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Before 2008 treaty shopping wasn’t a big concern because at that time when Chinese companies issued dividends overseas there’s no withholding tax on those dividends from foreign investment enterprises. But after 2008 a 10 percent dividend withholding tax is installed on those transactions so after that the government does pay a lot of concern on the treaty shopping behaviors of the multinational companies.
They actually issued several circulars in this regard. The first one is the 2009-601 Beneficial Ownership circular. We call that Circular 1. So what is says is to define the concept of a beneficial ownership. In the treaty context if a Chinese company distributes dividend or pays a royalty or interest to a foreign party in order for the foreign party to claim treaty benefits the foreign party has to be a beneficial owner. It is something defined in the treaty. So the Chinese circulars serves as unilateral interpretations of this circulars saying that obviously the foreign party cannot be an agent, cannot be a conduit. It has to be an owner of this income.
But beyond this dominion control concept, the Chinese regulations also state that the foreign party must have a physical operation in the holding company’s jurisdiction. So it cannot be an empty box. So they need to look at the number of people in these holding companies, what kind of assets they have, what kind of risks they take, whether they make their own decisions, etcetera.
So for us, when we do the international tax planning we have to review the current holding structure. So let’s say if a Chinese company is currently held by a Hong Kong intermediate holding company, then we need to look at whether Hong Kong has commercial substance or not and if not what can we do to beef up the substance. There are various ways a company can do--. A company can send more people to Hong Kong, either through secondment or through just the transfer and then companies can get more business functions to this Hong Kong holding company, have it perform R&D services, have it perform for example marketing services on behalf of affiliates. Then we can have the Hong Kong entity serve as regional treasury center. We can move some valuable assets underneath this Hong Kong company by transferring intangible properties or actually injecting additional equity interest into Hong Kong so that this Hong Kong entity not only serves as a holding vehicle for China but also a holds other entities within the Asia Pacific region.
So all of those measures will help you, support your argument that this Hong Kong company is a beneficial owner and therefore is entitled to the treaty benefits under the relevant agreement.
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