Optimizing Profit in a Dividend Repatriation by DTA: A Case Study

Overseas investors who derive dividends from China are normally subject to a 10 percent corporate income tax (CIT) in China. The invested company that distributes the dividends or profits is obliged to withhold the relevant tax and file with the tax bureaus in charge.

However, per the provisions of double tax avoidance agreements (DTAs), overseas investors have a chance to enjoy a lower tax rate on China-sourced dividends if the overseas investor is a tax resident of the other party to a tax treaty and is the beneficial owner of the dividends, depending on the corresponding articles in the DTA.

Overseas investors shall make a self-assessment on whether they are qualified for DTA benefits and file a report to the tax authority to enjoy the DTA benefits.

For investors/applicants that are hoping to be qualified to enjoy the treaty benefit on their China-sourced dividends, the determination of their Beneficial Owner (BO) status has always been a key point.

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On February 3, 2018, China’s State Taxation Administration (STA) released the STA Announcement [2018] No.9, which integrated and updated a series of issues concerning the BO status determination.

The Announcement has introduced a new “same jurisdiction/same treaty benefit rule” in respect of multi-tier holding structures, under which some overseas companies can be qualified as BO and enjoy the DTA benefits.

Here, based on a particular case study, Dezan Shira & Associates (DSA) provides a detailed analysis of the new “same jurisdiction/same treaty benefit rule” when applying the DTA benefits to avail lower tax rates for the repatriation of dividends.

Scenario

Company A is a tax resident of Hong Kong (not a listed company) and directly holds 100 percent equity interest of a wholly foreign owned enterprise (WFOE) in China. Company A does not carry out substantive business activities except for the holding of the WFOE.

Company F is also a tax resident of Hong Kong and directly owns 100 percent equity interest of Company A. Company F carries out trading activities all over the world.

The WFOE in China plans to distribute its accumulated profit as dividends to its parent company A and hopes to enjoy a preferential tax rate of five percent for dividend under DTA between Hong Kong and Mainland China.

Key issues

To claim the tax treaty benefits on the dividends distributed by its WFOE, Company A must be determined as a BO based on the rules set out by the STA Announcement [2018] No.9.

In determining the BO status of the overseas investor, the Announcement No.9 listed out five unfavorable factors as follows:

• The applicant (the company that is applying for the DTA benefits) is obligated to pay 50 percent or more of the income, within 12 months from receipt of the income, to a resident of a third country (region); “obligated” shall include agreed obligations and de facto payment even though there is no agreed obligation.
• The applicant does not carry out substantive business activities.
• The treaty counterparty country (region) does not levy tax on the relevant income or exempts tax on the relevant income, or levies tax but the actual tax rate is very low.
• In addition to the loan contract for which interest is derived and paid, there is/are other loan or deposit contract(s) between the creditor and the third party where the amount, interest rate and date of execution, etc. are similar.
• In addition to the transfer contract for use rights such as copyright, patent, technology, etc. for which the royalties are derived and paid, there is/are other transfer contract(s) for use rights or ownership in relation to copyright, patent, technology, etc. between the applicant and a third party.

However, the applicant can still be determined as a beneficial owner without conducting the above-mentioned unfavorable factors test under the “safe harbor” rule, if the applicant is:

• the government of the treaty counterparty;
• a resident of the treaty counterparty which is a listed company in the treaty counterparty;
• an individual who is a resident of the treaty counterparty; and/or
• 100 percent of the applicant’s shares are held by one or several persons set out in item (1) to item (3), and the multi-tier holders holding the shares indirectly are China residents or residents of the treaty counterparty.

DSA study

After a preliminary assessment, Company A failed to pass the five unfavorable factors test of beneficial ownership under the STA Announcement [2018] No.9 because the company did not carry out substantive business activities. The company is not eligible for the safe harbor rule either.

So, does Company A still have any chance to enjoy treaty benefits on dividends? Under the STA Announcement [2018] No.9, a further review on the status of Company F is necessary.

The “same jurisdiction/same treaty benefit rule” regulated in the Announcement [2018] No.9 state that:

Where the income derived by the applicant from China is dividend income, if the applicant does not satisfy the criteria for “beneficial owner” but the person who holds 100% of the applicant’s shares directly or indirectly satisfies the criteria for “beneficial owner” and the circumstances falls under either of the following scenarios, the applicant shall be deemed as a “beneficial owner”:

• the aforesaid person who satisfies the criteria for “beneficial owner” is a resident of the country (region) for which the applicant is a resident;

——“same jurisdiction” rule.

• although the aforesaid person who satisfies the criteria for “beneficial owner” is not a resident of the country (region) for which the applicant is a resident, but the said person and the multi-tier holders holding the shares indirectly are persons who satisfy the criteria.

“satisfies the criteria for “beneficial owner” shall mean that it can be determined that the person is a “beneficial owner” upon comprehensive analysis conducted pursuant to the provisions of Article 2 of this Announcement.

“a person who satisfies the criteria” shall mean that the said person, when derives dividend income from China, enjoys identical or more favorable tax treaty treatment pursuant to a tax treaty entered into between China and the country (region) for which he/she is a resident, than the tax treaty treatment enjoyed by the applicant.

——“same treaty benefit rule”.

Company F is an HK tax resident and directly owns 100 percent equity interest of Company A. In this case, Company F can pass the unfavorable factors test and is qualified as a BO, therefore Company A can be deemed as a “beneficial owner” as well for the dividend distributed from the WFOE under the “same jurisdiction” rule.

Summary

The Announcement [2018] No.9 increased the chance of enjoying treaty benefits on dividend for applicants who are neither qualified as a beneficial owner nor eligible for the safe harbor rule in the past.

The Announcement [2018] No.9’s explanatory note set out several examples to clarify the applicant’s BO status under different investment structures. It is clear that even if an applicant lacks BO status, the applicant still has a chance to be deemed as a BO as long as the shareholder who directly or indirectly owns 100 percent equity interest of the applicant satisfies the criteria for BO and meet the criteria set in the Announcement [2018] No.9 (“same jurisdiction/same treaty benefit rule”).

Disclaimer: This case study is one of the scenarios that meets the same jurisdiction/same treaty benefit rule. For different group structures, analysis will be made case by case.

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