When investing through a Dutch holding company the Chinese investors benefits from the Dutch participation exemption regime. Provided that there is complied with the conditions of this regime are dividend income and capital gains derived by the Dutch holding company from its (foreign) subsidiary corporate income tax exempt.
The new tax treaty also focuses on the prevention of tax avoidance. In that respect, the new treaty contains a number of anti-abuse provisions. The new treaty also contains a new provision about the exchange of information between the Netherlands and China. It is expected that this new treaty will enter into force as per January 1, 2015. The current tax treaty will be terminated at the time the new tax treaty enters into force.
In this news item we will inform you with the most relevant characteristics of this new tax treaty.
Scope of the treaty
Although Hong Kong is a special administrative region of China, Chinese tax law does not apply to Hong Kong. The Netherlands concluded a separate tax treaty with Hong Kong which entered into force as per January 1, 2012.
In this new tax treaty The Netherlands is defined as the country the Netherlands included with the Carribean island administrations of Bonaire, Sint-Eustatius and Saba.
A person who is a resident of one of the contracting states and who is liable to tax is eligible to the benefits of this new tax treaty. According to the protocol of this new treaty the Dutch tax exempted investment institution (so-called ‘vrijgestelde beleggingsinstelling’) shall not be entitled to the benefits of this treaty because of the fact that the result of this investment vehicle is not liable to Dutch corporate income tax.
Under the new tax treaty a permanent establishment will also include a building site, or construction, assembly or installation project or supervisory activities in connection therewith if such site, project or activities last more than twelve months. With this extension of the time period Dutch companies are more flexible to carry on such activities in China without creating a permanent establishment and vice versa. Service activities can also qualify as a permanent establishment subject to the condition that the activities are for the same or a related project and are carried out for more than 183 days within any twelve-month period. If these activities are of a consultancy nature there can also arise a permanent establishment.
In case of profits from survey, supply, installation or construction activities only so much of these profits shall be attributable to a permanent establishment as results from the functions performed, assets used and risks assumed at or through the permanent establishment.
When Netherlands and Chinese enterprises are associated (owned or controlled by the same or common interest) the transactions between these associated enterprises must be set against the arm’s length price. According to this principle the price set between associated enterprises should be the same price set between two unrelated parties engaged in the same or similar transactions, under the same or similar conditions on the open market.
The arm’s length principle is the internationally most accepted principle used to allocate profits made by enterprises involved in cross-border transactions. The Netherlands has adopted the OECD transfer pricing guidelines in its domestic corporate income tax law to determine the arm’s length price and in the tax treaties it is involved in. China as a non OECD member also follows these transfer pricing guidelines in principle however the international tax practice learns that the tax authorities in China intend to deviate from aforementioned guidelines on the field of the so-called location specific advantages (i.e. cost savings attributable to operating in a particular market with lower prices than in its own domestic market) When the tax authorities of China identify location specific advantages which are attributable to China they will be of the view that this profit should be liable to tax in China. Transfer pricing discussions must be solved by a mutual agreement procedure between the competent authorities of both states
The new tax treaty reduces the dividend withholding tax rate to 5% if there is complied with the condition that the beneficial owner directly holds at least 25% of the share capital of the company paying the profit distribution for at least a year prior to the distribution. If the beneficial owner holds less than 25% (subject to the main purpose test) the dividend withholding tax rate amounts to 10%.
If the beneficial owner of the dividends of a company is the government of the other contracting state or one of its institutions or a company which is wholly owned by the other contracting state there will not be a dividend withholding tax imposed. It is clear that this provision is attractive for Chinese State owned enterprises that are owned by the Chinese government.
An interest withholding tax with a maximum of 10% is imposed on payments from China and received by a beneficial owner who is a tax resident of the Netherlands. Now that the Netherlands does not levy an interest withholding tax on interest payments the beneficial owner who is a tax resident of China can receive a net amount which is the same as the gross amount of the interest.
There applies an interest withholding tax exemption on interest paid to or on loans guaranteed or insured by the government or a local authority, the central bank or any institution wholly owned by the other contracting state.
A withholding tax on royalty payments with a maximum of 10% is imposed on payments from China and received by a beneficial owner who is a tax resident of the Netherlands. The Netherlands does not levy a withholding tax on royalty payments. A reduced withholding tax rate of 6% (10% of 60% of the gross amount of the royalties) is specified for remunerations of any kind received for the use of, or the right to use industrial, commercial or scientific equipment paid from China.
With this 6% withholding tax rate on outbound royalty payments investments from the Netherlands in China can be structured directly and not through Hong Kong intermediate holdings.
The tax sparing credit for interest and royalties under the existing DTA is no longer available.
Historically, the tax policy of China has been to retain taxing rights of assets based in China. In particular the right to tax capital gains from the disposal of shares in Chinese resident companies. Under the 1987 tax treaty such gain is taxable in China as for Chinese tax purposes these shares are considered to be located in China.
If a Dutch tax resident alienates shares in a Chinese resident company, under the new tax treaty, and realizes a capital gain this capital gains is only liable to tax in China if:
- The shares derive more than 50% of their value (in) directly from immovable property which is located in China;
- The Dutch resident person at any time during a twelve-month period prior to the alienation of the shares in the Chinese resident company (in) directly held a participation of at least 25% in this Chinese resident company.
In addition, capital gains derived from the alienation of shares which are listed on a recognized stock exchange may be taxed only in the country in which the owner of the shares is tax resident provided not more than 3% of the listed shares are sold during the fiscal year concerned. The same applies when aforementioned shares are held by the government of the other contracting party, any of its institutions or any other entity the capital of which is (in) directly wholly owned by the other contracting state.
For the dividend, interest and royalties article there will apply a so-called main purpose test. If the main or one of the main purposes of any person concerned with the creation or assignment of the relevant shares, debt-claims or rights in respect of which the dividends, interest and royalties are paid is to take advantage of the benefits of these articles (this tax treaty) by means of aforementioned creation or assignment, these benefits under these articles will not be available. Further guidance is welcome in order to obtain clarity about the circumstances under which a creation or assignment will fall under the scope of this main purpose test.
Both China and the Netherlands are also permitted to put in practice their own domestic anti-abuse provisions (e.g. China: circular 698) to the extent this does not give rise to taxation contrary to the treaty.
Mutual agreement procedure
The new tax treaty provides for a mutual agreement procedure between the competent authorities of the states. The procedure can be initiated upon request of a taxpayer if it appears that the measures taken by one of the states result in taxation that is not in accordance with the treaty. If the competent authorities of both states by mutual agreement have reached a solution within the context of the treaty on the interpretation of a term not defined in the treaty or on differences in qualification which would result in double taxation or double exemption, this solution will, after publication thereof by both competent authorities be binding in similar cases in the future.
Exchange of information
The new treaty provides for an exchange of information between the competent tax authorities of the contracting states. The new treaty does not provide for spontaneous or automatic exchange of information. Contracting states are obliged to cooperate with a request for information. The fact that certain requested information is held by a bank or other financial institution is not a valid ground to refuse the request for information.
Both states shall endeavour to lend assistance to each other in the collection of taxes to which the new tax treaty applies.
The new Netherlands / Chinese tax treaty contains improved provisions which will further promote investment and trading between the two countries.
- The new tax treaty provides for a reduced withholding tax rate on dividends of 5% in situations where the beneficial owner of the dividends is a resident company of one of the contracting states and directly holds at least 25% of the capital paying the dividends in that other contracting state;
- The new tax treaty provides investors protection for gains derived from the alienation of (quoted) shares.
Please do not hesitate to contact us in case you have any question about the new tax treaty.
Nijmegen, February 12, 2014