect to dividends; and, qualified treaty benefit applicants may apply a “same country/same treaty benefit rule” under multi-tier holding structures. These breakthroughs will increase non-resident taxpayers’ chance of enjoying treaty benefit on dividends and will be largely welcomed.
 

Meanwhile, Public Notice 9 has also tightened the first two unfavourable factors of Circular 601. This will be challenging for some non-resident taxpayers as their treaty benefits may be denied for the lack of BO status.
 

Public Notice 9 will take effect from 1st April 2018. Management of multi-national corporations (MNCs) are suggested to review whether the new changes brought by Public Notice 9 will increase their companies’ chance of enjoying treaty benefits under the existing investment structure and business models. If needed, they may consider carrying out internal restructuring in order to gain leverage on the breakthroughs in Public Notice 9. If the extended safe harbour rule or the "same country/same treaty benefit rule” cannot be applied, the management will need to re-evaluate the impact of the amended unfavourable factors and establish strategies to deal with these changes. Meanwhile, they also need to prepare proper and sufficient documentation to be able to face potential challenges from tax authorities.
 

Background

In 2009, the SAT released Circular 601 to set forth seven unfavourable factors1 in determining BO status. It subsequently issued Public Notice 30 in 2012 to provide further interpretation on Circular 601 and introduced a safe harbour rule.2 This was for listed companies to claim treaty benefit on dividend income. In order to address the uncertainties and key issues identified in non-resident administration over the years, the SAT released Public Notice 9 to provide amendment and further interpretation to comprehensively update the assessment principles regarding BO.
 

Changes to the Unfavourable Factors

Public Notice 9 made some amendments to the unfavourable factors in Circular 601 by tightening the 1st and 2nd factors, deleting the 3rd and 4th factors and retaining the 5th to 7th factors. 1st and 2nd factors are amended as follows:
 

1. The applicant has the obligation to pay more than 50% (note: the threshold was 60% in Circular 601) of the income within 12 months of receiving the income to a third jurisdiction tax resident. “Obligation” shall include both contractual obligation and any factual payment even though the applicant has no contractual obligation to pay.
 

2. The applicant does not carry out substantive business activities. Substantive business activities shall include substantive manufacturing, trading and management activities, etc. Whether or not an applicant’s business activities are “substantive” shall be assessed based on the functions performed and risks undertaken by the applicant. An applicant’s substantive investment and management activities may be construed as substantive business activities where an applicant carries out both non-substantive investment, management activities and other business activities. If the other business activities are insignificant, the applicant’s overall business activities cannot be considered as being substantive.
 

As is shown in the amendment to the 1st unfavourable factor, the SAT not only looks into the legal contractual payment obligations but also examines whether any factual payment exists. According to the explanatory notes of Public Notice 9, even if the applicant has not made any cash payment, certain intercompany transactions such as netting-off inter-company payable/receivable or other genuine commercial arrangements (e.g. extending loan to group companies by the applicant after receiving income from China) may be considered as factual payment which may become unfavorable in determining the BO status.
 

Public Notice 9 sets out detailed guidance regarding the 2nd unfavourable factor on substantive business activities. Substantive business activities include manufacturing, trading and management activities as well as investment and management activities. The explanatory notes to Public Notice 9 have provided some guidance on what investment and management activities are. E.g.: pre-investment research, project analysis, investment decision, execution, post-investment management, industry analysis, market research, regional headquarters function, treasury function, financing function, etc. The explanatory notes to Public Notice 9 also provide a few case studies. Based on SAT’s analysis of these cases, it appears that the SAT has a higher expectation of “substantive business activities” than before. For the situation where an applicant carries out no substantive investment and management activities and other business activities, the explanatory notes further gives an interpretation by way of an example: where the income generated from the other business activities by the applicant is less than 8% of its total income, the other business activities are insignificant.
 

3rd and 4th unfavourable factors in Circular 601 are deleted because their assessment criteria have already been incorporated into the 2nd unfavourable factor as amended by Public Notice 9.

BT 201804 Finance 04Extended scope of non-tax residents eligible for the safe harbour rule with respect to dividends

Public Notice 9 extends the safe harbour rule with respect to dividends of listed companies to also include governments and individuals: i.e. if the applicant is the government, a listed company or an individual who are tax residents of a tax treaty jurisdiction, a company 100% directly or indirectly owned by the above mentioned government, a listed company or an individual, the applicant can be directly considered as the BO of the dividends and there is no need to assess the case against the five unfavourable factors.
 

The explanatory notes to Public Notice 9 set out three diagrams for illustration purpose (please refer to Case 1, Case 2 and Case 3 of the Appendix). In Case 3, as long as the individuals, the listed company (who are Hong Kong tax residents) and Hong Kong government have a 100% collective shareholding in the applicant (i.e. Hong Kong tax resident D), the applicant is eligible to apply the safe harbour rule to the dividends.
 

The “same country/same treaty benefit rule” for a multi-tier holding structure with respect to dividends

Before the release of Public Notice 9, if the immediate dividend recipient is neither eligible for the safe harbour rule under Public Notice 30 nor qualified as a BO upon being assessed based on the unfavourable factors as stipulated in Circular 601, dividends received by the applicant from China cannot enjoy the relevant treaty benefits. Public Notice 9 sets out a breakthrough so that, even if the immediate dividend recipient is not qualified as a BO, it can be deemed to be the BO of the dividend where certain conditions are satisfied. Specifically, the immediate shareholder of the Chinese TRE (i.e. the applicant) can be deemed as the BO of the dividend received from China and enjoy the relevant tax treaty benefit under either of the following two scenarios:
 

Scenario 1:
The shareholder directly or indirectly holding 100% equity interest of the applicant qualifies as a BO against the five unfavourable factors of Public Notice 9. The above-mentioned shareholder and the applicant are tax residents of the same tax jurisdiction (“the same country rule”).
 

The explanatory notes to Public Notice 9 set out examples as shown in Case 4 and Case 5 of the Appendix. In both cases, both Hong Kong tax resident F and Hong Kong tax resident E are tax residents of the same tax jurisdiction. Although E does not qualify as the BO of the dividend, it can be deemed to be the BO as long as F qualifies as a BO upon being assessed based on the five factors mentioned in Public Notice 9 (even if there are intermediate holding companies from other tax jurisdictions between them).
 

We understand the underlying rationale of the same country rule is that: Since Hong Kong tax resident F (which can pass the five factors under Public Notice 9) could have enjoyed the tax treaty benefit with regard to the dividend if it had directly invested in the Chinese TRE, it can be seen that the intention of Hong Kong tax resident F of setting up Hong Kong tax resident E and BVI company is not to take advantage of the preferential treatment under the dividend article of the Mainland/Hong Kong double tax arrangement.

BT 201804 Finance 03Scenario 2:
Although the applicant and the shareholder who directly or indirectly holds 100% equity interest of the applicant are tax residents of different tax jurisdictions, the applicant can be deemed to be the BO as long as the above-mentioned shareholder qualifies as a BO upon being assessed based on five factors in Public Notice 9. The above-mentioned shareholder and all the intermediate shareholders in between are tax residents from jurisdictions with the same or better treaty benefit with respect to dividends as compared with the applicant (“the same treaty benefit rule”).
 

The explanatory notes to Public Notice 9 set out an example as shown in Case 6 of the Appendix. In that case, the Hong Kong tax resident G does not qualify as a BO but the Singapore tax resident, I, can qualify as a BO upon being assessed based on the five factors under Public Notice 9. Hong Kong tax resident G can be deemed to be the BO of the dividends because the dividends article under the China/Singapore tax treaty and the Mainland/Hong Kong double tax arrangement are the same. It is important to note that under Scenario 2, the real BO (i.e. Singapore tax resident I) and all the intermediate shareholders (i.e. Singapore tax resident H) have to be tax residents from tax treaty jurisdictions and can enjoy the same or better treaty benefit with respect to dividend as compared with the applicant. In addition, Public Notice 9 requires all the offshore shareholders along the investment chain to obtain a tax resident certificate from the tax authorities of their own jurisdiction.
 

We understand the underlying rationale of the same treaty benefit rule is that: Since Singapore tax resident I (which can pass the five factors under Public Notice 9) could have enjoyed the tax treaty benefit with regard to the dividends if it had directly invested in the Chinese TRE, it can be seen that the intention of Singapore tax resident I in setting up Singapore tax resident H and Hong Kong tax resident G is not to take advantage of the preferential treatment under the dividend article of the Mainland/Hong Kong double tax arrangement.
 

It is noteworthy that the “same country/same treaty benefit rule” is only applicable to situations where the direct or indirect shareholding percentage of the immediate holding company is 100%. In other words, it shall not apply to any case with less than 100% shareholding structure. It should also be noted that this “same country/same treaty benefit rule” is not applicable to interest article or royalty article under tax treaties.
 

Other Major Changes

Other major changes brought by Public Notice 9 with respect to BO determination include:

• As China has adopted the minimum standard, i.e. the principal purpose test (“PPT”) with respect to Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) of OECD’s (Organization for Economic Co-operation and Development) BEPS (Base Erosion and Profit Shifting) project, Public Notice 9 no longer uses terms such as "conduit company" or "tax avoidance purposes" as originally used in Circular 601 and Public Notice 30. This provides an avenue for the Chinese tax authorities to use PPT to deny tax treaty benefits.
 

• Public Notice 9 also further clarifies the requirement of tax resident certificates for various circumstances for record filing purposes.
 

• It also clarifies that shareholders receiving dividends, creditors receiving interest, licensors receiving royalties shall not claim themselves as agents or designated recipients receiving income on behalf of others to let other parties enjoy the tax treaty benefit.

BT 201804 Finance 06The Takeaway

Extension of the eligibility of the safe harbour rule and adoption of the "same country/same treaty benefit rule” both reflect the SAT’s implementation of the PPT mechanism. This signals a big step forward by the Chinese tax authorities in aligning its interpretation and implementation of tax treaties with international standards which will be greatly welcomed by non-resident taxpayers.
 

Generally speaking, the technical principles and administration guidance set out in Public Notice 9 will bring both joy and concerns to non-resident taxpayers. On one hand, extending the eligibility of the safe harbour rule and adopting the "same country/same treaty benefit rule” for dividend income will increase the chance of non-resident taxpayers enjoying the tax treaty benefits. This clearer guidance will also reduce the difficulties faced by local level tax authorities in their post-filing administration. On the other hand, in order to prevent tax treaty abuse, the amended unfavorable factors are very stringent. The Chinese tax authorities will look into both the form and substance/fact of the arrangements and will pay more attention to the substantive business activities of an applicant.
 

In addition, although the implementation of the PPT mechanism reflected in Public Notice 9 will bring benefits to taxpayers, dropping of terms, such as, "tax avoidance purposes", so as to apply the PPT to deny treaty benefit will result in more challenges to taxpayers, i.e. an applicant that can successfully pass the BO test against the five factors in Public Notice 9 and may still be denied of the treaty benefit if tax authorities determine that the arrangement was carried out to take advantage of benefits available in certain tax treaties.
 

There are still some uncertainties which remain to be clarified. For example, regarding the 1st unfavourable factor, dispute may arise if the local level tax authorities treat certain genuine intra-group transaction as a factual payment. As to the 2nd unfavourable factor, the local level tax authorities and the applicants may have disputes on whether the applicant carries out substantive investment and management activities, whether other business activities are significant. Moreover, examples stated in the explanatory notes to Public Notice 9 for the "same country/same treaty benefit rule" are limited. In practice, there may be other investment structures that are not designed for treaty shopping purposes, but it remains to be seen whether these types of structures can also be eligible for the "same country/same treaty benefit rule".
 

MNCs should review their existing investment structure and business models against the extended safe harbour rule and the "same country/same treaty benefit rule” and assess whether it is possible to carry out internal restructuring in order to leverage on these benefits. In any case, proper and sufficient supporting documents (e.g. contracts, invoices, receipts, accounting entries, etc.) should be put in place in case of tax authorities' challenges.

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