Use of Seychelles CSL for Tax Planning Purposes for China
ADDITIONAL READINGS: USE OF SEYCHELLES CSL (SPECIAL LICENSE COMPANY) FOR TAX PLANNING PURPOSES FOR CHINA
CHANGES IN CHINA
Ongoing Chinese tax reforms are resulting in the reduction and phasing out of various tax concessions granted to foreign investors. Such reforms are occurring due to WTO requirements (level tax playing-field for domestic and foreign businesses) and also given the large FDI inflows which have already occurred. As such, and increasingly over time, more foreign investors will be exposed to higher Chinese taxes. In particular, China’s recently enacted Enterprise Income Tax (“EIT”) Law (effective from 1 January 2008) introduces a new uniform income tax regime which applies to both foreign and domestic enterprises (replacing the previous “dual” regime by which Foreign Investment Enterprises (FIEs) and domestic enterprises were subject to two different sets of income tax laws). Under the EIT Law, withholding tax at the rate of 20% applies to China-sourced income derived by a non-resident enterprise without an establishment or place of business in China. While there is provision for reduction or exemption of withholding tax by the State Council, as yet such measures have not been introduced. Additionally, while Chinese tax enforcement and collection has often in the past been haphazard, China is becoming increasingly serious about tax collection (for example, Chinese tax collection was up by over 22% for year ended 2006). Therefore, there will be increased levying and collection of Chinese withholding taxes. In this context, it should be noted that tax exempt IBCs (which have commonly been used as intermediary holding companies to hold shares in Chinese companies for foreign investors) will no longer always be suitable (as tax exempt IBCs may not access Double Taxation Avoidance Agreements, which provide a solution for reduction of Chinese withholding tax).
Seychelles / China DTA – using a CSL
Use of a CSL, in conjunction with the Seychelles / China DTA, provides for significant scope to reduce Chinese withholding tax exposure. The Seychelles / China DTA caps Chinese withholding tax on:
- dividends at 5% (Article 10(2) of the DTA);
- interest at 10% (Article 11(2) of the DTA); and
- royalties at 10% (Article 12(2) of the DTA),
provided that the CSL has a permanent establishment and its effective management in Seychelles (see below) and that the CSL is not tax resident in and not managed from China. In contrast to the position under the Seychelles / China DTA, PRC companies are generally subject to 20% Chinese tax on payments to non-residents, except for Foreign Investment Enterprises (which are exempt under prevailing law) and Foreign Enterprises (which enjoy a concessionary 10% withholding tax rate, but which may be further reduced using a Double Taxation Avoidance Agreement). As indicated above however, China is in the process of phasing out the present tax incentive regime enjoyed by foreign investors.
Another key benefit under the DTA is that no tax is payable in Seychelles (on Chinese-sourced income of the CSL) if Chinese withholding tax of at least 1.5% is paid on payments made by a Chinese company to a CSL. More particularly, a CSL is liable to Seychelles business tax at rate of 1.5% on worldwide taxable income (gross income less allowable deductions). Significantly however, under Article 23 of the Seychelles / China DTA, withholding tax paid in China can be credited and set-off against the 1.5% Seychelles business tax payable by the CSL to fully discharge all business tax liability in Seychelles (ie. no tax payable in Seychelles). As mentioned above, CSLs are exempt from Seychelles withholding tax on dividends, interest and royalties.
Another potential fiscal benefit under the Seychelles / China DTA is complete avoidance of Chinese tax on capital gains made by a CSL selling shares held by it in a Chinese Company if the CSL holds less than 25% of the issued shares in the Chinese Company and the assets of the Chinese Company do not principally consist of immovable property (real estate). This will be of particular relevance to China oriented collective investment funds and private equity funds (ie. entities which intend to acquire small stakes in numerous Chinese companies). PRC has indicated that at some time in the near future, the taxing of capital gains on shares will be enforced (unsurprising given PRC’s need to dampen down over-heating securities markets, etc).
Comparison with the Other China DTAs with Mauritius, Hong Kong & Barbados
A Protocol (amending the China / Mauritius DTA) was signed in 2006, which revised the position in relation to the exemption status as regards taxation of capital gains by Mauritian GBL1 companies upon the disposal of shares in Chinese Company. In short, the position is now the same as under the Seychelles / China DTA.
Mauritius GBL1 Companies are subject to Mauritius tax on Chinese sourced income – 15% base rate, which may be reduced to 3% by tax credits. A key advantage Seychelles has is that under the Seychelles / China DTA (Article 23, the “tax credit” provision) and assuming at least 1.5% withholding tax is paid in China), there will be no Seychelles tax payable. In contrast, the prima facie Mauritius tax exposure is 3% (although this may be further reduced by allowable deductions).
HONG KONG-CHINA DTA
Under the Hong Kong / China DTA:
- If a Hong Kong Company holds at least 25% of the issued share capital in Chinese Company, the dividends paid to the Hong Kong Company are subject to Chinese withholding tax capped at 5%; and
- If a Hong Kong Company holds less than 25% of the issued share capital in Chinese Company, the dividends paid to the Hong Kong Company are subject to Chinese withholding tax capped at 10%.
In contrast, under the Seychelles / China DTA – whether or not a CSL holds more or less than 25% shares in Chinese Company, dividends are subject to Chinese withholding tax not exceeding 5%. Given the very close “proximity” between China and Hong Kong (and the imminent prospect of increased “exchange of information” between the PRC and HK tax authorities), some investors prefer to have more “distance” between their intermediary holding company and its Chinese subsidiaries, borrowers or licensees, as the case may be. Another potential issue with use of a Hong Kong company is exposure to Hong Kong tax to the extent that any Hong Kong sourced income should arise.
Reliable rumours persist of an imminent amendment protocol to revise the Barbados / China DTA to bring its treatment of capital gains into line with Mauritius, Seychelles and Hong Kong. Barbados Companies are subject to Barbados tax on Chinese sourced income at a rate from 1 to 2.5% of taxable income (with a minimum of 1% tax rate). In contrast and as set out above, under the Seychelles / China DTA (“tax credit” provision) and assuming at least 1.5% withholding tax is paid in China), there will be no Seychelles tax payable.
Effective Management in Seychelles
It is important to note the necessity (in a Seychelles / China DTA reliance case) for the CSL to demonstrate permanent establishment and effective management in Seychelles (see below); and not to be managed from or resident in China (ie. including no Chinese resident directors). If effective management of a CSL is not in Seychelles, tax relief (including reduced Chinese withholding tax rates) under the DTA will not be available. In terms of aiming to ensure Seychelles effective management, a CSL which seeks to access and benefit under the Seychelles / China DTA should (at minimum):
- Have all or a majority of Seychelles resident directors;
- Have a bank account in Seychelles and all funds relating to CSL transactions (including dividend, interest or royalty income) should flow through such bank account (even if only modest deposits are left there); and the Seychelles resident directors should have signing power on the Seychelles bank account;
- Hold Board meetings and pass resolutions in Seychelles;
- Ensure that Minutes of Board meetings include operational decisions relating to the CSL, and in particular in respect of fundamental decisions such as borrowing funds, entering contracts, making investments, etc;
- Ensure, wherever practicably possible, that legal contracts (to be entered into by the CSL) be signed by the directors in Seychelles (general Powers of Attorney should never be issued, although “limited” Powers of Attorney may be acceptable in respect of certain specific transactions).
In conclusion, Seychelles CSLs represent an astute choice of holding company entity for foreign investors into China, particularly so in light of the ongoing tax “changes” occurring in China. Seychelles has maximized its appeal and effectiveness as an offshore financial centre by developing innovative products and policies and striking a commercially sensible balance between market demands and regulation. With Seychelles offshore industry growth surging and continuing to gather momentum, it is well placed to make an increasingly significant impact on the international financial services market.
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