The State Administration of Taxation (SAT) issued Notice 601 (Guo Shui Han  No. 601) listing factors that the tax authorities should consider in determining whether an offshore party (not resident in China for tax purposes) receiving dividends, interest, royalties and other passive income from China qualifies as the beneficial owner of that income under China’s tax treaties. In June, 2012, SAT issued Announcement 30 (Guo Shui Gonggao  No. 30) directing local tax authorities 1) not to deny beneficial owner status on the basis of one unfavorable Notice 601 factor or grant such status because no intent to evade taxes is expressly set out in the taxpayer’s documentation, 2) listing documents the tax authorities may review to make a final determination, 3) providing a safe harbor under Notice 601 for listed companies and their subsidiaries located in the same country as the listed company, and 4) allowing beneficial owner status even if income is received through an agent.
Notice 601 is an anti-treaty-shopping rule. A taxpayer denied beneficial owner status under Notice 601 is not able to take advantage of the treaty benefits of its jurisdiction of establishment or residence, e.g., reduced Chinese withholding rates on dividends, royalties, interest and other passive income.
The unfavorable factors set out in Notice 601 that prevent an applicant from qualifying as a beneficial owner include:
The applicant is obligated to distribute a substantial part of the proceeds it receives, e.g., 60% or more, within a specified time, e.g., within 12 months after receiving them, to residents of a third country.
- The applicant has few operational activities except holding the properties or rights that generate the income it receives.
- If the applicant is a company, it has few assets and its scale of operations and staff does not correspond the the amount of income it receives.
- The applicant has limited control or right to dispose of its assets and assumes little risk regarding its income or the properties or rights that generate its income.
- The jurisdiction were the applicant is established or resident imposes no tax or a very low tax on its income or grants an exemption from tax.
- The applicant has back-to-back loan or deposit contracts with a third party corresponding in amount, interest rate and dates with a loan contract generating interest from China taxed at a reduced rate under the relevant treaty or agreement.
- The applicant has back-to-back copyright, patent or technology transfer or license contracts with a third party corresponding with copyright, patent or technology transfer or license contracts generating royalties from China taxed at a reduced rates under the relevant treaty or agreement.
Notice 601 also requires the taxpayer to produce a certificate to prove its status as a beneficial owner, a requirement now clarified in Announcement 30.
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