According to "Announcement of the State Taxation Administration on Several Issues Relating to Enterprise Income Tax on Gains from Indirect Transfer of Assets by Non-resident Enterprises", if a non-resident enterprise indirectly transfers equity and other assets of a Chinese resident enterprise through arrangements that do not have reasonable business purposes to evade its enterprise income tax obligations, the tax authorities have the right to re-characterise the indirect transfer transaction and treat it as direct transfer of equity and other assets of Chinese resident enterprise.

1. Definition of Equity and Other Assets of Chinese Resident Enterprises
   
   Equity and other assets of Chinese resident enterprises refer to assets of a Chinese establishment or place of business, immovable property in China and equity investment in PRC resident enterprises, etc, in respect of which gains from its transfer by a direct holder, being a non-resident enterprise, would be subject to CIT in accordance with PRC laws and regulations
   
   
2. Definition of Indirect Transfer of Taxable Property in China
   
   Indirect transfer of taxable property in China refers to the transaction where a non-resident enterprise, through the transfer of equity and other similar rights and interests in a foreign enterprise that directly or indirectly holds taxable property in China, generates the same or similar substantive results as the direct transfer of taxable property in China, including the situation where the shareholders of a foreign enterprise change due to the reorganization of a non-resident enterprise.
   
   
3. Factors to be Considered in Determining Reasonable Business Purpose
   
   To determine a reasonable business purpose, all arrangements related to the indirect transfer of taxable property transactions in China should be considered as a whole, and the following relevant factors should be comprehensively analysed in combination with the actual situation:
   
   

   (1)	Whether the main value of the equity of overseas enterprises is directly or indirectly derived from taxable assets in China;
   (2)	Whether the assets of overseas enterprises are mainly composed of direct or indirect investments within the territory of China, or whether the income they obtain mainly comes directly or indirectly from within China;
   (3)	Whether the actual functions performed and risks borne by overseas enterprises and their subsidiaries directly or indirectly holding taxable assets in China can prove that the enterprise structure has economic substance;
   (4)	The duration of existence of overseas enterprise shareholders, business models and related organizational structures;
   (5)	The situation of income tax payable on the indirect transfer of Chinese taxable property transactions abroad;
   (6)	The substitutability of indirect investment and indirect transfer of taxable property in China by the equity transferor compared with direct investment and direct transfer of taxable property in China;
   (7)	The applicable tax treaties or arrangements in China for income from the indirect transfer of taxable property in China;
   (8)	Other relevant factors.

   
   

Kaizen’s Kind Reminder

In the actual tax collection and administration process, tax authorities often follow the principle of "substance over form" to conduct a comprehensive analysis and judgment on the overall arrangement and all elements of the transaction.

Generally speaking, taxation will be comprehensively considered through the following aspects:

(1)	Determine whether the main subject matter of the indirect transfer transaction is taxable property in China by the source of the equity value of the transferred overseas enterprise and the composition of the assets and income of the overseas enterprise.
(2)	Through functional risk analysis, determine the economic substance of the transferred overseas enterprise and its other overseas middle-level subsidiaries. Usually, starting from the equity setting of the relevant enterprises as well as their business conditions and financial information such as personnel, property and income, the correlation between the equity of the transferred enterprise and the actual functions performed and risks borne by the relevant enterprises, as well as its substantive economic significance in the enterprise group structure, is analyzed.
(3)	Consider the planning traces of indirect transfer transactions and related arrangements through time intervals.
(4)	Determine whether there are cross-border tax benefits based on the tax payable abroad. The situation of income tax payable abroad includes the tax payable by the equity transferor in its home country and the tax payable in the location of the transferee. The tax payable situation should not only take into account the actual taxes paid for indirect transfer transactions abroad, but also consider the application of overseas tax laws that affect the tax base of overseas income tax, such as overseas profit and loss offsetting and loss carry-forward. If the overall income tax payable in the resident country of the equity transferor and the location of the transferee is lower than the amount of tax payable in China for the indirect transfer transaction, it can be proved that there is a cross-border tax benefit in the indirect transfer of taxable property in China.
(5)	Determine whether there is reasonable commercial substance in indirect transactions through the analysis of substitutability between direct investment and direct transfer of taxable property in China and indirect investment and indirect transfer of taxable property in China. Substitutability analysis will take into account a variety of commercial and non-commercial factors such as market access, transaction review, transaction compliance and transaction objectives, and will not be determined based on a single factor (such as market access restrictions).

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