
In what might be the regulation that slipped through the traditional media wires, Jay Boyle of EXPAT CFO just forwarded me a potential bombshell of a regulation where China will look to tax all those offshore transactions that investors have come to rely upon when setting up their China vehicles.
… and it went into effect January 1, 2008
In short, the circular is meant to specifically address the offshore sales of China based assets, and Deloitte has already put together their thoughts on what this means for investors (download file here):
Circular 698 makes it clear that the Chinese government intends to tax indirect transfers, many uncertainties still need to be clarified. It is unclear how the 12.5% effective tax rate of the offshore intermediary holding company is to be determined; for example, will the minimum 12.5% rate criterion be met if the jurisdiction of the intermediary company has a tax rate higher than 12.5% but does not tax capital gains? In the case of a direct transfer of a Chinese resident enterprise by a foreign entity, the SAT will easily be able to identify the transferee as the withholding agent; this will be more difficult in the case of an indirect transfer of a Chinese resident enterprise.
It is unclear how the tax bureau will enforce taxation of such offshore transfers in practice. Where transactions involve a large group of companies in a global merger or acquisition, the requirement to disclose all of the information concerning the transaction may create an overwhelming administrative burden and involve the submission of information that will be irrelevant. From the buyer’s perspective, the impact and consequences of a seller’s noncompliance are not entirely clear.
Where I myself am a bit lost in this new “clarification” is the simple fact that the very reason why many firms chose to set up offshore is to effectively dodge authorities who might otherwise block the sale of an asset. That, tax aside, the ability of a firm to sell their HK or BVI shares to another firm without the approvals of Beijing was a huge asset in itself. So much so that those who were able to “clean” a mainland asset and structure it offshore were typically paid a premium for their effort.
An effort that may no longer be enough.
At the same time, my personal opinion is that this clarification will be used as the exception vs. the norm, and that it will be used as a negotiation chip for firms who have found themselves past another red line. Simply getting access to the data in some of the “standard” islands is going to be tough, but if Beijing wanted to force the issue they clearly could under the guise of this law (recognized outside of China or not) as firms would be force to comply or face roadblocks/ fines in other areas.
So, regardless of whether or not we see a team of investigators start opening up the HK books, I think investors would be wise to see that things are getting tighter all around, put down the rose colored glasses, and begin reassessing the risk levels of “traditional” China models.
Any lawyers want to weigh in on this issue?
Update 1: While emailing back/ forth to a Beijing based lawyer, he also was unsure of how the enforcement of this would be possible/ take place, and in my most recent reply to him I asked whether this rule was actually geared for chasing overseas Chinese IPOs vs. domestic M&A. I do not have his answer yet.
Anyone have thoughts on that possibility?










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