China Explains Tax Position on the MLI

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Abe Zhao

Abe Zhao Baker Mckenzie Fenxun, China

Abe Zhao is International Tax Director at Baker Mckenzie Fenxun, China

China has signed a multilateral instrument (MLI) to implement treaty-related BEPS measures and submitted a position paper to indicate its views on the instrument. China's participation in the MLI will make its existing treaty network more consistent and precise for the purpose of preventing treaty abuse. Future analysis of Chinese tax treaties should take into account the impact of China's MLI position. This article summarizes China's stance on the main articles of the MLI and comments on the potential rationale behind it.

China signed the multilateral convention to implement income tax treaty related measures to prevent base erosion and profit shifting (“convention” or “MLI”) on June 7, 2017. China has the second largest treaty network in the world. The MLI serves to update the Chinese existing income tax treaties on a mass scale as China allows it to cover 102 income tax agreements that were previously entered into with foreign jurisdictions. The income tax arrangements that the PRC has with Hong Kong (China has also submitted a MLI position paper on behalf of Hong Kong, which is also a signatory of the convention), Macau, and Taiwan are outside the scope as they are viewed by China as territories. China has submitted a paper to OECD to outline its positions with respect to specific articles in the convention.

Opt in? Opt out?

China opts out of Article 3 of the convention on transparent entities entirely. This may reflect the fact that China has not finalized its domestic tax regulations on pass-through entities such as partnerships and wishes to mitigate potential inconsistencies between its domestic rules and treaty provisions.

In addition China does not adopt Articles 12–15 in the convention relating to permanent establishment (“PE”). China's domestic tax regulations contain extensive provisions on PE, and they are likely adequate to address PE related tax abuses in China without incorporating the convention language.

It is curious though why China did not take on the triangular provision in Article 10 of the convention, because no existing Chinese domestic rules address this kind of tax arrangement or potential gap. While China expresses a commitment to resolve cross-border tax disputes through consultations with competent tax authorities in other jurisdictions, it does not follow the mandatory arbitration articles in the convention, potentially out of sovereignty considerations.

Although China skipped out on some convention articles, it has elected for a number of them to apply that will help make the existing Chinese treaties more precise and consistent.

It adopts paragraph 1 of Article 4 in the convention (dual resident entities), and the preamble texts in paragraph 1 and paragraph 3 of Article 6 in the convention (purpose of a covered tax agreements) for all of its 102 income tax treaties.

For Article 7 in the convention (prevention of treaty abuse), China picks the “principal purpose test” language in paragraph 1 but passes over a simplified or a comprehensive Limitation on Benefits (“LOB”) test.

The existing Chinese beneficial ownership (“BO”) rules heavily embrace the “substance” concept (e.g. operating assets, business personnel, commercial activities, etc.) with anti-conduit elements embedded. Adopting LOB tests may cause difficulty in alignment with the “substance” orientation of the domestic BO rules.

For Article 8 in the convention (dividend transfer transactions), China takes in the recommended language that requires a one-year minimum holding period for a nonresident substantial shareholder to enjoy a preferential dividend withholding tax rate from the source country. Such a one-year minimum holding period requirement was already prescribed in China's domestic regulation eight years ago, i.e. Circular 2009-81. Therefore, this adoption should not bring additional impact on foreign shareholders with Chinese investments. For the purpose of Article 8, China also notifies its current income tax treaties that prescribe preferential dividend withholding tax rates for substantial nonresident shareholders. Surprisingly, the income tax treaty between China and the U.K., which lowers the statutory 10 percent Chinese dividend withholding tax rate to 5 percent for a 25 percent shareholder from the U.K., was not listed in the position paper.

For Article 9 in the convention (capital gains from alienation of shares and interests of land rich entities), China reserved on the language that would impose a one-year examination period for determining whether the target entity being transferred is land rich (e.g. deriving its principal value from Chinese real estate) or not. This is likely because in its domestic regulations, i.e. Circular 2010-75 and Circular 2012-59, China has stipulated a more stringent three-year examination period on the nonresident transferor in similar situations. Therefore including the convention language would create unnecessary conflict with the domestic rules. Nevertheless, China adopts the convention language from Article 9 to expand the definition of land rich entities so that they encompass not only companies but also partnerships and trusts with values mainly derived from Chinese immovable properties. This could be a significant change for foreign investors holding Chinese real estate through non-corporate forms of entities.

For Article 11 of the convention (the saving clause), China subscribes to the language in paragraph 1 which clarifies that China's income tax treaties do not affect the taxation of the Chinese residents except with respect to listed situations.

For Article 16 in the convention (mutual agreement procedure), China reserves on the first sentence of paragraph 1 but promises to meet the minimum standard for dispute resolution under the BEPS package. It accepts the languages raised by the convention to give a taxpayer three years to present its case to the competent tax authorities, mandate the competent tax authorities to resolve the case through consultation and mutual agreement, and make the implementation of any agreement reached without being subject to any time limit.


The convention and China's position paper in combination will render treaty analysis in China more complex than ever before. Taxpayers not only need to assess the impact of provisions from the existing treaties and protocols, but also must determine whether any of the treaty provisions could be affected by articles of the MLI that China either chooses to adopt or not to reserve on.

As China has the right to update its positions continuously, its subsequent submissions to the OECD depository need to be carefully monitored. In addition, unilateral positions from China may not actually change a particular income tax treaty. The notifications from China's treaty partner countries should also be tracked to assess whether China's positions will in fact become treaty provisions, taking into account the specific compatibility clauses in the convention. For provisions that China does not choose to take on board, we will expect to see these issues raised up and addressed during China's bilateral negotiations with other countries in the future.

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Abe Zhao is International Tax Director at Baker Mckenzie Fenxun, China.

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