share companies and individual income tax by alicejenny



H-share companies and
individual income tax
Abolition of individual income tax exemption puts H-share companies
in the spotlight. Jeremy Ngai, Danny Yiu and Raymond Chan explain

           n 9 June 2011, a Chinese company          on 4 January 2011 has invalidated the entire       announcement. The main points of the
           with H-shares listed on the Hong          Circular 45, including the individual income tax   circular are:
           Kong stock exchange made a public         exemption on dividends.                               T
                                                                                                        •	 	 he	SAT	acknowledges	that	individual	
announcement that it would temporarily with-            In fact, the collection of withholding income      shareholders who are Hong Kong residents
hold 20 percent of individual income tax upon        tax on dividends began in 2008 after the new          and who receive dividends from non-
distributing the final dividends to its individual   Corporate Income Tax Law came into effect.            foreign-invested enterprises listed in Hong
shareholders for the year ended 31 December          A 10 percent withholding income tax was               Kong shall generally be subject to a treaty
2010. If any shareholders were eligible for tax      imposed on the payment of dividends arising           rate of 10 percent under the China-Hong
treatment provided in double tax arrange-            from post-2007 after-tax profits to foreign           Kong taxation agreement.
ments upon approval by the relevant Chinese          corporate shareholders, including those owned         T
                                                                                                        •	 	 hose	individual	shareholders	who	are	tax	
tax bureau, the company would refund the             by non-resident individual shareholders but           residents of a country that has a 10 percent
excess withheld tax to them. The announce-           registered under the name of corporate nomi-          dividend treaty tax rate in its double taxa-
ment attracted the attention of the markets          nees or brokers.                                      tion agreement with China do not need to
and put the abolition of the individual income          To avoid income tax on dividends, some             make specific applications for entitlement
tax exemption under Circular 45 (Guoshuifa           non-resident individual shareholders held             to the 10 percent treaty rate as would
[1993] No. 45) in the spotlight.                     their shares directly in their own name to            otherwise be required under Circular 124
                                                     qualify for the individual income tax exemption       (Guoshuifa [2009] No. 124).
From exemption to collection                         under Circular 45, instead of registering under       F
                                                                                                        •	 	 or	individual	shareholders	who	are	tax	
According to China’s domestic individual             the name of corporate nominees or brokers.            residents of other countries which have
income tax law, dividend income and capital          However, with the abolition of individual             entered into a double taxation agreement
gains derived by non-resident individuals from       income tax exemption under Circular 45, the           with China with an applicable treaty rate of
overseas listed shares of Chinese tax-resident       domestic standard individual income tax rate          higher or lower than 10 percent, the treaty
enterprises are considered income sourced            is 20 percent.                                        rate in the relevant double taxation agree-
from China and within the scope of individual                                                              ment should be followed.
income tax. However, non-resident individuals        Clarifications by relevant
previously enjoyed specific exemptions under         authorities                                           The detailed procedures are set out in the
the following tax circulars:                         With the abolition of Circular 45, non-resi-       table on the opposite page.
•	 	 ircular	45	exempted	income	tax	(indi-           dent individual shareholders who are Hong             Circular 363 (Guoshuihan [2011] No. 363)
   vidual income tax and the former foreign          Kong tax residents and who receive divi-           updates the list of double taxation agreement
   enterprise income tax for corporate               dends from mainland non-foreign-invested           countries with a treaty rate other than 10 percent
   shareholders) on dividends and capital            enterprises listed in Hong Kong are generally      as originally specified under Circular 348.
   gains derived by non-resident individual          subject to a treaty rate of 10 percent (instead       Before Circular 348 was issued, the Hong
   investors from B-shares and overseas              of the domestic standard individual income         Kong Inland Revenue Department issued
   listed shares, such as H- and N- shares of        tax rate of 20 percent) under the Arrange-         a press release dated 4 July 2011 which
   Chinese tax-resident enterprises.                 ment between the Mainland of China and the         mentioned a reply from the SAT to the
•	 	 ircular	20	(Caishuizi [1994] No. 20) ex-        Hong Kong Special Administrative Region for        department. The reply was also attached
   empted individual income tax on dividends         the Avoidance of Double Taxation and the           in a letter recently issued by the Stock
   derived by non-resident individual investors      Prevention of Fiscal Evasion with respect to       Exchange of Hong Kong Limited to mainland
   from a foreign-invested enterprise, which         Taxes on Income. The company’s decision to         companies listed in Hong Kong. The content
   generally refers to a Chinese company with        withhold 20 percent individual income tax          of the reply is in line with Circular 348.
   at least 25 percent equity ownership by           and refund the excess caught public attention
   foreign investors. It should be noted that        because non-resident individual sharehold-         How simplified is the
   some of the listed Chinese tax-resident           ers may have to go through complicated             procedure under Circular 348?
   enterprises are foreign-invested enterprises.     application procedures to obtain the reduced       The clarification under Circular 348 should
                                                     rate under the treaty benefit.                     reduce the administrative burden of both
  But the issuance of Public Notice [2011]              The SAT issued Circular 348 (Guoshuihan         non-resident individual shareholders and
No. 2 by the State Administration of Taxation        [2011] No. 348) subsequent to the company’s        the Chinese tax authorities in terms of the

44   August 2011
                                                                                                                                                    A PLUS

application procedures required in
Circular 124. However, it appears that
the burden of ascertaining whether the              dividend paid to their non-
non-resident individual shareholders are            resident individual shareholders in
eligible for the treaty rate falls on the payers    accordance with Circular 348.
of dividends as withholding agents (i.e.               Nevertheless, what constitutes foreign
the mainland companies distributing the             equity ownership for the purpose of assessing     to individual income tax
dividends).                                         the foreign-invested enterprise status of the     on capital gains arising from
   A few H-share companies have announced           company remains unclear, such as whether it       the disposal of as H-, N-, S- and B-shares.
that they will strictly follow the guidance under   includes only founder shares (i.e. the shares     Unlike the individual income tax withholding
Circular 348 and withhold individual income         owned by the shareholders prior to the IPO)       on dividends where the withholding amount is
tax at 10 percent for those eligible for the 10     according to Circular 87 (Guoshuifa [1993]        determinable and can easily be administered
percent treaty rate, and at the applicable          No. 87). The status of shares subscribed and      by the overseas listed companies, there has
rate for those not eligible. But it remains to      owned by foreign investors after the IPO is       been no individual income tax collection on
be seen how the H-share companies, as the           also in doubt. Further clarification from the     capital gains so far.
withholding agents, will be able to identify the    SAT will be required on how to assess the            Non-resident individual shareholders may
tax residence of their non-resident individual      foreign-invested enterprise status for H-share    also be entitled to protection from capital gains
shareholders and withhold the individual            companies.                                        tax according to the relevant double taxation
income tax at the appropriate rates.                   It is not yet known whether the individual     agreements. If the Chinese tax authorities do
                                                    income tax exemption for foreign-invested         indeed start to enforce individual income tax
Lack of clarity over listed                         enterprises under Circular 20 will prevail        collection despite the difficulties, the practical
foreign-invested enterprises                        in the long run as non-resident corporate         approach towards a tax treaty claim under Cir-
It is worth noting that both the reply from the     shareholders have been subject to                 cular 348 might still be a good reference point.
SAT to the Inland Revenue Department and            withholding income tax for dividends paid
Circular 348 only deal with dividends paid          by foreign-invested enterprises since 2008.       Conclusion
by listed non-foreign-invested enterprises.                                                           The issuance of Circular 348 demonstrates the
This may imply that non-resident individual         Tax treatment on gains on                         SAT’s practical approach towards the granting
shareholders are still exempt from individual       trading of H-shares                               of treaty benefits. Assuming that non-resident
income tax if the dividend paying company           All the above tax circulars are silent on the     individual shareholders of H-share companies
is an foreign-invested enterprise pursuant          tax treatments on gains derived by non-           are predominately Hong Kong tax residents, tax
to Article 2(8) of Circular 20. Some H-share        PRC residents on the trading of H-shares.         treaty benefit claims available under Circular
companies have announced themselves to              However, another implication of the abolition     124 would not bring about additional individual
be foreign-invested enterprises and thus will       of Circular 45 is that non-resident individual    income tax collection for China’s tax authorities
not withhold any individual income tax on the       shareholders are now technically exposed          when compared to upfront individual income
                                                                                                      tax withholding at 10 percent. It only results
  Applicable withholding tax rate                   Withholding tax procedures                        in an administrative burden for both Hong
  If the treaty rate under the double taxation      The withholding agent can apply for treaty        Kong resident individual shareholders and
  agreement is lower than 10 percent.               benefit on behalf of the individual shareholder   the Chinese authorities. Capital gains tax on
                                                    and, upon approval by the tax authorities,        the trading of A-, B- and overseas listed shares
                                                    the overpaid tax will be refunded via the
                                                    withholding agent.
                                                                                                      by non-PRC residents should be the next
                                                                                                      controversial topic addressed by the SAT.
  If the treaty rate under the double taxation      The withholding agent shall withhold and
  agreement is higher than 10 percent, but          settle the tax at the rate that is stipulated
  lower than 20 percent.                            in the double taxation agreement and no
                                                    application for treaty benefit is needed.
  If the shareholder’s home country does not        The withholding agent shall withhold and          Jeremy Ngai is a PwC China tax and business advisory
  have a double taxation agreement with China,      settle the individual income tax at the rate of   partner, Danny Yiu is a PwC tax services partner and
                                                                                                      Raymond Chan is the firm’s senior manager, China tax and
  the applicable treaty rate is 20 percent.         20 percent.
                                                                                                      business advisory.

                                                                                                                                           August 2011     45

To top