Managing Offshore Holding Companies from China: Recent Case May Suggest Increased Tax Risk

As our readers know, foreign investments into the People’s Republic of China (“PRC”) are typically structured through one or more holding companies domiciled in offshore jurisdictions. Planned and implemented properly, an offshore holding company structure can provide investors with enhanced governance and economic rights, ease of public listing and disposal without triggering onshore regulatory approvals, and reduced withholding tax rates on returns of their PRC investments compared to a direct investment into a PRC entity.

In recent years, however, the PRC State Administration of Taxation (“SAT”) has issued a series of circulars that evidence a significantly increased scrutiny on the use of offshore holding companies to structure foreign ownership in operating businesses in the PRC. In Guoshuihan [2009] No. 601 (“Circular 601”), for example, the SAT emphasized that an offshore holding company may only take advantage of the preferential withholding tax rates under a double tax treaty between the PRC and the offshore jurisdiction if the holding company is the “beneficial owner” of the applicable income. Among other things, Circular 601 requires a “beneficial owner” to have substantive operating activities and not be merely an agent or “conduit”.

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