Indirect share transfers with economic substance held taxable

On 30 August 2013, China Taxation News reported that the Jiamushi State Tax Bureau (JSTB) in Heilongjiang province deemed a company registered in the Caymans and listed in Hong Kong, HK Listco, as a PRC resident enterprise (RE) using a “substance over form principle” that found the effective management of HK Listco was located in China.

As a result of the RE re-characterisation, the JSTB was able to assess PRC capital gains tax on the US private equity fund sellers and collect some RMB279 million (US$45.5 million) in taxes on the equity transfer.

In July 2011, the US private equity fund sellers transferred their shares in HK Listco to a third-party buyer. The tax bureau believed that the actual substance of the transaction was a transfer of shares in the four PRC subsidiaries. But the JSTB thought it was risky to apply Notice 698 and look through HK Listco because the target was a Hong Kong listed company. The JSTB therefore sought other grounds on which to tax the transaction. According to the report, the JSTB discovered that the senior management responsible for daily production, operations and management of HK Listco performed their duties mainly from the premises of a PRC subsidiary. As a result, the JSTB considered re-characterising HK Listco as an RE, and eventually taxed it based on the general anti-avoidance rule.

Business Law Digest is compiled with the assistance of Baker & McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker & McKenzie by e-mail at: Zhang Danian (Shanghai) danian.zhang@bakermckenzie.com