The new China-Russia Double Tax Treaty and its protocol entered into force on 9 April 2016, and will apply to income derived on or after 1 January 2017. The treaty contains some notable changes.
Zero withholding tax on interest. Unlike the current treaty, which provides a 10% withholding tax rate on interest, the new treaty allocates the exclusive right to tax interest to the resident state. That is to say, interest derived by a Russian tax resident will be no longer be subject to enterprise income tax (EIT) in China, or vice-versa. This provision is quite unusual and is rarely found in China’s tax treaties.
Reduced withholding tax on dividends and royalties. The treaty reduces the withholding tax on dividends to 5% if: (1) the beneficial owner is a company directly holding at least 25% of the capital of the company paying the dividends; and (2) this holding equals at least €80,000 (US$88,000). For all other situations, the applicable tax rate continues to be 10%. In addition, the new treaty lowers the withholding tax rate on royalties from the current 10% to 6%.
Expanded exemption for gains from share transfers. The new treaty removes the 25% shareholding threshold. It provides that capital gains derived from transfer of shares in a company other than a land-rich company are taxable only in the resident state. This means Russia will join the few jurisdictions such as Ireland, South Korea and Estonia, with tax treaties with China that provide a broad tax exemption for gains from share transfers without a shareholding percentage requirement.
Anti-treaty abuse. Consistent with the majority of China’s recent tax treaties, the new treaty with Russia contains additional provisions denying treaty benefits on dividends, royalties, interest and other income if the main purpose, or one of the main purposes, of creating or assigning the rights for which the payments are made is to take advantage of the treaty benefits.
More importantly, the new treaty introduces a limitation on benefits (LOB) clause to ensure a sufficient link between the entity claiming the treaty benefit and its state of residence. In order to enjoy the treaty benefit, the LOB clause requires the non-tax resident to be a “qualified person”, or to have located in the resident state, active business activities that are substantially related to the generation of the relevant income item. We expect this LOB clause to create difficulties for companies without sufficient economic substance when trying to claim treaty benefits under the new treaty.
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-mailing Danian Zhang (Shanghai) at: [email protected]