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What are some of the problems facing companies employing tax effective treaty structures in Asia Pacific? The problems circle around countries like India, China and Korea. The problems emerge because treaties use a legal term beneficial ownership which is clearly understood in the developed world – the United States, Western Europe and Australia. The concept technically means owning legal and beneficial ownership of the shares. So the issue of beneficial ownership is a holding company will always beneficially own the shares and its subsidiary unless it’s made a sale of either the legal or equitable estate in the shares.
That concept however has a wider meaning in Asia Pacific. The Chinese and Indian governments have issued rulings and circulars around the concept of substance. The view that is being taken is that you can only beneficially own a share in a subsidiary if the shareholder has economic and real substance and economic and real decision making over that particular subsidiary.
Let’s look at a very simple example first. Holdco uses a subsidiary in Mauritius which owns a company in India. The company in Mauritius has one director. The shareholders of that company, Holdco, have all the real decision makers. Now whether the Mauritius company will sell the shares in the Chinese company will be made in substance by Holdco so therefore both India, China, Korea even, Indonesia will treat Holdco as a beneficial owner of the shares in China or India and will disregard the ownership by the Mauritius company.
That concept has been taken to different levels in different markets. For example, in Indonesia the government has provided detailed substance requirements covering issues like number of employees, activities, meetings. Other countries like China and India have left it more vague. The difficulties companies have is without knowing the precise rules it’s very difficult to confidently predict what would be accepted and not accepted in either market.
If we look at somewhere like Australia, the issue turns not on beneficial ownership. The issue turns on the general anti-avoidance provision. General anti-avoidance provisions also exist in India and China, however, as I said earlier, the decision in those markets is made around beneficial ownership. In Australia the scenario turns on whether the holding company was inserted for the dominate purpose of achieving a tax benefit. The reason it’s a relevant question is Australia has a general treaty override which provides that if there’s a conflict between the application of the treaty and Part 4A, which is the general anti-avoidance rule, the general anti-avoidance rule will prevail.
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