Capital gains tax (“CGT”) has been a key issue surrounding the investment by QFIIs and RQFIIs in the Mainland Chinese securities market. Mainland Chinese tax authorities have publicly decided to retrospectively collect CGT for the period from 17 November 2009 to 16 November 2014.

For quite a while, the Mainland Chinese tax authority’s stance on CGT earned by QFIIs and RQFIIs has been vague. Simultaneously with the launch of the Shanghai-Hong Kong Stock Connect programme on 14 November 2014, the CSRC, the State Administration of Tax (“SAT”) and the Ministry of Finance (“MOF”) jointly issued two tax circulars, i.e. Caishui [2014] No. 79 (“Circular 79”) and Caishui [2014] No. 81 (“Circular 81”). Pursuant to Circular 79, gains realized from the transfer of Chinese equities by QFIIs and RQFIIs are tentatively exempted from corporate income tax with effect from 17 November 2014. However, the Circular also emphasized that capital gains realized prior to 17 November 2014 remain subject to corporate income tax.

In February 2015, SAT staff publicly mentioned that CGT for gains realized prior to 17 November 2014 would be levied on a transactional basis with no netting off among multiple transactions permitted. This may result in the actual CGT payable by certain QFIIs and RQFIIs exceeding the amounts of tax provision made, where the tax provisions had been made on the basis of net asset value. In such cases, QFIIs and RQFIIs may need to divert a portion of their current net assets to make up the shortfall between the CGT payable and the tax provision.

Similarly, for QFIIs and RQFIIs that did not make any tax provision, collection of the CGT may have a significant impact on their assets, adversely affecting the interests of existing investors, particularly those who made their investments after the gains corresponding to the income tax had been realized. In addition, with respect to investment products that were liquidated before the collection of CGT, it still remains to be seen who will be responsible to actually pay the tax. As it will be difficult to trace the investors of those investment products which have been wound up, the tax authorities may, instead, pursue the respective QFIIs and RQFIIs who had provided such products.

QFIIs and RQFIIs are urged to consider taking the following steps:-

• coordinate with their service providers to review their past transactions;
• prepare the relevant filings to the Mainland China tax authorities;
• determine the impact (if any) of CGT on their investment products and investors; and
• enhance the disclosure on CGT in the relevant offering documents to the relevant investors.