Stock Connect, QFII / RQFII and Taxation

Stock Connect, QFII / RQFII and Taxation

The Shanghai-HK Stock Connect ("Stock Connect") is a pilot programme that allows foreign individuals and institutions (without QFII/RQFII licenses) to invest into China A Shares on the Shanghai Stock Exchange (referred to as Northbound trading). In addition, there is a reciprocal arrangement “Southbound trading” whereby certain PRC individuals and institutions can trade on the Hong Kong Stock Exchange.

Before the programme's official launch, the Ministry of Finance and the State Administration of Taxation jointly released Caishui [2014] No.81 ("Notice 81") on the China taxation rules in relation to Stock Connect. Under Notice 81, gains derived by foreign investors on the trading of A shares through the Stock Connect, will be temporarily exempt from PRC corporate income tax, business tax, and individual income tax. In addition, the notice confirmed that dividends will be subject to 10% withholding tax and that it is the company distributing the dividend has the withholding obligation. If the recipient of the dividend is entitled to a lower treaty rate, they can apply to the in-charge tax bureau of the payor for a refund. The Notice came in to effect on 17 November 2014.

QFII / RQFII

Along with the launch of the landmark Stock Connect, the Ministry of Finance and the State Administration of Taxation also jointly released Caishui [2014] No.79 ("Notice 79") to address the long outstanding tax issues in relation to QFII's and RQFII's. Under Notice 79, QFIIs and RQFIIs (without an establishment or place of business in the PRC; or having an establishment in the PRC but where income derived in China is not effectively connected with such establishment) will also be temporarily exempt from corporate income tax on gains derived from the trading of shares effective from 17 November 2014.

However, it is clearly stipulated in Notice 79 that QFIIs and RQFIIs will be subject to corporate income tax on gains realised before 17 November 2014. Although Notice 79 confirms that QFIIs and RQFIIs will be subject to tax on pre-17 November capital gains derived from the transfer of equity investment, it still leaves uncertainties on a number of key issues, including tax treaty applications and administrative procedures with regard to tax reporting and filing obligations. On 26 February 2015, in a training session organised by AMAC and attended by more than 200 QFIIs/RQFIIs and custodian banks a tax official from the Beijing Municipal State Tax Bureau verbally addressed some of key issues arising since the issuance of Circular 79. Importantly it was confirmed at the meeting that the tax filing deadline for A share capital gains tax reporting (where the QFII/RQFII custodian bank is located in Beijing) is 31 July 2015.

Reporting scope and tax calculation basis

Based on the messages conveyed during the training session, the reporting scope in Beijing includes all types of investment income derived by QFIIs / RQFIIs. Such investment income includes PRC sourced dividends, interest and capital gains realised from the disposal of PRC equity investments (e.g., A-shares, securities funds whose assets consist wholly or partly of A shares, warrants and CSI 300 index). Capital gains realised from the transfer of bonds and pure bond funds are outside the taxation scope. The Beijing tax official who spoke at the meeting also mentioned that QFIIs / RQFIIs would only be subject to PRC withholding income tax in respect of equity investment income realised between 17 November 2009 to 16 November 2014 (i.e. a 5 year look back period). It was also confirmed that withholding income tax on capital gains realised from the disposal of equity investments should be calculated on a transaction-by-transaction basis. Losses arising from a transaction cannot be offset against gains from another transaction. As regards to cost base, both weighted average and first-in-first-out are acceptable as long as the same method is consistently applied. Transaction costs are not deductible in computing the withholding income tax payable. As part of the tax filing package, QFIIs / RQFIIs are required to prepare numerous documents including amongst others, transaction-by-transaction breakdowns of income received (amount involved, name of the shares, cost base involved), tax payment status etc.

Proof for tax withheld on dividend and interest

The burden of proof that the relevant withholding income tax on dividends and interests has been settled rests with QFIIs / RQFIIs. They are required to submit the proof of withholding income tax paid, which may take the following forms: a tax payment certificate ("TPC") with the QFII / RQFII's name issued by the PRC tax authorities; TPC with name of withholding agent (e.g. the listed company) together with a list of QFIIs / RQFIIs' names and corresponding tax paid issued by the PRC tax authorities; or a TPC with the name of the withholding agent (e.g. the listed company) together with certification of the QFII / RQFII's name and corresponding tax paid.

Late payment surcharges may be imposed if withholding income tax on dividends and interest have not been properly withheld and paid at the source. However, no late payment surcharge will apply to withholding income tax on capital gains if QFIIs/RQFIIs file their tax returns on time.

Tax treaty application

The Beijing tax bureaus will accept and review tax treaty applications for the 5 year look-back period if a QFII / RQFII is eligible for treaty relief under an applicable tax treaty. It has also been verbally confirmed that Beijing tax bureaus will treat the fund as the treaty applicant in a "QFII / RQFII + fund" structure. The treaty applicant should follow the requirements of Circular 124 for tax treaty application. In particular, the treaty applicant is required to submit the tax resident certificate and identify immovable properties-rich companies (as applicable).

Given the above administrative procedures in Beijing are based on verbal comments and there is no written material/circular from the Beijing tax officials, there could be variations in practice when QFIIs / RQFIIs perform tax reporting. In addition, Shanghai and Shenzhen tax officials have yet to share their views in such a public setting. While one may believe that when dealing with such high profile tax issues, all the officials should try to apply consistent treatment, the possibility of deviation cannot be ruled out. For example, on April 1 the 3rd branch of the Shanghai tax bureau issued “Tax Notice 2015 No.1” which confirmed that the filing deadline for A-share capital gains tax is 30 September 2015. QFIIs / RQFIIs should closely monitor the development and formulate the action plan accordingly.

Marie Coady, Tax Partner, and Jeremy Ngai, Partner, PWC

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