New tax treaty implementation rules


The State Administration of Taxation (SAT) on 9 February 2018 issued the Bulletin on Certain Issues Relating to Implementation of Tax Treaties (bulletin No. 11), which revises and supplements China’s existing treaty interpretation rules under circular No. 75 with respect to permanent establishments (PEs), international shipping and air transport, artists and athletes, and partnerships. (Circular No. 75 refers to the Notice of the State Administration of Taxation on the Interpretation of the Agreement Between the Government of the People’s Republic of China and the Government of the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income and the Protocols Thereof.) Bulletin No. 11 took effect on 1 April 2018.

Key provisions

Permanent establishments. Bulletin No. 11 introduces two noteworthy directives for assessing a non-resident enterprise’s PE exposure in China.

First, bulletin No. 11 provides that a foreign entity that operates a non-legal person joint educational institution or a joint educational programme with a Chinese partner in China should be treated as having a PE in China. This provision addresses a longstanding area of uncertainty that has led to tax disputes for foreign universities with operations in China.

The new provision in bulletin No. 11 appears to close the door for a foreign entity to argue that its joint educational institution or joint educational programme in China is not a PE.

Second, bulletin No. 11 provides that the “six-month” threshold for a non-resident enterprise to have a service PE should be interpreted to mean a “183-day” threshold. Most of China’s tax treaties provide that a foreign enterprise will have a PE in China if its employees or other personnel stay in China for more than a certain amount of time during a 12-month period in connection with a service project or connected service projects.

In some of China’s treaties, the threshold is six months, while in other treaties, particularly more recent ones, the threshold is 183 days. With the clarification provided under bulletin No. 11, a foreign enterprise from a treaty jurisdiction with the six-month service PE threshold can now accurately manage the presence of personnel in China to avoid crossing the threshold for creating a service PE.

International shipping and air transport. Bulletin No. 11 replaces the provisions in circular No. 75 on the interpretation of the international shipping and air transport clauses in China’s tax treaties.

Bulletin No. 11 adopts the internationally accepted principle that income derived from the time or voyage charter of ships, or the wet lease of aircraft, should be characterized as income from international transportation, i.e. as income derived from the operation of ships or aircraft in international traffic. Circular No. 75 excluded such income from the scope of international transportation income, unless it was merely incidental to the operation of an international transportation business.

Bulletin No. 11 retains the circular No. 75 interpretation that bare boat charters, dry leases of aircraft and leases of containers are not within the scope of international transportation business unless they are incidental to the operation of an international transportation business. However, the definition of “incidental” is more stringent under bulletin No. 11 than under circular No. 75.

Like circular No. 75, bulletin No. 11 defines “incidental” to mean: (1) that the enterprise’s business registration or other relevant documents demonstrate that its core business is international transportation, and (2) that the enterprise’s revenue from the “incidental” business does not exceed 10% of its total international transportation revenue within a fiscal year.

However, bulletin No. 11 further provides that an “incidental business” must be closely connected with the enterprise’s international transportation business and cannot be considered as a separate business or a separate income source. This additional condition is subjective, and it remains to be seen how Chinese tax authorities will interpret it. Another uncertainty that is not clarified in bulletin No. 11 is whether the 10% revenue test is based on the non-resident enterprise’s worldwide revenue or only its China-sourced revenue.

In other aspects, bulletin No. 11 is basically consistent with circular No. 75 with respect to international transportation.

Partnerships. Bulletin No. 11 marks the first time the SAT has issued official rules about a partnership’s eligibility for treaty benefits. The bulletin covers not only partnership but also “other entities with a similar nature” (collectively “partnerships”). It does not define the term “entities with a similar nature”, and it is not clear whether, for example, a US limited liability company with look-through treatment under US federal tax rules may fall within this category.

Bulletin No. 11 provides different tax treatments for a partnership depending on whether it is formed under Chinese or foreign laws. Under Chinese tax rules, a Chinese partnership is a tax-transparent entity and the partners are liable to pay tax in China on their respective income shares. For a Chinese partnership, bulletin No. 11 allows its foreign partner to claim treaty benefits if the partner is taxed on its respective share of the partnership income in the partner’s country of residence.

In contrast, bulletin No. 11 generally views a foreign partnership as an independent non-resident taxpayer. Bulletin No. 11 does not allow a foreign partner of a foreign partnership to directly claim treaty benefits in China with respect to income derived by the partnership, unless permitted under an applicable tax treaty.

Instead, the foreign partnership itself must establish its eligibility for treaty benefits. In order to do so the foreign partnership must, as a minimum requirement, submit a tax residency certificate supporting that the foreign partnership is liable to pay income tax in its country of residence based on its domicile, residence, place of establishment, place of management or other criteria of a similar nature.

Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by e-mailing Danian Zhang (Shanghai) at subscripton ad blue 2022