Foreign investors in China are increasingly becoming multiple investors in a number of wholly-owned subsidiaries or joint ventures – collectively called foreign investment enterprises (FIEs). As they do so, they are having to consider more complex ownership structures.
Having a single foreign owner of all FIEs may be attractive if the investor anticipates ploughing back Chinese-taxed profits from one FIE into another. The investor will then qualify for a relief under which 40"per cent of the Chinese tax underlying the reinvested dividend (100 per cent for high technology ventures) will be refunded. This relief would not be available if the dividends were paid to one overseas company and reinvested by another.
However, this relief may be of little value given the tax holidays in China. The investor often prefers to hold each FIE through a separate overseas subsidiary, to make divestment by selling its subsidiary more straightforward. This avoids both the need to renegotiate joint venture contracts for a change in foreign investor and the 20 per cent Chinese tax withheld from capital gains on the sale of its FIE.
Chinese holding company
There are size criteria to be satisfied before a foreign investor can form a holding company in China, such as the US$30m investment requirement. However, having satisfied these criteria, and contrary to the position in many other countries, there are no local tax advantages in doing so. There is no general system of tax consolidation in China to offset profits and losses and the use of a holding company tends to increase taxes. If, for example, the holding company provides common services to its subsidiaries and recharges costs, this will be subject to five per cent business tax, which is not refundable to the subsidiary. US investors may derive some US tax benefits from use of the holding company due to their domestic laws relating to controlled foreign companies.
Although there may be some other advantages of holding companies, due to the size criteria they seem to be used mainly to demonstrate commitment to the China market on behalf of the foreign investor – a status symbol.
Location of investor
Investors may wish to reduce withholding taxes levied on payments made outside China by locating the group's direct investor in a country with which China has negotiated one of its 40 or more double taxation treaties. China does not currently levy withholding tax on dividends paid to an investor in an FIE, but the normal 20 per cent withholding tax rate on interest, royalties and technical assistance fees is reduced, usually to 10 per cent under these treaties. Reduction of its tax on capital gains on divestment is, however, very rare. It is relieved completely, in practice, in only two treaties usable for tax planning – Mauritius and Switzerland. Mauritius, due to the simplicity of its tax and company law system for foreign investors, is now popular.
If the investor uses different group companies to own each FIE and is not therefore concerned about Chinese tax on capital gains, a common location, particularly with Hong Kong investors is the British Virgin Islands, used for simplicity and familiarity. However, as BVI is not party to any double tax treaties, loans to and licensing of the FIE would need to be structured through other parts of the group, so interest and royalties did not suffer 20 per cent withholding tax.
International tax aspects of structuring investments into China will be considered in a later article.
This update is prepared by Charles Norris, Ernst & Young China Liaison Partner, in the UK using information provided by Ernst & Young offices in China and Hong Kong. For more information, please contact Charles Norris on (44) 171 931 4147 or Alfred Shum, Executive Partner of Ernst & Young's China division in Hong Kong on (852) 2846 9959.