On 1 October 2009, Guoshuifa [2009] 124 (“Circular 124”) came into effect. Before Circular 124 was issued, different local-level tax bureaus adopted different administrative practices with regards to non-residents claiming benefits under Sino-foreign double tax agreements ("DTA"). To harmonise standards and to counter any abuses of the DTA system, Circular 124 sets out comprehensive measures for administering the DTA benefit claims of non-tax resident enterprises and individuals in China, in relation to their China-sourced income.

Circular 124 does benefit non-tax resident enterprises and individuals in that it provides certainty and clarity on the tax treatment of China-sourced income. However, it also imposes additional compliance and administrative burdens. Going forward, a tax residence certificate issued by an offshore jurisdiction will not be considered conclusive evidence of the offshore “tax residence” status of an enterprise claiming DTA benefits in China. The Chinese tax authorities will undoubtedly use the information collected pursuant to Circular 124 to analyze the commercial substance and rationale for the establishment of a non-resident investment holding company in a favorable tax-treaty jurisdiction (e.g. Singapore or Hong Kong) to hold any Chinese investment. The business and economic purpose of any transaction involving non-tax resident enterprises and individuals will be scrutinised closely to determine the “beneficial owner” of any income derived from China.

Summary of Circular 124
Applicability – Circular 124 applies to “treaty treatments” (defined as any reduction or exemption of income tax liabilities by applying any DTA that would otherwise be payable under China’s domestic income tax laws and regulations) granted to any “non-resident” (defined as any foreign company or individual that is not a Chinese tax resident but that is subject to Chinese tax under China’s domestic tax laws or an applicable DTA). Unless a non-resident complies with the requisite approval or filing procedures set out in Circular 124, DTA benefits will be denied.

Filing vs Approval – Circular 124 distinguishes between passive income[1] and active business income[2]. Passive income is subject to approval, and prescribed reports must be filed with the in-charge tax authorities when claiming DTA benefits in respect of active business income. An application for approval must be lodged with the relevant provincial tax bureau, and once obtained, such approval will be valid for three years in respect of the same income. Under the record-filing procedure, a non-resident must file the prescribed documents, in advance, with the local bureau[3] responsible for its day-to-day tax affairs.

Processing Period – The designated approving tax authorities or the in-charge tax authorities have the authority to approve or reject a claim for DTA benefits. The time period for notification to the DTA applicant ranges from 20 to 40 working days, depending on the level of the tax authorities responsible for processing the application, and may be extended by 10 working days with the approval of an authorised tax official.

Our suggested strategy in claiming DTA benefits
Failure to file the prescribed documents or obtain the necessary prior approval will compel the relevant tax authorities to charge the normal withholding tax on any payment to non-residents, without taking into account the relevant DTA. While Circular 124 allows a non–resident to claim a refund for overpaid tax when DTA benefits were not previously claimed, it is obviously much easier to avoid a tax payment than to reclaim an overpaid one. Further, legal liabilities may result from non-compliance: penalties and surcharges may be imposed in accordance with the Chinese Tax Collection Administration Law.

Non-residents are advised to plan well ahead if they are considering claiming benefits under any DTA. We recommend following these steps before applying for DTA benefits:

(1) Appoint a Local Agent
Following the promulgation of Circular 124, non-residents now have an option to appoint a local agent to assist with the filing and approval requirements. AFP Group, together with our local PRC partner NCO, is able to assist you with the stringent documentation requirements under Circular 124 in a cost-efficient manner.

(2) Maintain Documentation to prove commercial substance
Non-residents must put in place effective internal record-keeping systems, for two reasons. Firstly, supplying erroneous information to the tax authorities could trigger queries, or even worse, a full tax audit. Secondly, without the proper documentation, it would not be possible to substantiate the commercial substance behind the transaction structure (for example, the tax residency of an offshore holding company may not withstand scrutiny unless there are documents and records evidencing the conducting of business activities, holding of board meetings or the maintenance of books and records offshore).

Conclusion
Circular 124 is a welcome development that provides unity and clarity to the system. However, if you are a non-resident, we would advise you to conduct a diagnostic review of your existing business arrangements and related party transactions with Chinese affiliates. This will help you determine whether you need to improve your corporate structure, and will thus help you avoid the closer scrutiny of the tax authorities in the future.

[1] Such as dividends, interest, royalties or capital gains.
[2] Such as payment for dependent or independent personal services, permanent establishment and business profits and other DTA relief.
[3] This may be a different bureau from the provincial tax bureau under the approval procedure.