2014.11.25 Dingfa (David) Liu、CHENG, Hong (Julie)、Fangfang (Lori) Xiang
On November 14, 2014, the Ministry of Finance, the State Administration of Taxation and China Securities Regulatory Commission released the Circular on Tax Policy relating to the Pilot Program of Shanghai-Hong Kong Stock Connect (“Circular 81”) and the Circular on Issues concerning the Temporary Exemption of Enterprise Income Tax on Capital Gains Received by W88优德中国官方网站s and RW88优德中国官方网站s from Transfer of Stocks and Other Equity Investments in the Territory of China (“Circular 79”). The two new circulars have clarified the income tax, business tax and securities (stock) stamp duty treatment in respect of the Pilot Program of Shanghai-Hong Kong Stock Connect (“Stock Connect”) and the tax issues concerning capital gains received by qualified foreign institutional investors (“W88优德中国官方网站s”) and Renminbi W88优德中国官方网站 (“RW88优德中国官方网站s”).
We set forth below our analysis of the key provisions of these two new circulars.
I. Tax Treatment of Stock Connect
1. Background of Circular 81
Stock Connect is a mechanism which links the securities trading and clearing between Hong Kong Exchanges and Clearing Limited (“HKEx”) and Shanghai Stock Exchange (“SSE”). It enables the investors in the Mainland to trade certain stocks listed on HKEx and investors in the Hong Kong market to trade certain stocks on SSE. As an initiative to strengthen the relationship between Hong Kong and the Mainland capital markets, Stock Connect paves the way for further opening up capital investments inbound and outbound Mainland China.
Before the release of Circular 81, tax treatment of Stock Connect had been the focus of Mainland and Hong Kong investors’ attention. Circular 81 further clarified the tax treatment of Stock Connect under PRC tax laws, while providing certain special policy preferences, with a view to facilitating the smooth implementation of the Stock Connect mechanism.
2. Highlights of Circular 81
Pursuant to Circular 81, the tax treatment of trading stocks through Stock Connect by both Mainland investors and Hong Kong/overseas investors is summarized below.
A. Income Tax on Capital Gains Received from the Transfer of Stocks
The Mainland individual investors investing on HKEx: temporary exemption within the stipulated period (November 17, 2014 to November 16, 2017).
The Mainland enterprise investors investing on HKEx: subject to enterprise income tax at regular rate.
Hong Kong/overseas investors (including individual investors and enterprise investors hereinafter) investing in A-shares: temporary exemption, without a sunset provision.
B. Income Tax on Dividends
The Mainland individual investors investing on HKEx: withholding tax at the rate of 20%.
The Mainland enterprise investors investing on HKEx: subject to enterprise income tax at applicable rate; exemption in case of holding H shares for 12 consecutive months or longer.
Hong Kong/overseas investors investing in A-shares: withholding tax at the rate of 10%; subject to more favorable tax treaty treatment if applicable.
C. Business Tax on Net Capital Gains from the Transfer of Stocks
The Mainland individual investors investing on HKEx: temporary exemption, without a sunset provision.
The Mainland enterprise investors investing on HKEx: will be taxed or exempted from tax under the current rules.
Hong Kong/overseas investors investing in A-shares: temporary exemption, without a sunset provision.
D. Securities (stock) Stamp Duty
Hong Kong/overseas investors investing in A-shares: subject to securities stamp duty pursuant to law.
II. Tax Policy Concerning W88优德中国官方网站s/RW88优德中国官方网站s
1. Background of Circular 79
In addition to Stock Connect, currently foreign investors have access to the Mainland capital markets through W88优德中国官方网站s/RW88优德中国官方网站s. In light of the similarity in the nature and economic substance between Stock Connect and W88优德中国官方网站/RW88优德中国官方网站 scheme and to avoid unfair tax treatment and potential tax avoidance resulting from unfair tax treatment, Circular 79 provides that capital gains derived by W88优德中国官方网站s/ RW88优德中国官方网站s from their transfer of equity investments including stocks in China are temporarily exempted from income tax as of November 17, 2014. In the meantime, Circular 79 makes it clear that capital gains realized by W88优德中国官方网站s/RW88优德中国官方网站s before November 17, 2014 shall be subject to income tax.
2. Summary of Current Tax Framework concerning W88优德中国官方网站s/RW88优德中国官方网站s
A. Income Tax on Capital Gains Derived from the Transfer of Stocks
Pursuant to the PRC Enterprise Income Tax Law and its implementation regulations (collectively “PRC EIT Law”), capital gains derived by W88优德中国官方网站s/RW88优德中国官方网站s from the transfer of equity investments including stocks in China shall be subject to enterprise income tax. However, the public finance and tax authorities never issued any written guidance on the income tax treatment of capital gains derived by W88优德中国官方网站s/RW88优德中国官方网站s subsequent to PRC EIT Law. In practice, most of the tax authorities did not collect capital gains tax from W88优德中国官方网站s/RW88优德中国官方网站s and W88优德中国官方网站s/RW88优德中国官方网站s rarely paid tax voluntarily. One exception is Lehman Brothers Case. It was reported by China Taxation News in January 2011 that Beijing Haidian State Tax Bureau, under the authorization of the International Tax Division of Beijing State Tax Bureau, deemed that Lehman Brothers had recognized RMB3,995,616,235.61 capital gains from its investment in China and then levied enterprise income tax in the amount of RMB399.56 million.1 This is one of the very few cases known to the public that the tax authorities imposed tax on the capital gains realized by W88优德中国官方网站s.
Pursuant to Ciruclar 79, the tax treatment of capital gains from the transfer of equity investments including stocks in China is summarized below:
Capital gains received as of November 17, 2014: temporary exemption, without a sunset provision.
Capital gains received before November 17, 2014: subject to income tax pursuant to law.
B. Income Tax on Dividends
Pursuant to the Circular of the State Administration of Taxation on Issues Concerning the Withholding and Remitting of Enterprise Income Tax on Dividends and Interests Paid to W88优德中国官方网站s by Chinese Resident Enterprise (Guoshui Circular [2009] No. 47), dividends obtained by W88优德中国官方网站s which are sourced from within China shall be subject to withholding tax at the rate of 10%. China Taxation News has also reported some cases where the tax authorities levied tax on the dividends received by W88优德中国官方网站s.2
C. Business Tax
Pursuant to the Circular of the Ministry of Finance and the State Administration of Taxation on the Business Tax Policies for Qualified Foreign Institutional Investors (Caishui [2005] No.155), capital gains derived by W88优德中国官方网站s from trading of securities conducted in China through PRC companies shall be exempted from business tax.
3. Comments on Circular 79
A. Scope of Application
Circular 79 applies to W88优德中国官方网站s/RW88优德中国官方网站s which do not have an establishment or site in China or those which have an establishment or site in China but the capital gains derived from the transfer of equity investments including stocks are not effectively connected with the establishment or site in China.
Where W88优德中国官方网站s/RW88优德中国官方网站s have an establishment or site in China and the capital gains derived are effectively connected with such establishment or site, W88优德中国官方网站s/RW88优德中国官方网站s shall be subject to a 25% enterprise income tax with respect to the net gains or deemed profits.
B. Temporary Exemption
Circular 79 provides for temporary exemption with respect to capital gains received from the transfer of equity investments including stocks as of November 17, 2014. However, Circular 79 does not specify when the temporary exemption will expire. Whether such capital gains will be taxed in the future is subject to further rules to be released by the government authorities.
C. Capital Gains before November 17, 2014 are Taxable
As discussed above, except Lehman Brothers Case, neither did the PRC tax authorities actually collect capital gains tax from W88优德中国官方网站s/RW88优德中国官方网站s nor did W88优德中国官方网站s/RW88优德中国官方网站s voluntarily pay such capital gains tax so far. Although Circular 79 sets forth that capital gains received before November 17, 2014 by W88优德中国官方网站s/RW88优德中国官方网站s shall be subject to tax, whether the tax authorities will implement this rule remains uncertain. If the tax authorities start to implement this rule, it remains to be seen from when W88优德中国官方网站s/RW88优德中国官方网站s will have to retroactively pay such tax and how the capital gains payable will be cal
1. Lehman Brothers made its last tax payment in China
http://www.ctaxnews.net.cn/html/2011-01/07/nw.D340100zgswb_20110107_4-02.htm;
2. Jiangsu collected Two Tax Payments from Non-resident W88优德中国官方网站 into the Treasury. http://www.ctaxnews.net.cn/html/2009-07/01/nw.D340100zgswb_2009-07-01_1-06.htm;
Lianyungang Conducted Specific Evaluation on W88优德中国官方网站 and Collected Tax Revenue of 0.41 Million
http://www.ctaxnews.net.cn/html/2010-05/12/nw.D340100zgswb_2010-05-12_1-06.htm
Shanxi Collected the First Tax Payment from W88优德中国官方网站
http://www.ctaxnews.net.cn/html/2009-08/28/nw.D340100zgswb_2009-08-28_1-08.htm
