Circular on Issues Concerning Implementation of the Dividends Articles Under Taxation Treaties

As of 2009, China has entered into bilateral treaties to avoid double taxation and prevent tax evasion (Tax Treaties) with 89 countries, such as the United States and Japan, as well as regions such as Hong Kong and Macao. These treaties provide residents of both "Contracting States" with preferential tax rates on business profits, dividends, interest, capital gains and other types of income. The treaties define "residents" to include companies, partnerships and other collective entities as well as individuals.

In March 2006, China's State Administration of Taxation (SAT) issued the Circular on Issues Concerning Implementation of the Interest Articles Under Taxation Treaties (the Interest Circular). Now the SAT has promulgated a similar document, the Circular on Issues Concerning Implementation of the Dividends Articles Under Taxation Treaties (the Dividends Circular), in order to clarify and streamline the application and implementation of that portion of China's bilateral tax treaties governing taxes on dividends, particularly where conflicting tax rates might apply.

As provided in the Tax Treaties, the term "dividends" refers to income from shares or other rights (but not debt claims), participation in profits, as well as income from other corporate rights.

Preferential tax treatment under the Tax Treaties is granted in two manners: to any resident of a Contracting State (i.e., China or the other signatory to the treaty); or to any company that holds a minimum proportion (usually 10 percent or 25 percent) of capital of the company paying the dividends. The preferential tax rate on dividends ranges from 5 to 15 percent for residents of different countries and regions. (Absent a tax treaty, the rates vary, but are almost always higher.)

Qualifications for Preferential Tax Treatment

The Dividends Circular provides guidelines for the taxation of foreign taxpayers who earn income from dividends in China. In order to enjoy the preferential tax rate as provided in one of the Tax Treaties, a foreign taxpayer must satisfy certain requirements.

If the preferential tax treatment is granted to all residents of the other Contracting State (including companies), the taxpayer must:

• be any person who, under the laws of that other Contracting State, is liable for taxes therein by reason of his domicile, residence, place of head office, place of incorporation or any other criterion of a similar nature; and
• be the beneficial owner of the relevant dividends paid.

In addition, the income treated as dividends must be recognized as income from an equity investment, such as dividends and bonuses, by Chinese tax laws.

If the preferential tax treatment is being granted to a company, the taxpayer must:

• be a company under the laws of the other Contracting State;
• directly hold the required proportion of capital of the Chinese company that pays the dividends; and
• continually hold the required proportion of capital at all times within twelve months before obtaining the dividends.

Relationship with Chinese Tax Laws

Under the current tax regime—i.e., since China's Enterprise Income Tax Law took effect on January 1, 2008—a nonresident taxpayer that is a foreign company and does not have a place of effective management located in China must pay a 10 percent withholding tax on income derived from China, including dividends, interest, royalties, rent and capital gains. (For more detailed information, please refer to our summary of the Enterprise Income Tax Law and the Implementing Regulations for the Enterprise Income Tax Law in the May 2007 and February 2008 issues of China Law Update, respectively.)

If a foreign taxpayer is entitled to the 10 percent withholding income tax rate, and if the preferential tax rate provided by the foreign taxpayer's relevant Tax Treaty is higher than the 10 percent rate, the Dividends Circular allows the foreign taxpayer to choose the more favorable tax rate under such circumstances.