Taxation authorities have so far mostly paid attention to overseas non-resident enterprises, while there has been little supervision of transfers of equities in overseas-incorporated enterprises owned by Chinese residents. That could change shortly though, Chinese taxation authorities have already put capital transactions, mainly equity transfers, as one of the main regulation tasks in 2011, and there the possibility that such financial transactions will be reported during the supervision campaign.
We recently encountered a case: Mr. A and Mr. B are Chinese mainland residents. Mr. A set up shareholding company C in an offshore jurisdiction (not recognized as a Chinese domestic resident enterprise). C has a subsidiary D on China's mainland for real operations. Mr. A hopes to transfer the equities in C at a high premium to Mr. B. This case involves taxation obligation concerning personal income tax and should attract people's attention.
strong> Recognition of taxation obligation
The income from transferring equities in overseas companies by Chinese residents falls into the category of income from the assignment of property under the Individual Income Tax Law of The People's Republic of China.Tax on income from the assignment of property shall be calculated and paid on the proceeds of a single assignment of property less the original value ofthe property and reasonable expenses.Transfer of property shall be taxed at a rate of 20%.
Fulfilling the taxation obligation
According to the Individual Income Tax Law, the income earner should bethe tax payer of individual income tax and the unit or person that affects the payment should be the withholding agent. Therefore, assignors of the equities have the obligation to pay the tax while the buyers, as withholding agents, should pay the personal income tax when paying the transaction fees. When withholding agents fail to pay the tax, taxation authorities will pursue assignors for the tax payment and impose a fine between 50% and 3 times the unpaid tax on the withholding agents. Imposing a fine on withholding agents is a passive move to ensure tax levy and is not necessarily reasonable. But it apparently has some deterrent force. Buyers should pay close attention to the original value of property owned by sellers in order to verify the income from the transfer.
Supervision of individual taxable income
Equity transfers among individuals are usually conducted via private accounts,which are not effectively connected with the taxation supervision system, making it hard for taxation authorities to perform supervision. Also, because information concerning shareholders in indirectly-controlled overseas shareholding companies is not regularly updated in the business licenses in real operation entities on China's mainland, it's impossible for taxation authorities to track the changes of information or pursue the tax payment due to equity transfers.
strong> Analysis of special tax-related issues
When the tax bill is relatively large, assignors usually hope to avoid related taxation obligation. For example, assignors may require a statement in the equity transfer agreements that all taxation expenses should be shouldered by assignees. Such a move though is unlikely to be recognized by the tax law. It's only to soothe psychological concerns. The taxation obligation won't change due to the financial agreements between both parties. However, taxpayers can passon the financial obligation via the withholding arrangement.
Transfer of offshore equities has increasingly become a target for taxation supervision. It will bring challenges to both tax payers and tax authorities. There will likely be debates on the fairness of law enforcement authorities as well as maintenance and coordination of interests within the country or among countries and regions.
