Which Countries have Double Taxation Treaties with China?

In this article we look at how double taxation treaties work in China, and what businesses need to do to ensure full tax compliance in China. 

Overview of Double Taxation Treaties in China

China has established an extensive network of Double Taxation Treaties (DTTs) with countries around the world to prevent double taxation and tax evasion, fostering international trade and investment. These treaties are bilateral agreements which ensure that income earned by residents of either China or the treaty partner is taxed only once.

Key Characteristics:

• Aim: To avoid double taxation and to encourage foreign investment and trade.
• Coverage: Includes multiple forms of income such as business profits, dividends, interest, and royalties.

Table 1: Quick Facts

DTTs in China delineate taxing rights between the signatory countries, which can involve sharing or allocating taxing rights. The actual enforcement of these treaties is subject to domestic law. In addition, China’s DTTs typically follow the OECD Model Tax Convention on Income and on Capital to some extent, aligning with international standards.

The impact on taxpayers is significant, reducing the overall tax burden and clarifying tax obligations for cross-border economic activities. These treaties also provide mechanisms for resolution of disputes arising from tax matters, enhancing legal certainty for taxpayers.

China continuously seeks to expand its treaty network, adjust existing treaties, and align with international tax trends to maintain a stable and attractive business environment and to mitigate risks associated with cross-border transactions.

Key Principles of Double Taxation Treaties

Double Taxation Treaties (DTTs) serve as agreements between two countries that aim to prevent the same income from being taxed by both jurisdictions. The core principles underlying China’s DTTs stem from international tax practice and the need to promote cross-border trade and investment.

Residence-Based Taxation: DTTs generally follow the principle that residents of a contracting state should only be taxed by their home country. However, the source state where the income arises can also have taxing rights, but these rights are limited by the treaty.

Permanent Establishment: Income derived by a foreign entity is taxable in the source state only if the entity has a permanent establishment there. The treaties define what constitutes a permanent establishment, often requiring a fixed place of business or certain types of physical presence.

Withholding Taxes: For cross-border payments such as dividends, interest, and royalties, the treaties often reduce the rate of withholding tax below the rate that would apply in the absence of a treaty.

Tax Credit and Exemption: Chinese DTTs generally allow a tax credit for foreign taxes paid, or alternatively, may provide an exemption whereby income is taxed only in one of the countries.

Mutual Agreement Procedure (MAP): To resolve disputes, DTTs typically include a MAP. This enables tax authorities from both countries to engage in discussion and negotiation to settle disagreements relating to treaty interpretation or application.

Exchange of Information: DTTs facilitate the exchange of tax information between countries, enhancing transparency and helping prevent tax evasion.

These key principles reflect China’s commitment to upholding international standards while fostering a conducive environment for foreign investment and preventing fiscal evasion.

Methods for Avoiding Double Taxation

In China, several strategies are employed to mitigate the issue of double taxation for individuals and companies engaged in cross-border trade and investments. These approaches conform to international standards and are designed to promote fair taxation.

Tax Credits: One fundamental method is the tax credit system. Tax authorities allow credits for taxes paid overseas to be deducted from the tax owed in China on the same income.

Tax Exemptions: Certain income types are exempt from taxation in China if they’ve already been taxed in another jurisdiction. This method directly reduces double taxation by not subjecting the same income to tax twice.

Reduced Tax Rates: Under treaty provisions, reduced withholding tax rates are applied to interests, dividends, and royalties paid by China to residents of the treaty partner country, reducing the tax burden.

Mutual Agreement Procedures (MAP): If double taxation disputes arise, affected taxpayers can invoke MAPs, which are bilateral negotiations aimed at resolving these disputes in accordance with treaty terms.

Permanent Establishment (PE): Double taxation treaties delineate the specific conditions under which a foreign entity is considered to have a PE in China. The criteria limit the circumstances that trigger taxation for foreign businesses.

Transfer Pricing Adjustments: Transfer pricing rules are critical for avoiding double taxation of multinational companies. China’s regulations ensure that inter-company transactions are priced fairly, preventing income from being taxed more than once.

By employing these methods, China aims to create an equitable environment for international business, encouraging foreign investment and promoting economic collaboration.

Types of Taxes Covered

In China, DTTs primarily target two classes of taxes:

Individual Income Tax (IIT):

Applied to the income of individuals working and residing in China, including wages, salaries, and other forms of compensation.

Enterprise Income Tax (EIT):

Levied on the profits of companies and enterprises operating within Chinese territory, encompassing both domestic and foreign entities.

Additionally, these agreements may cover an array of other taxes, subject to the specific provisions within each treaty. The breakdown often includes:

Value-Added Tax (VAT):

Charged on the sale of goods, provision of services, and importation of products.

Business Tax:

Imposed on businesses providing services, transferring intangible assets, or selling immovable property within China.

Real Estate Tax:

Applies to the ownership of property and land usage rights.

The treaties aim to prevent double taxation and foster economic cooperation by outlining the taxing rights of each contracting state, providing clarity and predictability for taxpayers. They also often stipulate reduced withholding tax rates on dividends, interest, and royalties to encourage cross-border investments.

It is vital for taxpayers to refer to the specific treaty in question, as the coverage of taxes can vary significantly from one agreement to another.

Process of Tax Treaty Negotiation and Implementation

The negotiation and implementation of double taxation treaties in China involves several structured phases. These treaties aim to prevent the same income from being taxed by two countries. The process typically begins with preliminary discussions between China and the potential treaty partner to identify mutual concerns and objectives. These discussions set the stage for formal negotiations.

Formal Negotiations

1. Initial proposal: Usually, China or the counterpart proposes a draft treaty.

2. Bilateral meetings: Delegates from both countries discuss terms and provisions.

3. Agreement on Articles: Key terms like residency, permanent establishment, and withholding taxes are debated and agreed upon.

Technical Review

After negotiations, a technical review is undertaken to ensure the treaty’s provisions are precise and the language is consistent with international standards.

Signing and Ratification:

The finalized draft is signed by representatives of both countries.

The treaty requires the ratification by the legislative bodies in both countries before it can enter into force.

Implementation:

Following ratification, the treaty is published, and guidelines for implementation are disseminated to relevant authorities and taxpayers.

Exchange of Information:

China’s tax authorities maintain dialogue with their foreign counterparts to facilitate the exchange of taxpayer information as per the treaty’s provisions.

This meticulous process ensures that once in effect, the treaties provide clarity and certainty to taxpayers, avoiding double taxation and fostering international trade and investment.

Benefits of Tax Treaties for Investors

Tax treaties, also known as Double Taxation Agreements (DTAs), provide significant advantages for investors looking to engage in cross-border economic activities. By clarifying the tax obligations of investors in both the source and residence country, these treaties play a crucial role in fostering international investment.

One primary benefit is the reduction of tax rates on different income streams such as dividends, interest, and royalties. For instance:

• Dividends: The tax rate may be reduced from a typical 20% to as low as 5-10%.
• Interest: Standard rates might be decreased from 20% down to 10% or less.
• Royalties: Reductions can also apply here, potentially decreasing rates by half or more.

Another advantage is avoidance of double taxation. Investors often face the risk of being taxed in both the source and residence country for the same income. Treaties ensure that the investors receive credits or exemptions, thus eliminating this risk.

Capital gains taxes are usually either eliminated or significantly reduced under tax treaties. When an investor sells an asset, the capital gain may be taxed only in their country of residence, providing a clear framework for tax liabilities.

Furthermore, tax treaties generally offer clear dispute resolution mechanisms. When ambiguities arise, these mechanisms enable taxpayers to reach timely resolutions without excessive costs.

Lastly, they often address information sharing between tax authorities. This transparency helps in facilitating compliance while protecting investors against potential legal issues that arise from unintentional tax evasion.

Investors must always seek comprehensive legal advice to navigate and leverage these treaties effectively, since there may be specific provisions and criteria that apply.

Impact on International Trade and Investment

Double Taxation Treaties (DTTs) have a substantial influence on international trade and investment flows. China’s extensive network of such treaties facilitates cross-border transactions by providing greater tax stability and reducing the tax burden on investors.

International Trade: DTTs lower customs duties and tax rates on exported and imported goods. This reduction enhances trade competitiveness by reducing the cost of goods for importers and exporters. A study by the World Trade Organization indicates that countries with more DTTs tend to have higher trade volumes.

• Export Increase: Chinese exporters benefit from reduced withholding tax on profits, resulting in lower prices for end users.
• Import Cost Reduction: Importers incur less tax on goods entering China, encouraging a diverse market of international products.

Foreign Direct Investment (FDI): By preventing double taxation of foreign investors, China’s DTTs make the country more attractive for investment. The treaties often include provisions that protect against discrimination and offer dispute resolution mechanisms.

1. Tax Certainty: Investors commonly prefer predictable tax regimes, which DTTs provide, allowing for more reliable investment planning.
2. Return on Investment (ROI): Reduced double taxation means higher ROI, a significant draw for international investors.

Intellectual Property and Services: DTTs cover royalties, fees, and other income from services, promoting the exchange of technology and skills. They mitigate the risk of excessive taxation, thereby incentivizing innovation and the sharing of intellectual property.

By optimizing the tax environment for cross-border economic activity, Double Taxation Treaties contribute to a robust international trade framework and a conducive climate for foreign investment, solidifying China’s position in the global economy.

Common Provisions in China’s Tax Treaties

China’s tax treaties commonly feature several provisions aimed at avoiding double taxation and preventing fiscal evasion. These treaties typically follow the model tax conventions of the Organisation for Economic Co-operation and Development (OECD).

Residence: A person or entity is generally considered a resident of the state where they are liable to tax. The treaty applies to these residents.

Permanent Establishment: The treaties define what constitutes a ‘permanent establishment’ (PE), which usually includes a place of management, branch, office, factory, or workshop. A PE is crucial for determining the tax jurisdiction over business profits.

Withholding Taxes: They often reduce withholding tax rates on dividends, interest, and royalties paid to residents of the treaty partner, compared to the rates under domestic law.

Capital Gains: Provisions typically allocate taxing rights on capital gains from the alienation of property, which usually gives the right to tax to the state of residence unless the gains pertain to immovable property or PE.

Income from Employment: Salaries, wages, and other similar remuneration are taxable only in the state of residence unless the employment is exercised in the other state.

Methods for Eliminating Double Taxation:

• Exemption Method: Income may be exempt in the residence state if it is taxed in the source state.
• Credit Method: A tax credit is provided in the residence state for taxes paid in the source state.

Mutual Agreement Procedure (MAP): Taxpayers can request the competent authorities of the treaty states to resolve disputes regarding treaty interpretation or application.

Exchange of Information: They include an article that permits the exchange of information between tax authorities of the treaty states to prevent fiscal evasion.

Non-Discrimination: These provisions ensure that nationals of one treaty state are not subject to more burdensome taxation in the other state than nationals of that other state in the same circumstances.

This list is not exhaustive, and the specifics of each treaty may vary.

Limitation of Benefits and Anti-avoidance Measures

China’s double taxation treaties often contain Limitation of Benefits (LOB) clauses to prevent treaty shopping, which is the practice of structuring a multinational corporation to take advantage of more favorable tax treaties available in certain jurisdictions. LOB clauses typically stipulate that only residents who meet certain conditions can benefit from the tax treaty. These conditions may include:

• Ownership structure requirements: Ensuring the company seeking benefits is owned by residents of one of the treaty countries.
• Substantive business activities: Requiring the company to have an actual business presence in the jurisdiction.

Anti-avoidance measures are also a significant component of these treaties. They are designed to prevent the abuse of tax treaties and to ensure that the treaties are used in the spirit they were intended. Specific anti-avoidance measures China employs include:

• Principal Purpose Test (PPT): A provision that denies the benefits of a tax treaty if one of the main purposes of an arrangement or transaction is to obtain those benefits.
• Transfer Pricing Regulations: These ensure that transactions between related parties are conducted at arm’s length, reflecting market value, to prevent profit shifting.
• Controlled Foreign Corporation (CFC) rules: These attributes undistributed income of a foreign subsidiary to a resident parent company if the subsidiary is primarily investment-oriented or earns passive income.

In summary, China’s approach to LOB and anti-avoidance in its double taxation treaties is multifaceted, incorporating various criteria and regulations to safeguard against misuse and to promote fair tax practices.

Dispute Resolution in Double Taxation

When double taxation disputes arise between taxpayers and authorities in China, the primary resolution mechanism is through Mutual Agreement Procedures (MAP). The process initiates when affected taxpayers submit their cases to the respective national tax authorities. Tax authorities of both countries involved consult to resolve the dispute following the terms of the applicable Double Taxation Treaty (DTT).

The steps of MAP are as follows:

1. Submission of Case: Taxpayers present their case to their local tax authority.
2. Review by Authorities: Both countries’ tax authorities review the case independently.
3. Consultations: Authorities engage in discussions to negotiate a solution.
4. Resolution and Implementation: If a mutual agreement is reached, it is applied to rectify the situation.

It is important for taxpayers to note the time limits for initiating a MAP; generally, this is within three years from the first notification of the action resulting in double taxation.

Arbitration is also available under certain DTTs. If MAP does not lead to a resolution, the case may be considered for arbitration, providing the involved treaty includes an arbitration clause. Arbitration decisions are typically binding.

Chinese authorities are also working on improving the efficiency and effectiveness of dispute resolution mechanisms by adhering to international standards, such as the Base Erosion and Profit Shifting (BEPS) Action Plan developed by the OECD. These standards aim to ensure fair and consistent resolution of tax disputes worldwide.

Role of the State Administration of Taxation

The State Administration of Taxation (SAT) in China has a pivotal role in the implementation and management of Double Taxation Treaties (DTTs). It operates to ensure that the treaties are applied correctly and benefits such as reduced tax rates and exemptions are administered in accordance with the agreements.

Key Responsibilities:

• Enforcement: The SAT enforces the provisions of DTTs, ensuring that all taxable entities comply with the terms established.
• Interpretation: It provides clarification and guidance on the interpretation of treaty provisions to prevent misapplication and disputes.

Coordination:

• The agency coordinates with international tax authorities to facilitate cross-border information exchanges critical to the enforcement of DTTs.
• It assists in resolving disputes arising from treaty interpretation through mutual agreement procedures.

Documentation and Compliance:

• The SAT mandates that taxpayers provide documentation to prove eligibility for treaty benefits.
• Taxpayers must comply with the SAT’s reporting requirements to claim any benefits under a DTT.

Prevention of Tax Evasion:

• The SAT is vigilant against practices that aim to exploit DTTs for tax evasion.
• It employs measures to detect and prevent treaty abuse.

Capacity Building:

The SAT conducts training for tax officials on the nuances of DTTs to enhance their ability to administer these agreements. It also raises awareness among taxpayers about the benefits and obligations under DTTs.

Through its authoritative role, the State Administration of Taxation ensures that China’s network of Double Taxation Treaties is managed effectively, upholding both the spirit and the letter of the international agreements.

Implications of BEPS on China’s Double Taxation Treaties

The introduction of the Base Erosion and Profit Shifting (BEPS) initiative by the OECD has significant implications for China’s Double Taxation Treaties (DTTs). China has actively participated in the BEPS project and has committed to implementing its measures to prevent tax evasion and avoidance.

• Action 6 of BEPS, which address treaty abuse, prompts China to include Principal Purpose Test (PPT) clauses in its DTTs. This ensures the granting of treaty benefits only when the transactions or arrangements are not aimed primarily at obtaining those benefits.
• Action 7 deals with the artificial avoidance of permanent establishment status. Chinese DTTs are being modified to prevent multinational enterprises from exploiting the definition of permanent establishment, thus ensuring fair taxation.
• China is likely to revise the transfer pricing rules under Action 8-10 of BEPS, affecting how Chinese tax authorities and foreign entities engage in related-party transactions and share profits.

Under the Multilateral Instrument (MLI), China can swiftly amend its existing tax treaties to be in line with BEPS recommendations. The MLI allows participating jurisdictions to transpose results from the BEPS project into their bilateral tax treaties without renegotiating each treaty individually.

Following the BEPS guidelines, China’s approach should lead to greater transparency, reducing opportunities for tax avoidance and ensuring a fairer distribution of tax revenues. These changes also reflect China’s support for the global movement towards a more robust international tax framework.

Recent Developments and Updates

In 2019, China took a significant step to prevent double taxation and promote foreign investment by revising its Double Taxation Treaties (DTTs) with various countries. Notably, amendments were made to the DTTs with Singapore, India, and the UK, which came into effect in 2020. These updates primarily offer clarity on tax residency status and permanent establishment, which are vital for cross-border businesses.

Key Changes:

• Withholding Tax: The rate on dividends, interest, and royalties was adjusted to better align with international standards.
• Capital Gains Tax: Provisions were adjusted to narrow the scope of tax on capital gains, particularly favouring the sale of shares in real estate-rich companies.
• Tie-breaker Rule: Introduction of a more detailed tie-breaker rule for determining tax residency of entities and individuals.
• Information Exchange: Enhancement of information exchange clauses to support tax authorities in combating tax evasion.

In 2021, the protocol to the DTT between China and Barbados entered into force. It introduced improvements on mutual agreement procedures and taxation of services, setting a precedent for future treaties.

The most recent development, as of January 2024, was the initiation of negotiations to revise the DTT with the Netherlands, a key trading partner, to reflect current economic relations and tax policy priorities.

China is expected to continue updating its Double Taxation Treaties, ensuring they remain relevant and supportive of its economic objectives. These adjustments are typically accompanied by detailed guidance from the relevant Chinese tax authorities to assist taxpayers in interpreting the changes accurately.

Case Studies and Practical Examples

The implementation of Double Taxation Agreements (DTAs) in China can be illuminated through various case studies. In one instance, a multinational corporation with operations both in mainland China and Hong Kong was able to navigate the complexities of taxation through China’s DTA with Hong Kong. By attributing the correct amount of profits to their operations in mainland China and leveraging the DTA provisions, the corporation optimized its tax liabilities.

Example of Royalty Payments:

• Before DTA: A German company pays 20% withholding tax on royalties in China.
• After DTA: With the Sino-Germany DTA, the tax rate reduces to 10%.

Further insight is provided by a collaboration between a Chinese and a Dutch company. Prior to the China-Netherlands DTA, the Dutch company faced a withholding tax rate on dividends at 10%. Post-agreement, the rate was lowered to 5%, significantly reducing the Dutch company’s tax burden and enhancing bilateral investment flows.

Cross-Border Transactions have been greatly facilitated, as detailed in the China-UK DTA case. A UK investor receiving interest from Chinese bonds saw the withholding tax rate cut from the standard 10% to 7%. This reduction in tax rate is directly attributable to the DTA.

An essential component of China’s DTAs is the Exchange of Information article, which aids in curtailing tax evasion. A real-time example involved the exchange of tax information between China and Australia, contributing to the transparent resolution of a complex cross-border tax case.