New Zealand China Trade Association: Tax and Finance

Navigating through Taxing times in China

Tue, 29 Jun 2010 00:00:00 +1200

Let’s face it; tax is confusing enough as it is without the legislation itself being unclear. Thankfully, China’s State Administration of Taxation (“SAT”) recognised that its Corporate Income Tax (“CIT”) law had fallen into this trap. Recently, the SAT has issued Circular 79 to clairfy the timing of income recognition, the tax treatment of certain expenses and the determination of the tax base for fixed assets under the CIT law.

Income Recogntion

Circular 79 addresses the recognition of particular types of income including rental income, income arising from debt restructuring, capital gains from the transfer of equity interests, as well as dividends, profits and other investment income.

Rental income

Under the Detailed Implementation Rules (“DIR”) to the CIT, rental income arising from the provision of the right to use fixed assets, packing materials or other tangible assets is required to be recognised for tax purposes on the payment dates set out in the relevant contracts. Circular 79 clarifies that where the lease contract spans more than one calender year and the rent is paid in advance, the rental income can be spread evenly over the leasing period and recognised as taxable income in each of the years within the lease period.

Income arising from debt restructuring

Income derived from debt restructuring is required to be recognised as taxable income on the date that the debt restructuring contract or agreement comes into effect.

Capital gains derived from equity sales

Circular 79 reiterates the CIT law by stating that income from equity sales is calculated as the difference between the sale proceeds and the purchase price, and that the retained earnings and reserves attributable to the equity sold cannot be deducted from the sale proceeds.

Note also, that Circular 698 requires non-resident sellers to file tax returns and pay CIT within 7 days of the earlier of the transaction date specified in the sales contract, and the date the sale proceeds are received. For more information on Circular 698 please see our February 2010 article.

Dividends, profits and other investment income

Dividend income is required to be recognised on the day it is resolved to make a distribution of profits or convert retained earnings into equity. Note that the conversion of share premiums into equity is not required to be recognised as income, and therefore the cost base of the shareholder’s investments will not be increased.

Tax treatment of certain expenses

• Expenses incurred in the generation of tax-exempt income

The CIT law specifically states that expenses incurred in the generation of non-taxable income are non-deductible. However, it is silent on the deductibility of expenses relating to tax-exempt income. Circular 79 clarifies this situation by stating that unless otherwise specified, expenditure incurred in the generation of tax-exempt income is deductible.

• Start-up expenses

Circular 79 specifies that expenses incurred in the start-up period are not to be considered losses in the current period, rather they must be either deducted in the first year of operations or be amortised over a period of 3 or more years in accordance with Article 9 of Circular 98. Please note that once a taxpayer elects to apply a particular method, that method cannot be changed.

• Entertainment expenese

Under the CIT law up to 60% of business entertainment expenditure can be treated as deductible for tax purposes, however, the deduction is capped at 0.5% of the entity’s total revenue for the year. Circular 79 clarifies that for entities engaged in equity investment (including group headquarters and venture capital investment companies), the level of dividends received and capital gains received from share transfers can be used as the basis for calculating the point at which the deduction for entertainment expenditure will be capped.

Determination of tax base for fixed assets

Circular 79 specifies that in situations where a fixed asset has been put to use and the entity hasn’t received all the invoices relating to the purchase of the asset due to a construction payment not being settled, the entity can temporarily use the purchase price specified in the relevant contracts for depreciation purposes. However, Circular 79 also specifies that an adjustment must be made to reflect the actual purchase price within 12 months of putting the asset to use.

Application date

It should be noted that Circular 79 does not specify an effective date, however, as it relates to the CIT law it is believed that it should retroactively applied from 1 January 2008.

VAT

Now that we’ve looked at income tax it’s about time we looked at an indirect tax such as value added tax (“VAT”). The major change to China’s VAT rules is that general VAT taxpayers are now able to deduct input VAT incurred on the purchase of fixed assets. This reform also abolished the preferential import VAT treatment available to foreign-invested entities, including the exemption from VAT on equipment for R&D centres.

Those of you with R&D centres will already be aware that because R&D centres are not general VAT taxpayers, they are unable to credit input VAT incurred on the purchase of fixed assets against output VAT. However, you may not know that this was an unintended effect of the VAT reform, and is one that the Chinese government has been trying to rectify ever since.

In order to resolve this issue the Ministry of Finance, the General Administration of Customs (“GAC”) and the SAT jointly issued Circular 115 which grants an import VAT exemption on “equipment” imported by R&D centres and a full VAT refund on “equipment” purchased by R&D centres that was manufactured in China. “Equipment” means experimental equipment and appliances which are required to carry out scientific and technological research, development and teaching.

Provided that certain criteria are met, the import VAT exemption is available to foreign-invested R&D centres, whether they are independent legal entities, R&D departments or branches of foreign-invested entities. The criteria vary depending when the centre was established.

For R&D VAT exemption criteria please click here.

Numerous R&D centres are able to receive a refund for VAT incurred on the purchase of Chinese manufactured equipment, including, centres meeting the criteria outlined above, national engineering R&D centres, state key laboratories, enterprise technical centres and other qualified centres that have been approved by the National Development and Reform Commission, the Ministries of Finance and Science and Technology, GAC, or the SAT.

Whilst the exemption and refund policies outlined currently ‘fix’ the problem caused by the 2009 VAT reform, they are only a temporary fix, because the benefits under Circular 115 are only valid until 31 December 2010. This means that in order to get the benefit of these VAT relief measures you need to act now and assess whether you will qualify under the exemption.

For any further details please contact Joanna Doolan, Tax Partner at Ernst & Young and co-ordinating partner for the Ernst & Young NZ China Overseas Investment Network joanna.doolan@nz.ey.com and Florence Wong Senior Manager at Ernst & Young florence.wong@nz.ey.com

Source: Navigating through Taxing times in China

What the HK Double Tax Agreement Means for You

Mon, 24 May 2010 00:00:00 +1200

A long overdue and rather exciting announcement (for those who get excited about tax) is that New Zealand and Hong Kong are entering into Double Tax Treaty negotiations. While we have had a double tax agreement with China since 1986, Hong Kong has never been part of this.

All those investing in China know that often it is advisable to do this via Hong Kong but the lack of a Double Tax Treaty between Hong Kong and New Zealand means you can feel a little over-exposed when it comes to resolving any tax issues.

Before we move away from Hong Kong being used as a gateway for investing in China, remember you cannot just use a Hong Kong company to qualify for tax concessions if in fact your Hong Kong presence lacks substance.

Hopefully the Government will also move up a gear and enter into renegotiations with China to update our Double Tax Treaty. Given our model Free Trade Agreement with China and also the growing importance of China to New Zealand it is high time this is given priority status and with the significant changes to the tax world since 1986 it is critical we step into gear and ensure our double tax treaties with major trading partners are up to date.

The Hong Kong Legislative Council has also been busy and has formalised its disclosure of information rules. Following this it has adopted the latest international standards on exchanging information with our tax jurisdictions.

There are three new Double Tax Agreements that Hong Kong has signed with countries including the Netherlands and Indonesia and six other agreements that are awaiting signature with countries including France and Ireland.

Other Double Tax agreements Hong Kong is negotiating at present in addition to New Zealand include the UK, the UAE and Switzerland.

While you may now be losing your enthusiasm for tax and starting to nod off, what this all signals is a major change in the way Hong Kong and many other countries around the world exchange information relating to tax matters. Previously the information exchanged by the Hong Kong Inland Revenue was very limited.

While all this does not add up to a free-for-all concession and domestic safeguards have been established, it signifies that Hong Kong is following a worldwide trend of adopting more transparency when it comes to tax. Too often in using Hong Kong as a gateway into China some of the day to day administrative matters such as where this company is actually tax resident have been ignored. With all these changes on the horizon along with our recent changes to the controlled foreign company rules it is an opportune time to re-look at your existing structures and give them a health check.

The Hong Kong budget for 2010 also contained tax measures that are designed to enhance the attractiveness of Hong Kong. These included reducing the corporate tax rate from 16.5% to 16% and the individual standard tax rate from 15% to 14.5% with a top marginal tax rate reducing from 17% to 16%. With such competitive tax rates this may be something we can only dream about when it comes to New Zealand. Added to this, small and medium enterprises are allowed to carry back tax losses of up to HK$1 million to up to three preceding years, pay tax in instalments without any surcharges where taxpayers are in financial difficulty, obtain a tax deduction for 100% of intellectual property rights and benefit from the super tax deductions of 150% for qualifying research and development and receive concessionary treatment for tax depreciation allowances for plant and machinery that is provided by Hong Kong taxpayers and used in Mainland China for import processing arrangements. Regional headquarter incentives are also being introduced.

At the individual level in addition to the reduction in the personal tax rates, a five-year extension is being allowed to the tax deduction for home loan interest and tax deductions are being allowed for up to HK$20,000 a year for private medical insurance premiums.

Hong Kong is not only our 9th largest market for exports it is often a critical spring board for investing into other regions including Asia Pacific and the European Union. These changes make Hong Kong a very attractive proposition for New Zealand businesses.

For any further details please contact Joanna Doolan, Tax Partner at Ernst & Young and coordinating partner for the Ernst & Young NZ China Overseas Investment Network joanna.doolan@nz.ey.com and Florence Wong Senior Manager at Ernst & Young florence.wong@nz.ey.com

Source: What the HK Double Tax Agreement Means for You

Hedging Your Currency Bets

Mon, 24 May 2010 00:00:00 +1200

An article appeared in the New Zealand Herald a few months ago which examined the currency hedging practices of Kiwi exporters. The conclusion seemed to be "damned if you do, damned if you don't". We asked our good friends at the HSBC what they thought and what tips they might have for exporters that are considering currency hedging.

1. How do interest rate movements affect New Zealand’s trade with China?

Interest rate movements in New Zealand can have an impact on the New Zealand dollar. Foreign investors who chase yield have previously driven up the NZD in what is known as the carry trade. The carry trade is where investors borrow low-yielding currencies and selling these currencies to invest in high-yielding currencies, gains can come from both an appreciating currency and increased interest income. This was one of the factors that saw the NZD trade above 0.8000 cents in 2007 / 2008.

Exporters who trade with China and sell their goods in US dollars may become uncompetitive at these very high currency levels. This is only one side of the story as a higher currency may be offset by higher prices for the goods that are traded. So there are more factors to take into account outside of the currency.

2. How would you rate Kiwi businesses understanding of and execution of exchange rate risk management?

Due to New Zealand’s geographic isolation we are a trading nation buying and selling many products and services in the international markets. This along with a relatively free market economy means many of our larger companies have a very good understanding of exchange rate risk management. For many smaller companies and new entrants to exporting and importing this may be a daunting task. Most quickly gain an understanding of exchange rate management through experience and by using the knowledge available through their Bank’s Treasury operation.

3. What are some of the common challenges facing Kiwi exporters who want to hedge against their exposure to exchange rate fluctuations?

The number 1 issue facing Kiwi exporters is the volatility in the New Zealand dollar. In 2009 the New Zealand dollar traded a range of 0.4895 to 0.7635 and our trade weighted index (a measure of the value of the New Zealand dollar relative to the currencies of New Zealand’s major trading partners) traded 50.66 to 67.99.

Another major issue is dealing into countries that have restricted convertibility of their currency this may result in forward hedging having to be done using the offshore USD–settled, non-deliverable markets. The Chinese renminbi (CNY) is one such currency that maintains a managed float. The currency is managed by the People’s Bank of China (PBOC) - China’s central bank. The renminbi is non-deliverable and partially convertible. The market for the CNY has been undergoing gradual liberalisation and HSBC provides pricing for both on-shore spot and forward market and off-shore in the non-deliverable forward market.

4. What advice do you have for exporters who want to reduce the risks associated with currency fluctuations?

All business that trade overseas are likely to be exposed to foreign exchange risk arising from volatility in the currency markets. The most common cause of foreign exchange exposure arises from having to pay invoices for imported materials priced in foreign currency or receiving foreign currency for your exported finished goods. For many business, the impact of exchange rate volatility can be significant.

Managing Foreign exchange risk does not have to be complicated. HSBC advocates the use of the following four- point plan. This simple plan lays the foundations for the management of your foreign exchange exposures :

• Understand your exposures

• Understand hedging products

• Develop a strategy

• Implement it

Point 1 - Understand Your Exposures

There is a raft of factors to take into account when assessing your exposure to foreign exchange rate risk, for example:

• What proportion of your business relates to imports or exports?

• What currencies are involved?

• What are the timings of payments?

• What impact would an adverse rate movement have on your profitability?

• Is the level of overseas business likely to change?

• Do you pay and receive in the same foreign currency - it may be possible to mitigate the exchange risk by using a foreign currency bank account?

Point 2 - Understand the Products

There are only three basic alternative methods to manage foreign exchange risk.

• Do nothing and buy or sell your currency in the spot market.

You act on the day you want to buy or sell your foreign currency. Whilst simple, this approach means you will not know how much New Zealand dollars you will need to pay or receive for your foreign currency until the day in question - this can be a high risk strategy as the exchange rate may have moved significantly since you agreed the price with your customer/supplier. If rates have moved the wrong way, your profit will be reduced accordingly.

• Lock in to fixed rates - as soon as you become aware of a need to exchange foreign currency at a future date, you can fix the exchange rate by booking a forward contract. This approach provides certainty but you could suffer an opportunity loss if rates subsequently move in your favour and you are obliged to transact at the forward contract rate.

• Use flexible products - a currency option will offer you the potential for upside benefit if rates move in your favour - like a spot deal, but will provide protection against adverse rate movements - like a forward contract. For this flexibility you will need to pay a premium although there are zero cost option products available where an up front premium is not required.

Point 3 - Develop a Strategy

It may not always be best to adopt any one of the three alternatives in isolation to manage your foreign exchange risk. Many businesses, reflecting their attitude to risk, their view of the currency markets, preparedness to pay premiums and a host of other factors, will adopt a portfolio approach - using a combination of spot, forward exchange contracts and currency options, HSBC works with there customers to develop a strategy that best meets the requirements of your business. For example in an uncertain exchange rate environment, you may decide to transact 25 per cent of your currency in spot, fix 25 per cent with a forward contract and cover 50 per cent with flexible solutions such as an option. This way, if rates move in your favour, you will benefit on 75 per cent of your exposure (spot and options) whilst if rates move against you, you are protected on 75 per cent (forward contracts and options). This is a balanced approach that provides flexibility, and avoids you paying a premium for all of your protection.

Point 4 - Implement it

It is often tempting to defer a decision to implement your foreign exchange risk management strategy, perhaps in the hope that rates may move in your favour in the short term. Historically, currency markets have been extremely volatile and unpredictable - it makes sense therefore, once you have formulated a strategy, to implement it without delay and ensure your profits are protected.

The information in this publication does not constitute an invitation, offer or recommendation to subscribe for or purchase any security, product, or service, nor does it contain investment recommendations or advice. The information and views are of a general nature and do not take into account your personal objectives, financial situation and needs. You should seek independent professional advice before making any investment decision. Neither HSBC nor any person associated with this publication accepts any liability for any loss or damage whatsoever that may directly or indirectly result from any, opinion, information, representation or omission, whether negligent or otherwise, contained in this publication.

Source: Hedging Your Currency Bets

FINANCE: China tax alert for year of Tiger

Fri, 19 Mar 2010 00:00:00 +1300

Chinese New Year is the longest and most significant festival in China. It officially got under way on 14 February this year, shifting from the Year of Ox to the Year of Tiger.

While most Chinese New Year celebrations are taking place in China, many companies outside China would be busy seeking to stay on top of the corporate requirements and the recent tax changes affecting their investment in China.

Companies are well advised to review their holding structures, and this should be done in partnership with your in-house team and your external advisors to ensure you take into account the recent changes in China, and implement sustainable tax strategies that help your business achieve its ambitions.

The Chinese State Administration of Taxation (“SAT”) has recently issued two Circulars (Circular 601 and Circular 698) which together represent the SAT’s latest attempt to tighten up access to Treaty benefits. Notably, it appears that the SAT has begun to adopt a substance-over-form approach when targeting cross border tax avoidance, and has increased activities in this area.

Circular 601 targets avoidance of treaty benefits on dividends, interest and royalties by interposing conduits / holding companies that essentially have no commercial purposes other than to obtain a more favourable tax rate.

Under Circular 601, in order to receive the benefit of a reduced withholding tax on dividends, interest, royalties or capital gains under a double tax agreement, you will now have to prove that you have “beneficial ownership” by submitting information and documents to the local tax authority.

The local tax authority now uses two tests to assess who has “beneficial ownership” - the technical test which examines whether restrictions apply to the investor’s ownership of the income; and the substance-over-form test which looks at the economic reality of the transaction rather than at its legal form.

Whilst both tests must be considered, they appear to be highly subjective with the final decision being made based on a totality of factors as opposed to a single decisive factor. We are expecting further guidance from the SAT regarding the actual application of the tests.

The following factors are considered to be unfavourable when testing beneficial ownership:

The recipient is obligated to distribute 60% or more of the Chinese-sourced income to a resident in a third jurisdiction within a certain period;
The recipient conducts little or no business activities other than holding the rights to the income received;
The recipient’s assets, size of business operations and human resources are disproportionately small when compared to the income received;
The recipient has virtually no rights to control the income or rights giving rise to the income and bears little or no risk;
The recipient is exempt from tax or is not subject to tax in their own jurisdiction or taxed at a very low rate;
The recipient receives interest income from a loan agreement and has an agreement which is substantially the same with a third party;
The recipient receives royalty income from an intellectual property transfer agreement and has an agreement with another party which relates to the same intellectual property.

The SAT has hinted that the critical factor is having business substance. However, it is unclear how much substance is needed in order to be the “beneficial owner”. What is clear is that if all you have is a holding company with a tax residency certificate, then there is a significant risk the holding company will be viewed as an agent and not the ultimate beneficial owner.

Circular 698 (with retrospective effect from 1 January 2008) provides further guidance on Corporate Income Tax administration on gains from equity sales derived by non-residents and also targets capital gain tax avoidance.

More specifically, in the case of an indirect sale of equity interests in a Chinese resident company through the disposal of shares in a non-Chinese intermediate holding company, Circular 698 asserts SAT’s rights to invoke the general anti-avoidance rules, to disregard the intermediate holding company if its existence serves no commercial purposes except for the avoidance of tax liabilities.

Circular 698 gives the SAT authority to “look-through” the immediate parent in order to determine which party is actually the beneficial owner and therefore prove that the immediate parent is not entitled to the reduced withholding tax rates provided in the relevant double tax agreement.

Prior to the enactment of Circular 698, retained earnings and reserves were excluded from the calculation of gains made from equity sales by non-residents.

Circular 698 now defines taxable gains from equity sales as the difference between the sales consideration and the purchase cost. Sales consideration includes cash, non-monetary assets and rights as well as the Chinese resident company’s retained earnings and reserves, whilst the purchase cost is the capital contribution to the Chinese resident company, or if acquired through a previous owner, the original price paid by that owner for the interest.

Non-resident sellers are now required to file a return and pay tax on gains from any direct sales of Chinese resident company shares within 7 days of the earlier of the transaction date or the date of receiving the sale proceeds. However, if a withholding agent has withheld tax on the equity gain, this obligation is removed. Any gain derived from the buying or selling of Chinese company stocks on public stock exchanges are also excluded.

In the case of indirect equity sales through the disposal of an intermediary located in a jurisdiction with an effective tax rate of less than 12.5%, Circular 698 imposes a self-reporting obligation on the non-resident seller.

The non-resident seller has 30 days from the conclusion of the equity transfer agreement to submit the following documentation to the local tax authority:

The equity transfer agreement;
A statement describing the relationship between the seller and the intermediary;
A statement describing the relationship between the intermediary and the Chinese resident company;
A statement outlining the seller’s commercial purpose for establishing the intermediary; and
Any other information required by the tax authority in charge.

If after examining this information the authority concludes that the indirect sale lacks commercial purpose and the main purpose of the intermediary is to avoid Chinese tax, the SAT may disregard the intermediary and “look-through” to the non-resident investor.

This transaction will then be placed under the 7 day self-reporting and payment obligation which applies to direct sales of Chinese resident company shares. If the non-resident fails to comply with the 7 day requirement they will incur penalties and surcharges.

The SAT has not put a limit on the number of entities which can be “looked-through” and therefore there is potential for any indirect transfer to be subject to capital gains tax.

Circular 698 also contains a transfer pricing element which allows the tax authorities to adjust prices between related parties if such prices are not calculated on an arm’s length basis.

In a situation where a seller disposes of its equity interests in multiple subsidiaries at the same time, the Chinese resident company whose equity is being disposed is now required to submit the transfer agreement to the tax authority. In a case where the agreement fails to demonstrate an accurate allocation of the transaction value to the resident companies, the SAT can adjust the value according to appropriate methods.

If you have investments in China it is critical that you ensure you have an effective plan in place to deal with these recent changes in Chinese tax administration.

This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information.

Source: FINANCE: China tax alert for year of Tiger