Meaning
Transactional structures involve the sale of an offshore entity that holds interests in a Chinese subsidiary. An indirect foreign equity transfer occurs when the shares of a foreign holding company are sold, resulting in an effective change of ownership for the underlying Chinese assets. These deals are subject to taxation in China if the offshore company lacks economic substance.
Transaction Structure
Holding companies are often registered in jurisdictions with favorable tax treaties to manage global assets. In an indirect foreign equity transfer, the immediate target is not the Chinese company but its parent entity. This structure allows for the transfer of control without a direct change in the local company register.
Taxation Trigger
Notice 7 provides the criteria for when these offshore sales become taxable. If the tax bureau determines that the indirect foreign equity transfer was organized to avoid Chinese tax, it will recharacterize the sale as a direct transfer. This leads to a ten percent tax on the gains derived from the Chinese portion of the business.
Reporting Requirement
Parties to the deal have a choice to report the transaction to the Chinese authorities. While reporting an indirect foreign equity transfer is technically voluntary, it is standard practice to avoid potential penalties. The filing includes the share transfer agreement and a description of the commercial purpose of the structure.
