In a recently reported case, the local bureau of the State Administration of Taxation denied a Cayman Islands seller’s application for exemption from Enterprise Income Tax (EIT) on capital gains from the sale of a Cayman Islands holding company listed on the Hong Kong stock exchange, and RMB 279 million was levied in income tax. The tax was not levied under Notice 698, which reaches offshore holding companies that lack a reasonable business purpose. Nor did Notice 601 apply, which denies treaty benefits to an offshore company deemed not to be the beneficial owner of income but only a conduit for its parent company. Instead, the tax bureau found the transaction subject to PRC tax because the listed Cayman holding company was a PRC resident for tax purposes.
Under the EIT, a foreign company that is effectively managed in the PRC is treated as a resident of the PRC for EIT purposes and is subject to tax on its worldwide income. The State Administration of Taxation has issued notices setting forth specific scenarios under which a foreign company will be considered to be effectively managed in the PRC, but they only address situations in which the foreign company is controlled by a PRC company or individuals. In this case, the Cayman holding company was owned by another Cayman company that was in turn owned by a US private equity fund. It is a warning signal that foreign companies holding assets in China through offshore, publicly traded subsidiaries and conducting some degree of management from the PRC may be considered residents for tax purposes and subject to PRC tax on their worldwide income.
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