While the COVID-19 pandemic is escalating across the world, businesses are slowing down. With the situation having been contained in China, the government is helping the private sector to resume business. Since early February, policies have been issued by State Council and its Ministries to offer financial relief to companies. In recent years, foreign investment companies in China have been through testing times due to rising costs and the effects of the trade war. Now is the time for the owner and management of foreign investment companies to review their strategies and business plans, possibly to restructure and close down inefficient operations, streamline their business process and get prepared for the upturn of the next boom economy.
To restructure your subsidiaries in China
Indirect transfer of Chinese equity
Usually the foreign investors own their Chinese subsidiaries through one or more layers of holding companies offshore, usually in tax havens. If the foreign investor wishes to sell its China investment, it may do it through one of the holding layers. This is more convenient and less hassle in terms of handling the administrative procedures with different Chinese authorities.
However, such “indirect” transfer of equity shares of a Chinese company may trigger tax risks. The State Administration of Taxation (SAT) of China issued a Public Notice in 2015, “Several Issues Relating to Enterprise Income Tax on Transfer of Assets between Non-resident Enterprises”. It is defined in this Public Notice that when a non-resident company makes indirect transfer of assets such as the equity of a Chinese resident enterprise through arrangements but which do not have a reasonable commercial objectives but are in order to circumvent enterprise income tax payment obligations, then the foreign party transfers out will be liable for income tax in China. For an indirect share transfer, the transferor, the transferee, or the company with shares being transferred, should report the transfer to the tax bureau.
In practice, if a restructuring of group companies happens outside of China and one of the group company owns subsidiaries in China, it also triggers reporting in China. Failure in doing so might result in tax penalties in China.
Restructuring of Chinese subsidiaries
A foreign investor may have several subsidiaries in China either directly, or being owned by one or more subsidiaries. Some of the subsidiaries may not be performing well. The foreign investor wishes to close some of the subsidiaries. If different subsidiaries own different assets, such as one owns a piece of land, the other owns the production line or machines, how they are restructured in a tax efficient way is essential.
Basically, of the sale of assets from one company to another triggers turnover tax, i.e. Value Added Tax (VAT), local surcharges and Enterprise Income Tax (EIT). If the restructuring is conducted via a merger or acquisition within one group, there will be no turnover tax, and the income tax may be deferred if the merger and acquisition meet conditions set out the tax rules.
Whether a restructuring happens in China or offshore, good tax planning does not only save money, but also avoids the risk of a tax investigation and penalties.
Closing your subsidiaries in China, wisely
Due to supply chain relocation or any other reason, if a foreign investor wishes to close its business in China, it is always a headache. The process of liquidation and deregistration could take months, or even years. Previously, the major culprit usually is the tax deregistration procedure. The tax bureau will review the books for at least three years and conduct a thorough tax audit. The lack of communication from different authorities during the deregistration can drive people crazy! They may request duplicate documents or unreasonable pledges from the shareholders.
However, things have begun to improve. In 2018, the State Council issued a series of policies, requesting different authorities, such as the State Administration of Market Regulation (SAMR), the Ministry of Human Resources and Social Security (MoHRSS), the General Customs Administration (GCA) and the State Administration of Taxation (SAT) to jointly simplify the process for deregistration. The different authorities are requested to share information, simplify documentation and procedure and work together to expedite the deregistration process.
For tax deregistration itself, which is usually the bottleneck, the process is now greatly reduced. In several tax circulars issued by SAT in 2018 and 2019, they set out that, if a taxpayer meets the following conditions, then the tax deregistration shall be issued right away:
- There are no overdue taxes;
- The taxpayer is not under any tax investigation or tax audit;
- All VAT special invoices are handed in, and VAT machine is handed in;
- The tax credit level of the taxpayer is A or B level, or its holding company’s tax credit level qualifies.
State media has reported that since the start of the COVID-19 situation, the tax authorities have put more effort to provide online tax services and offer tax relief. Fewer tax audits and tax investigations are going on now. Originally, the SAT would hold a national meeting to announce tax investigation plans and strategies in early part of the year. Currently, this has been held up.
Recent reports from the international tax community say that the BEPS (Base Erosion and Profit Shifting) Action of the OECD (Organisation for Economic Co-operation and Development) fell short of revenue expectations in some countries. This is due partially to stricter tax enforcement measures will force investment out of a country. As COVID-19 is affecting the global economy, we anticipate that more countries will loosen their tax policies to revive the local economy, not just China..
Therefore, now is a good time for a foreign investor to restructure its business, closing under performing companies, and utilize the preferential tax policies the government enacts.
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