In brief
On 28 March 2014, China and Germany entered into a new double taxation agreement (DTA) and protocol (together referred to as ‘the new DTA’). The new DTA results in an extensive revision of the currently applicable treaty signed in 1985 (1985 DTA). The key changes include extending the time threshold of construction permanent establishment (PE) from six months to 12 months, reducing the withholding tax rate on dividends to 5%, as well as revamping taxing rights on capital gains. The new DTA is also designed to prevent granting of benefits in treaty abuse cases. If diplomatic procedures are completed by both sides within 2014, the new DTA could apply to income derived on or after 1 January 2015 at earliest.
In detail
The distinctive features of the new DTA are highlighted below.
PE policy adjusted
- The time threshold for a building site, construction, assembly or installation project to constitute a PE is extended from six months to 12 months.
- The time threshold for constituting a service PE is changed from six months to 183 days within any 12- month period. This offers a clearer and convenient approach to count the days in the determination of a service PE.
- The application of the independent agent exemption is further refined according to the United Nations Model Double Taxation Convention. The revised clause states that an agent who is devoting its activities wholly or almost wholly on behalf of an enterprise would be considered to be a dependent agent of that enterprise if the arm’s- length relationship is absent between the agent and the enterprise.
Coverage of international transportation income elaborated
The new DTA clarifies that profit from the operation of ships or aircrafts in international traffic also includes rental on a bare-boat basis of ships or aircrafts and the use of containers if such use or rental is incidental to the operation of ships or aircrafts in international traffic. In that respect, such profit is taxable only in the country of residence. Please note that China’s State Administration of Taxation (SAT) has expressed its view in the interpretation of the China/Singapore DTA that for such income to be regarded as incidental, it should generally not exceed 10% of the total income of the enterprise.1
Withholding income tax (WHT) rates reduced
- The WHT rate for dividends is reduced from 10% to 5% if the beneficial owner of the dividends is a company which directly holds at least 25% of the capital of the company paying the dividends.
However, the restricted WHT rate for dividends paid out of income or gains derived directly or indirectly from immovable properties by an investment vehicle in certain circumstances2 is increased to 15%. Such change will not affect German residents who receive dividends from China as the 10% domestic rate would still apply.
- 10% WHT rate remains on interest. However, interests paid to certain Chinese state-owned commercial banks will no longer be exempted from German tax under the new DTA.
- The restricted WHT rate on royalties paid for the use of equipment is reduced from 7% to 6%.
Capital gains provision Revamped
The 1985 DTA applies source taxation for most capital gains. The new DTA offers more reliefs as compared with the 1985 DTA. For example, the 1985 DTA allows source taxation on gains arising from all share transfers, while under the new DTA, if a German resident transfers shares in relation to China, China can only tax such gains when one of the following circumstances is met:
- the gains are from the disposal of shares of a property-rich company3, or
- the recipient of gains has a participation, directly or indirectly, of at least 25% in the capital of that company at any time during the 12-month period preceding such alienation.
In addition, regular trade of listed shares of a non-property-rich company on a recognised stock exchange are exempted from such source taxation as long as the total shares transferred in one year does not exceed 3% of the quoted shares.
Anti-treaty abuse provisions Added
An anti-treaty abuse article is inserted in the new DTA to deny treaty benefits on arrangements or transactions entered into mainly for the purpose of obtaining such benefits. In addition, it allows China and Germany to apply their domestic laws to prevent treaty abuse. This article is in line with the suggestions included in the Organisation of Economic Co- operation and Development Discussion Draft on Base Erosion and Profit Shifting (BEPS) Action 6 – prevent treaty abuse.4The newly added article also allows taxpayers, who consider the application of the anti-avoidance provision has resulted in them not being taxed in accordance with the treaty, to resort to Mutual Agreement Procedure (MAP).
Tax sparing benefit no longer Available
The 1985 DTA has a tax sparing clause which allows German tax residents to get a ‘deemed China tax credit’ of 15% for interest and royalties regardless of what was actually paid. However, under the new DTA, only tax actually paid in China can be credited.
The takeaway
The new DTA between China and Germany revises some tax allocation principles which could affect taxpayers who have cross-border business between the two countries.
The restricted WHT rate in the new DTA for dividends is decreased from 10% to 5%, which is a long-awaited welcomed change aligning Germany with other European countries, e.g. France, UK, the Netherlands, Denmark, Switzerland, etc.5Technically, the 5% WHT rate would apply to dividends paid on or after 1 January of the next calendar year following the year in which the new DTA enters into force, even though the dividends are from the profits earned in previous years. If there are any disputes with the tax authorities in this regard, taxpayers may consider the relevant dispute resolution mechanism including MAP to secure their entitlement to the legitimate treaty benefit.
In addition, the new DTA incorporates quite a number of anti-treaty abuse elements, which reflects the determination of both countries to enhance cooperation and tackle aggressive tax planning for treaty benefits. It is recommended that relevant parties should assess their current structures and arrangements and remain vigilant with regards to meeting the eligibility requirements for treaty benefits. Meanwhile sufficient documents should be put in place to withstand any possible challenges in the future.
Footnote
1. Circular Guoshuifa [2010] No.75 issued by the SAT provides interpretations on the DTA concluded between China and Singapore. The Circular clarifies that the interpretations therein are also applicable to other DTAs China has concluded if the provisions of the relevant articles are the same as those in the China/Singapore DTA.
2. It refers to an investment vehicle which distributes most of the income or gains derived from such immovable properties annually and whose income or gains from such immovable properties is exempted from tax.
3. A property-rich company refers to a company deriving more than 50% of its value, directly or indirectly, from immovable properties situated in China.
4. For more information about BEPS, please refer to our News Flash [2013] Issue 17 available at http://www.pwccn.com/home/eng/t axlibrary_chinatax.html
5. The restricted WHT rate is 5% in the revised DTAs between China and these European countries.
Reprinted with the permission of PricewaterhouseCoopers Consultants (Shenzhen) Ltd.,a PRC incorporated entity. Copyright 2014 PricewaterhouseCoopers Consultants (Shenzhen) Ltd. All rights reserved. The information in this article, which was assembled on the date specified in the article and based on the laws enforceable and information available at that time, is of a general nature only and readers should obtain advice specific to their circumstances from their professional advisors.
