Indirect Transfer of Chinese Company Shares by Non-Resident Enterprise

Client

Our client is an enterprise operating in China, whose parent company is a US corporation.

Recently, another US company acquired a 50% equity stake in this US Parent. This transaction resulted in a change of control over the Domestic Company, constituting an “indirect transfer of Chinese taxable company shares.”

Challenge

With the increasing frequency of cross-border capital flows, indirect transfers of Chinese domestic assets by non-resident enterprises through offshore structures have become a key focus for the Chinese tax authorities. In 2015, the State Administration of Taxation issued “Enterprise Income Tax on Indirect Asset Transfers by Non-Resident Enterprises” (Bulletin 7), which clarifies the tax treatment principles for such transactions.

The core of Bulletin 7 lies in the “Look-Through Principle”: if an offshore transaction is deemed to “lack reasonable business purposes,” the tax authorities can disregard the offshore structure and levy enterprise income tax on the gains derived from the indirect transfer.

Assessing whether “reasonable business purposes” exist requires a comprehensive evaluation of the following five factors:

• Whether the value of the equity in the offshore enterprise is derived primarily, directly or indirectly, from Chinese company
• Whether the assets of the offshore enterprise consist primarily of direct investments or substantive business operations
• Whether the transaction consideration aligns with the value and risks of the domestic assets
• Whether there are arrangements for “conferring benefits” for tax purposes among the transaction parties
• Whether feasible alternative direct transfer solutions exist

The client needed to demonstrate that this indirect transfer possessed reasonable business purposes and should not be subject to look-through taxation, and to manage the filing and documentation process with the in-charge tax authority.

Solution

Upon engagement, our professional tax team immediately conducted a comprehensive diagnosis of the transaction structure and commercial substance. Our integrated approach, combining rigorous analysis with proactive compliance, focused on the five assessment factors for “reasonable business purposes” under Bulletin 7.

Substance of the US Parent: We analyzed the US Parent’s asset composition, revenue sources, employee headcount, office presence, and business activities. Our findings confirmed it was not a “shell company” but possessed assets, personnel, and business activities of a certain scale. Its value was not primarily derived from the Domestic Company in China.

Arm’s Length Transaction Consideration: We reviewed the transaction agreements, asset appraisal reports, and comparable transaction analyses. This confirmed that the transaction consideration was based on the overall fair market value of the US Parent and was not abnormally divergent.

Absence of Tax-Driven Benefit Arrangements: Analysis of the backgrounds of the transacting parties, their relationships, and fund flows revealed no arrangements primarily aimed at tax avoidance.

Lack of Feasible Direct Transfer Alternative: The transaction was a share deal between two US-based companies, demonstrating commercial rationality and was not designed to circumvent Chinese tax.

Comprehensive Conclusion: We determined that this indirect transfer possessed “reasonable business purposes” and should not be subject to look-through taxation.

To ensure the transaction passed tax review smoothly, we assisted the client in preparing a complete set of documents and engaged in multiple rounds of communication with the in-charge tax bureau.

• Step 1: Prepared an organizational chart, compiled financial statements, and asset appraisal reports.
• Step 2: Elaborated in detail on the transaction background, business purposes, relationships between parties, and tax rationale in the Explanatory Statement.
• Step 3: Submitted the “Enterprise Income Tax Withholding Return” along with the complete set of supporting documents to the in-charge tax authority within 30 days post-transaction.

Outcome

Through our professional tax analysis and effective communication, the tax authority accepted the “Explanatory Statement” and supporting documentation we submitted. They recognized that the indirect transfer had reasonable business purposes, and our client was not required to pay additional enterprise income tax in China.

Facing a cross-border share deal with a China operating entity? Request a consultation to discuss Bulletin 7 assessment, explanatory filings, and tax authority engagement.