Recent international tax developments
Deloitte Belgium Tax Quarterly, Issue 44 - June 2011
Chinese tax authorities clarify tax treatment of non-resident enterprises
China’s State Administration of Taxation (SAT) issued a Bulletin on 28 March 2011 (Bulletin No. 24) that clarifies the tax treatment of nonresident enterprises, in particular, in relation to indirect transfers of the shares of a Chinese entity. Circular 698 of 10 December 2009 (applicable as from 1 January 2008) created considerable controversy and uncertainty, which the SAT now seeks to address.
Bulletin No. 24 took effect as from 1 April 2011, but also applies to transactions that took place before its issuance for which the relevant PRC tax matters have not been dealt with.
Recap of Circular 698
Circular 698 addresses the transfer of shares of a Chinese company by a nonresident company. Such transfer is subject to a 10% capital gains tax.
Nonresidents could in Chinese companies via offshore intermediary holding companies in order to avoid this capital gains tax. Circular 698 targets such transactions and imposes reporting requirements on the nonresident company that has “effective control” if the effective tax burden in the jurisdiction of the intermediary holding company is less than 12.5%, or if that jurisdiction does not tax foreign-source income. Further, the SAT is authorised to disregard the existence of the offshore intermediary company under China’s general anti-avoidance rule and impose withholding tax if it determines that the intermediary is established for tax avoidance purposes and lacks a business purpose.
Clarification of Circular 698
Circular 698 has been the topic of controversy since its issuance, not least due to the lack of clarity in the fundamental parameters under which the circular would apply to nonresident enterprises. The SAT has now sought to clarify these parameters, as well as some of the concepts used in Circular 698 (“foreign investor (party with effective control)”, “effective tax burden”, “does not tax foreign-source income”).
Moreover, the SAT goes into other issues, such as the timing of the withholding tax on payments in case where the contractual and actual payment dates differ and the corporate income tax treatment of guarantee fees, gains from the transfer of land use rights, finance leases and rental income from immovable property and income from equity investments.
The Bulletin contains several positive changes geared towards reducing the administrative burden on nonresident enterprises and providing more certainty in administrative procedures. However, the SAT’s definitions of certain parameters may expose other issues needing clarification.
Local tax bureaus have been increasing their enforcement efforts on Circular 698. Based on publicly available information on high-profile cases in Chongqing and Jiangdu, the local tax bureaus appear to focus more on the business substance of the intermediary holding company rather than its legal form or commercial purpose. In this important aspect, the Bulletin has not shed light on the SAT’s official position.
Consequently, it is reasonable to expect that the SAT will issue further clarifications and guidance on the above issues. In the meantime, taxpayers would benefit from undertaking regular reviews of their current PRC investment holding structures to identify any potential tax risks that may arise due to evolving PRC tax rules.
ECJ rules on VAT exemption for financial services
The European Court of Justice (ECJ) ruled on 10 March 2011 that fees for underwriting share issues are exempt from VAT (Skandinaviska Enskilda Banken AB Momsgrupp v. Skatteverket). Underwriting services are services that involve a credit institution providing, for consideration, a guarantee to a company that is about to issue shares, where under the guarantee the credit institution undertakes to acquire any shares that are not subscribed within the period for share subscription. The EU VAT Directive provides for a VAT exemption on financial services, but does not specifically mention underwriting services.
The case concerned a Swedish bank that provided an underwriting guarantee to a company that issued new shares. The bank considered the guarantee as an exempt supply, but the Swedish tax authorities argued that the supply (and fee) was outside the scope of the exemption and, hence, was subject to VAT.
The ECJ held that article 135(1)(f) of Council Directive 2006/112/EC must be interpreted as meaning that the exemption from VAT covers underwriting services supplied by a credit institution.
Government to request annulment of Commission decision on financial restructuring exception
The German government recently announced that it intends to file an application to the European Court of First Instance (CFI) for an action to annul the decision of the European Commission that the financial restructuring exception in German tax law constitutes incompatible state aid.
Under the change-in-ownership rules applicable as from 1 January 2008, a direct or indirect share transfer of more than 25% (and up to 50%) of the shares in a company that has loss carryforwards results in a pro rata (or full) forfeiture of those carryforwards. The financial restructuring exception, which allows ailing companies to keep their loss carryforwards even if there is a harmful change in ownership, was introduced in mid-2009, without being notified to the Commission.
Accordingly, the measure was considered unlawful aid and the Commission ordered Germany to recover all aid granted under the financial restructuring exception since it came into effect.
The German government, however, has maintained the position that the financial restructuring exception does not confer a selective advantage and thus does not constitute state aid. If the government is successful in its application, the exception could again apply to fiscal years 2008-2010. However, until the CFI issues a final decision, all tax advantages granted under the financial restructuring exception have to be recovered because the annulment action does not suspend the effect of the European Commission’s decision. The Federal Ministry of Finance has announced that it is preparing guidance that will clarify how the advantages will be recovered under German procedural rules.
Taxpayers that have made use of the financial restructuring exception should carefully analyse their situations to ensure they will be able to benefit from a potentially successful outcome of the action for annulment. Taxpayers will not be able to present arguments in the case because companies and similar parties do not have the right to intervene in such proceedings even if they can establish an interest in the results of the case. However, any company that is directly and individually affected by the decision of the Commission, e.g. because the company made use of the financial restructuring exception in the past, should have the right to bring an action for annulment before the CFI. A careful analysis is necessary, however, to determine whether this action would be sensible.
OECD releases survey on transfer pricing simplification measures
The OECD released its Multi-Country Analysis of Existing Transfer Pricing Simplification Measures on 10 June 2011 as part of a project launched in 2010 on the administrative aspects of transfer pricing. The Analysis presents the main findings from 33 OECD and non-OECD countries concerning their existing domestic law measures to simplify the application of their transfer pricing rules, to include safe harbours, less stringent documentation requirements, alleviated penalties and streamlined procedures.
The OECD states the survey will help inform the Committee on Fiscal Affairs as it works to improve transfer pricing administration, to include revisiting the existing OECD guidance on safe harbors and analysing the advantages and disadvantages of various forms of transfer pricing administrative simplification.
Tax accounting implications of U.K. Budget 2011 changes
The U.K. Budget 2011 announced on 23 March 2011 introduces the following changes to the main rate of corporation tax which will affect companies with operations in the U.K. and will have an impact on both current and deferred tax calculations:
- A reduction in the rate of corporation tax from 28% to 26% as from 1 April 2011, with further annual reductions of 1% until the main rate reaches 23% on 1 April 2014.; and
- An increase in the rate of the supplementary charge for ring fence trades (affecting North Sea oil and gas) from 20% to 32%.
The reductions in the tax rate to 26% and 25% are expected to be included in Finance Bill 2011, which is expected to pass in July 2011. The move to 26%, however, has effect as from 1 April 2011. The further rate changes discussed in the Budget (to 24% and 23%) are expected to be included in future Finance Bills.
Due to the methods being used to implement these changes, the impact on the deferred tax calculations of companies are expected to differ depending on whether a company reports under International Financial Reporting Standards (IFRS), US Generally Accepted Accounting Principles (US GAAP) or UK Generally Accepted Accounting Principles (UK GAAP).
- For reporting under IFRS or UK GAAP, tax rate changes are taken into account during the period in which the law is substantively enacted or enacted. The reduction in the rate of corporation tax to 26%, effective from 1 April 2011, was substantively enacted on 29 March 2011, following the last day of Budget debate. The further reduction to 25% will be substantively enacted when the Finance Bill 2011 passes the House of Commons. For the supplementary charge, this took place on Budget Day (23 March 2011).
- For reporting under US GAAP, tax rate changes are taken into account during the period that includes enactment. The current rate changes will not be considered enacted until the Finance Bill 2011 has received Royal Assent.
For a more detailed analysis of the tax accounting impact of these changes, reference is made to the Deloitte World Tax Advisor of 1 April 2011.