China's Capital Gains Taxation of Nonresidents and the Legitimate Use of Tax Treaties

This article deals with the taxation in China of gains derived by a non-resident shareholder from transferring shares of a Chinese legal entity, where those shares neither derive their value from immovable property situated in China nor form part of the business property of a permanent establishment that the non-resident shareholder has in China. This issue is of great significance because of several recent developments. Firstly, the introduction of Chinese domestic rules has had a direct impact on the taxation of non-residents transferring shares of, or interests in, Chinese resident entities. Along with these legislative developments, administrative cases such as the Yangzhou case (2010) and the Qingdao case (2009) have been published which illustrate how these regulations are to be applied in practice. Secondly, the State Administration of Taxation (SAT) has endeavored to include in its most recent tax treaties a provision governing gains arising from a cross-border disposal of shares which deviates from Article 13(5) of the 2001 UN Model and incorporated changes to counter “the most blatant avoidance strategies”, e.g. Mauritius (2006), Singapore (2007), Hong Kong (2008), Belgium (2009), Macao (2009) and Barbados (2010). Thirdly, the Chinese tax authorities have tightened up strategies to prevent what they perceive as the abuse/misuse of tax treaties. There are a series of cases dealing with transfers of shares by non-residents, such as the Xinjiang case (2008), the Chongqing case (2008), the Xuzhou case (2010) and the Fujian case (2010), in which taxpayers were denied tax exemption in China in respect of capital gains from a disposal of shares, on the basis of the provisions analogous to Article 13(5) and Article 13(6) of the UN Model that were included in the relevant tax treaties