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By Matthew, April 16, 2010 10:45 am

One of the common questions that  I am asked here, and in fact in my role at Hwuason, is in relation to the tax treatment of H-Shares – shares in Chinese companies that are listed on the Hong Kong stock exchange. I briefly mentioned this issue once before in a post (that was inspired by a question I received) and now I will provide a slightly more fuller explanation of the tax treatment of such shares.

Dividends

According to Articles 3 and 6 of the Enterprise Income Tax Law, non-resident enterprises are required to pay tax in relation to the dividends from shares in a resident enterprise. The relevant tax rate on such income is 10%. Despite this, up until November 2008, the general practice was that dividends from H-shares were exempt from tax. In November 2008, the State Administration for Taxation issued Guoshuifa [2008] No. 897 which indicated that tax was payable on such dividends and that the resident Chinese enterprise was a withholding agent for its non-resident shareholders.

Capital Gains

It has not been clearly stated whether non-resident enterprise are taxable on capital gains from H-shares. The current practice, based on previous regulations, is that the income from the transfer of H-shares is exempt from tax. However, there is some genuine concern that such a practice will be changed in the near future. Given that dividends are now taxed, I think it would be doubtful that an exemption for capital gains will be continued in the future.

In terms of removing the risk of changes to the tax treatment off capital gains,  it may be advisable  for investors to take advantage of favourable DTAs that prevent China from taxing holdings below 25%. The merits of such an option would be subject to the particular circumstances, and the powers that China’s tax officials have in accordance with the General Anti-Avoidance Rule always needs to be kept in mind.

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By Matthew, February 2, 2010 4:45 pm

What if a stock market analyst bases their advice/predictions on faulty assumption/s. Does this mean that their advice is wrong?

Robert Hsu, who touts himself as a bit of an expert on Chinese stocks, has, in an article on Market Watch entitled “What China Bubble?, articulated the view that China is not presently experiencing a bubble. Hsu’s self-proclaimed expertise in Chinese stocks stems from:

more than 15 years of investing in China, not to mention spending months at a time there and speaking the language

Yep he certainly has a comparative advantage as there isnt many people out there who can speak the Chinese language or have spent a few months here. Hsu then provides three reasons why continuing to invest in China is a wise choice for investors. One of his reasons is as follows:

Wealth creation: China is very friendly to investors and other owners of capital — despite calling themselves “socialists.” Leaders in Beijing understand that investors take risk when they put their money to work in the stock and real estate markets. That’s why China has friendly taxation policies — no capital gains tax, estate tax or property tax — in an effort to reward its owners of capital.

I have quite a few problems with this statement. On a general level the suggestion that China has friendly taxation policies is a bit of a stretch. On a more specific level, the suggestion that China does not tax capital gains or have a property tax is just plain wrong.

Capital Gains Tax

The old “China has no capital gains tax” raises its ugly head again. How has this myth been perpetuated? The drafters of Circular 698 would be a little suprised by the supposed lack of a tax on capital gains. My theory is that the reason why some people believe that China has no capital gains tax is that there is no separate tax law or regime entitled “capital gains” in China. Rather, the profit realised on the sale of an asset falls within the definition of “income” in the relevant laws. I have come across this problem before so perhaps it is time I detailed the applicable provisions. The applicable tax law in China depends upon the character of the relevant taxpayer; corporate or individual.

Corporate Taxpayers

Corporate taxpayers are subject to the Enterprise Income Tax Law (“EITL”). Article 6 of the EITL provides that “[a]n enterprise’s monetary and non-monetary incomes from various sources shall be the total amount of incomes, including:

1. income from the sale of goods;
2. income from the provision of labor services;
3. income from the transaction of property;
4. dividend, bonus and other equity investment proceeds;
5. income from interests;
6. income from rentals;
7. income from royalties;
8. income from accepted donations; and
9. other incomes.

So, included in the definition of income for the purpose of the EITL is proceeds from transactions in property (i.e. capital gains). “Property” includes real property, personal property and intangible assets. Robert, have you got this?

Individual Taxpayers

Article 2(9) of the Individual Income Tax Law provides that the income of individuals includes income from “the transfer of property”. Although individuals are generally provided with an exemption for the sale of listed shares. Restricted shares (as of December) and shares held by foreign persons in foreign invested enterprises are excluded from this exception.

Hsu could possibly contend that since he is talking about stock performance his point still remains valid. However, his point was more borader than that. He was talking about China’s economic performance rather than the potential returns from individual investments.

Property Taxes

Now this is where Hsu’s comments enter into the world of the bizarre. I am not certain what he means by property tax. I am not certain whether Hsu is talking about property in general or means “real property”. I am going to assume the latter. I am also not certain what type of property related tax he is saying China does not have. Given that he used this term in the same sentence as “capital gains tax”, I assume he is not talking about a tax on the difference between the purchase price and the sale price of the property when realised (we have already established that China does impose tax on such capital gains).  Accordingly, if China’s only tax related to real property is the aforementioned tax on capital gains, perhaps Hsu is right.

Unfortunately, Hsu is wrong. The following property related taxes exist in China:

1. Stamp Duty – stamp duty is payable upon documents transferring title to property (including land use rights) whether by purchase,  sale, inheritance. The stamp duty is 0.05% of the stated value of the transaction.
2. Deed Tax – this is a tax imposed on the total value of “land use rights” or “building ownership rights” when transferred.
3. Land Value Added Tax – a tax of between 30 to 60% of the sale land and buildings on land.

Now, perhaps Hsu was not referring to a transactional property tax but rather an annual tax on property holdings akin to the NSW “land tax”. Unfortunately, even if Hsu was limited to the meaning of property to such a tax, he would still be wrong. China also has the following taxes:

1. Urban and Township Land Use Tax – an annual tax on enterprises and individuals utilising land within cities, townships and mining areas. The tax varies from RMB 0.6 to 1.5 per square meter depending upon the location.
2. Urban Real Estate Tax – an annual tax on the owners of real property.

Now, not all these taxes will apply in every given circumstance and there are exemptions, but I think its fair to say that the assertion that China has no property taxes is clearly erroneous and ignorant. Some quick research via google would have confirmed whether the information was true or not.

Robert, are you still feeling confident about your investments in Chinese stocks?

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By Matthew, January 29, 2010 3:48 pm

I received the following question via email this week:

Can you recommend where you would suggest I go to get more detail about capital gains tax in China and if it would be applicable to my hedge funds that trade in Chinese “H” share equities?

My answer was as follows:

China does not have a separate capital gains tax but rather imposes tax on capital gains within its ordinary enterprise income tax and individual income tax regimes. The question of which particular regime would apply would depend upon the indentity of the shareholder i.e. is it is a corporate or individual investor.

The best place to start looking would be the terms of the laws themselves. In terms of corporate investors, Articles 3 and 6 of the Enterprise Income Tax Law and Article 7 of the Implementing Regulations are relevant. Importantly, the question depends on whether H-Shares have a Chinese source for the purpose of Article 3 of the EITL. Article 7 of the Implementing Regulations suggests an answer but unfortunately that suggestion is not overly clear. However, I think the better argument is that the transfer of H-Shares by non-resident corporate investors could be taxable under the EITL. Whether the SAT intends to adopt such a course is a different argument.