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China’s new rules on indirect transfers raise numerous issues

Could affect tax on past and future mergers, acquisitions, restructurings


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In early 2015, the People’s Republic of China’s State Administration of Taxation released Public Notice 2015 No. 7, Notice of Corporate Income Tax Issues in Relation to the Indirect Transfer of Properties by Non-Resident Enterprises (PN 15-7). This notice affects not only any applicable transactions after its issuance, but also any transactions since Jan. 1, 2008 that have not yet been assessed by the tax authorities.

Read our white paper, New PRC rules on indirect transfers have far-reaching implications, for more details.

PN 15-7 has far-reaching implications for foreign entities involved in mergers, acquisitions or restructurings. Key concerns include:

  • Is the transaction taxable? Under PN 15-7, Chinese tax authorities will consider a non-taxable indirect transaction to be a taxable direct transaction if the transaction does not involve a reasonable commercial purpose. It will, however, be difficult for buyers and sellers to determine if a transaction meets this threshold. Since the statute of limitations for anti-avoidance cases is 10 years, the risks this concern raises will likely complicate deal negotiations in some cases.
  • Is withholding required, and who will pay? Since failure to withhold will be penalized, and since the buyer is the corporate income tax withholding agent, buyers have an incentive to insist on reporting the transaction and withholding taxes even if many of the commercial purposes tests appear to be met. Sellers also have reason to be concerned. Under PN 15-7, they are required to file and pay the tax if the buyer fails to do so, and they have only seven days from the effective date of the transaction to comply.
  • Is there relief for intergroup reorganizations? Under PN 15-7, it is unclear if the shares of other group companies, such as the shares of the transferee’s parent, could be used. PN 15-7 is silent on whether a spinoff will qualify for intragroup reorganization relief.

For any applicable transaction, foreign investors should:

  • Review any open tax positions for indirect transfers, including but not limited to the history of the entities, substance, functions and availability of potential for treaty protection
  • Act more prudently in reviewing the investment structures and evaluate whether the indirect transfer has reasonable commercial purpose
  • Ensure sufficient documentation for both reasonable commercial purpose and substance
  • Evaluate whether the indirect transfer qualifies for safe harbors
  • Assess if voluntary reporting and tax withholding should be done
  • Clarify with tax professionals on the uncertain areas in relation to the interpretation and implementation of PN 15-7

For more details on PN 15-7, including possible safe harbors, read our white paper, New PRC rules on indirect transfers have far-reaching implications.


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