Chinese Tax Authority Rejects Barbados Company Claim For Treaty Benefits by Anthony Murty
According to information published online by China’s State Administration of Taxation (SAT) on March 16 a tax office of in Anhui Province recently rejected a Barbados company’s application to qualify its Chinese-source dividend income for the 5 percent tax rate provided under the Barbados-China income tax treaty.
The tax office reportedly initiated an investigation establishing that the Barbados company was an “offshore entity with limited liability” incorporated under the laws of Barbados. The tax authority concluded that an offshore entity with limited liability cannot be recognized as a beneficial owner in accordance with Guoshuihan  601 (Circular 601), and therefore, the company cannot apply the treaty rate to the dividends. The applicant has withdrawn the application.
Circular 601 does not state that an offshore entity with limited liability cannot meet the criteria for beneficial owner status, but it does provide that a conduit company cannot qualify as a beneficial owner. A company is treated as a conduit company if it is established mainly in an attempt to evade or reduce taxes or to shift or shelter profits. Such companies generally do not conduct actual business activities such as manufacturing, purchases and sales, and management, according to Circular 601.
There have been some other public cases in which Barbados companies were denied treaty benefits in China. Therefore, Barbados companies applying for special treaty treatment may be subject to more detailed review and investigation in the future.
This decision would appear not only to effect International Business Companies and Societies with Restricted Liability, but those resident regular companies that do not have other trading activity taking advantage of the ability to pay dividends received from non-resident companies to non-resident shareholders without the imposition of withholding tax as provided by Income Tax Act section 65(4E) effective from 2007.
Foreign companies investing in China through intermediate Barbados holding companies should consider creating necessary substance for the intermediate companies in order to meet the beneficial owner requirements; otherwise, they should consider reorganizing their corporate structure.