14 October 2012
The China Taxation News of 6 August 2012 reported a new case on determination of beneficial owner under tax treaties whereby the benefit of the treaty was denied. The case is summarized below.
In May 2012, the accountant of a Sino-foreign joint venture company engaged in container terminal services filed the resolution on distribution of dividends of 2009 to its 49% shareholder in Mauritius with the state tax bureau of Qingdao in Shandong province. The required documents were subsequently submitted by an accounting firm with the request for the application of the reduced tax rate of 5% on dividends under the China (People's Rep.) - Mauritius Income Tax Treaty (1994). The information collected by the tax authority indicated that the Mauritian company was established on 9 February 2000 while the joint venture company was established in February 2002, and that the Mauritian company had no personnel except seven directors. The state tax bureau became suspicious and conducted research on the taxpayer.
It was found that:
|-||the Mauritian company had no substantial business operations and only received passive income such as dividends and interest;|
|-||the registered capital of the Mauritian company was USD 9.81 million while the investment in the joint venture company amounted to USD 150 million;|
|-||the capital and income were entirely controlled by the shareholder;|
|-||only two of seven directors resided in Mauritius and there were no records for the payments of remunerations to the directors;|
|-||the Mauritian company was unable to provide the information on tax payments in Mauritius; and|
|-||the Mauritian company was unable to produce the evidence of distribution of dividends to its shareholder, neither the evidence of the discretion of the income received.|
To determine the status of the beneficial owner of the Mauritian company the state tax bureau carried out the "beneficial owner" test contained in the GuoShui Han  No. 601 which provides that the tax benefit on dividends may be denied if:
|-||the applicant of the tax benefit is obliged to pay or distribute the whole or a large proportion of income within a prescribed time;|
|-||the applicant does not (or almost not) have any business operations except the assets and rights stemming from the income received;|
|-||the amount of assets, business volume and number of personnel do not match the amount of income received in cases where there is a substantial business;|
|-||the applicant has little or no controlling power or discretion over the income received and bears no or little risks; and|
|-||the state of the applicant does not impose tax on the income concerned or grants a tax exemption for that income or the effective tax rate is extremely low.|
The state tax bureau concluded that the Mauritian company functions only as a conduit company and is not the beneficial owner of dividends as referred in the China (People's Rep.) - Mauritius Income Tax Treaty (1994). As a result the 10% withholding tax should apply. The taxpayer argued that the Mauritian company was responsible for the investment policy regarding the investment in the joint venture company which did not require personnel for production or sale, but this argument was not accepted by the tax bureau. At the end the taxpayer was denied the treaty benefit and had to pay the tax amount of CNY 61,88 million (USD 9.8 million).
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