Application of Russian double taxation agreements with China and Hong Kong
The strengthening interstate partnership between Russia and China is steadily influencing the expansion of international cooperation between the businesses of the two countries. Against this background, both pre-existing and new problems related to the application of double taxation agreements with China (2014) and Hong Kong (2016) are emerging. Based on the results of the study of law enforcement practice, the authors' attention is focused on issues that are becoming relevant today for Russian and Chinese companies when doing business, creating joint ventures and using other forms of economic cooperation. Special emphasis is placed on the limitations of the actual possibility of applying, on the basis of the Agreement on the Avoidance of Double Taxation with the People's Republic of China, a reduced tax rate on dividends to 5% in the context of the forced reaction of Chinese banks opening special accounts for Russian investors to pay for authorized capital, to the unprecedented sanctions pressure of unfriendly countries on the Russian economy. Nevertheless, it is noted that, despite the difficulties that arise, the friendly Chinese jurisdiction supports the conditions for solving the main tasks facing Russian and international business.
Keywords: international taxation, tax law of the People's Republic of China, law of the People's Republic of China, avoidance of double taxation, income tax, the People's Republic of China.
Trade and economic relations between Russia and China continue to develop at a faster pace. Trade turnover is increasing, and the use of national currencies in settlements during trade operations is becoming more frequent. At the same time, as it is rightly noted in the literature, "anti-Russian sanctions largely determine the deepening of China's trade and economic ties with Russia in the light of the intensification of the process of its turn to the East" <1>.
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<1> Gordienko D.V. Trade and economic cooperation of China with the countries of the world and Russia in the 14th five-year plan (2021-2025) // Problems of the Far East. 2022. N 4. P. 72.
Against this background, the expansion of commercial cooperation between entrepreneurs of the two countries is naturally observed. The number of foreign economic contracts being concluded is growing, as well as the creation of foreign companies, joint ventures in Russia and China, to whose activities the provisions of bilateral agreements on the avoidance of double taxation may be applicable.
As you know, the Government of the Russian Federation and the Government of the People's Republic of China signed an Agreement dated October 13, 2014 on the Avoidance of double taxation and on the Prevention of tax Evasion with respect to income taxes (hereinafter referred to as the Agreement with the People's Republic of China), which replaced a similar Agreement with the People's Republic of China dated May 27, 1994 <2>. Along with this, the Agreement dated January 18, 2016 between the Government of the Russian Federation and the Government of the Hong Kong Special Administrative Region of the People's Republic of China on the Avoidance of Double Taxation and Prevention of Tax Evasion with respect to Income Taxes (hereinafter referred to as the Agreement with Hong Kong) is also in force, applicable to tax periods starting from January 1, 2017 <3>.
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<2> A consistent analysis of the changes that have occurred in this part is contained in the Explanations of the Main State Tax Administration of the People's Republic of China dated 08/01/2016.
<3> Letters of the Ministry of Finance of the Russian Federation dated 08/9/2016 N 03-08-06/46561, the Federal Tax Service of Russia dated 08/31/2016 N ZN-4-17/16168.
Note that only the Macao Special Administrative Region (Macao) The People's Republic of China and Taiwan (China) are included in the list of states and territories that provide preferential tax treatment and (or) do not provide for disclosure and provision of information during financial transactions (offshore zones). In turn, neither China nor Hong Kong (excluded from the list in 2017) are currently <4> among the offshore territories.
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<4> Order of the Ministry of Finance of the Russian Federation dated 06/05/2023 No. 86n "On approval of the List of States and territories providing preferential tax treatment and (or) not providing for disclosure and provision of information during financial transactions (offshore zones)".
Moreover, there is reason to argue that at the moment the national tax and legal regulation of mainland China as a whole cannot be characterized as providing ample opportunities for tax optimization and the formation of a profit center for foreign investors.
This is supported by relatively high rates of basic taxes (corporate income tax (from 0 to 25%), value added tax (from 0 to 13%), personal income tax (from 3 to 45%), social contributions (up to 35-40% of the payroll), tax and non-tax mandatory public payments), as well as the uncertainty of legal regulation <5>, the targeting of tax benefits, etc.
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<5> See more details: Trofimov A.A. Budgetary systems of Russia and China: issues of legal regulation. M., 2022. pp. 34-35, 173-174.
The renewal of the Double Taxation Agreement with China and the conclusion of an Agreement with Hong Kong were another step towards the development of bilateral relations and the creation of conditions for the activation of business processes, including the removal of excessive administrative barriers. One of the positive aspects was the cancellation of the apostille of documents on tax residence <6>, which was previously recognized as mandatory <7>. In general, the Chinese authors note <8> that the new Agreement with China has encouraged Chinese companies to invest in Russia.
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<6> Savitsky A.I. From the certificate of residence to the policy of international taxation // Law. 2015. N 6. pp. 166 - 180.
<7> Letter of the Ministry of Finance of the Russian Federation dated 13.10.2021 N 03-08-05/82799.
<8> Sun Peng. A study on tax planning and risk control of Russian business // Harbin Polytechnic University, 2018.
Against this background, disputes in law enforcement practice based on relevant agreements are isolated. They relate mainly to the claims of tax authorities to the registration of documents confirming the location of the organization to substantiate the actual right to income when applying paragraph 1 of Article 312 of the Tax Code of the Russian Federation. Thus, in one of the cases <9>, the court refused to recognize as proper confirmation of the residence of a foreign organization on the basis of a certificate of state registration (certificates of incorporation), extracts from trade registers and other similar documents issued, in particular, by the Registrar of Companies of Hong Kong (Companies Registry). At the same time, the court reasonably pointed out that the competent authority of Hong Kong in this regard, by virtue of an Agreement with Hong Kong, is the Office of Internal Revenue (Tax Treaty Section, Inland Revenue Department of Hong Kong).
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<9> The decision of the Arbitration Court of the Ural District dated 03/23/2023 in case No. A60-19423/2022: "The permanent location of a foreign organization is confirmed by a document issued by the competent authority of a foreign state with which Russia has concluded an international agreement on the avoidance of double taxation. The document will be considered a proper confirmation if three conditions are met at the same time (letters of the Ministry of Finance of the Russian Federation dated 06/03/2021 N 03-08-05/43271, Federal Tax Service of Russia dated 06/03/2021 N SD-4-3/7777@, dated 02/20/2021 N SHYU-4-13/2243 (clause 1.1)): it indicates the name of the taxpayer; it is signed by an authorized official of the competent authority of a foreign State; it reflects that the person is a resident or a person with a permanent place of residence in this jurisdiction."
A special place in the application of double taxation agreements can be given to problems caused by the peculiarities of the state structure of the People's Republic of China.
Although China is a unitary state, but from the point of view of international taxation, in the context of the proclamation of the concept of "one state - two systems", the Agreement with the People's Republic of China applies only to taxpayers of mainland China, which does not include Hong Kong (Hong Kong), Macao (Macao) and Taiwan.
A doctrinal justification for the permissibility of a plurality of tax systems in a particular unitary state has also been proposed in Russian science <10>. This made it possible to clarify basic issues about the Chinese tax system, as well as to establish the possibility of applying the double taxation agreement concluded with mainland China to taxpayers from other tax systems only if the agreement is directly extended to the relevant relations. Nevertheless, judicial practice continues to reveal examples of attempts by taxpayers to justify the possibility of applying the Agreement with the PRC to tax periods before the Agreement with Hong Kong enters into force <11> in relation to Hong Kong partners, as well as in relation to Taiwanese counterparties (in conditions where there is no tax agreement between Russia and Taiwan) <12>. In light of the fact that such attempts were unsuccessful, the applicant in one case tried another option <13> - to insist on the application of the Agreement with Hong Kong to the tax periods up to 2017, but it was equally unsuccessful. The Arbitration Court did not support the reference to paragraph 4 of art. 5 of the Tax Code of the Russian Federation on the retroactive effect of normative acts that improve the rights of a taxpayer, since, firstly, this norm is not applicable to international acts that have a special procedure for entry into force and application (its effective date and the date of commencement of application for Russia is from January 1, 2017), and, secondly, The agreement itself does not improve the situation of taxpayers (tax agents).
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<10> See: Shepenko R.A. Legal regulation of the tax system of the People's Republic of China: dis. ... Dr. yurid. M., 2005; The same. Chinese Tax Law: sources and subjects. M., 2004. pp. 14-35.
<11> The decision of the AC of the City of Moscow dated 09/27/2018 in the case N A40-62634/18: "According to Article 108 of the Constitution of the Hong Kong SAR of the People's Republic of China, which entered into force on July 1, 1997, Hong Kong pursues its own tax policy, including continuing to pursue the previous policy of low taxes, adopt its own laws regarding types of taxes, tax indicators, tax reductions and exemptions, as well as other tax issues... Consequently, Hong Kong, in accordance with the Constitution, implements its own tax policy, accepts its own taxes, and the tax laws of the People's Republic of China, including the Agreement with the People's Republic of China on the Avoidance of Double Taxation, do not apply to the territory of this region." See also the judicial acts in case N A60-26858/2022.
<12> The position on these territories has been repeatedly confirmed by letters from the Ministry of Finance of the Russian Federation. See: letters dated 06.06.2008, 08.10.2008 N 03-08-13, 12.08.2021 N 0308-05/64903; see also: Shepenko R.A. Legal regulation of tax relations complicated by a foreign element in Taiwan // Problems of the Far East. 2021. N 3. P. 120.
<13> The decision of the AC of the city of Moscow dated 09/27/2018 in the case N A40-62634/18.
When evaluating such court proceedings, it should be noted, in addition to their small number, that they are often not associated with any problems in interpreting agreements that would be unique to these agreements. In this regard, the courts express their legal position mainly on the issues of determining the actual right to income; ascertaining the presence or absence of signs of a permanent representative office of a foreign company in the territory of the Russian Federation (by establishing the presence of a construction site, etc.); the possibility of accounting for payments (interest under a loan agreement between a Russian-Chinese organization operating under a concession agreement) as part of non-operating income tax expenses; taxation of income of investors - residents of the People's Republic of China on state and corporate securities of Russian issuers; taxation of income of a Russian hosting provider organization under an agreement with the People's Republic of China, etc.
As for the actual application of double taxation agreements, it should be borne in mind that the current state of affairs, caused by sanctions restrictions on the Russian Federation, in some cases leads to additional obstacles for Russian investors in practice to apply the benefits provided for by the Agreement with the PRC.
Thus, Chinese regulation traditionally provides that when a Chinese company pays dividends to its parent foreign (including Russian) company, taxation in the PRC occurs by withholding tax by the Chinese company paying dividends. These dividends are taxable in China as part of the profits of enterprises at a total rate of 10%. At the same time, Article 10 of the Agreement with the People's Republic of China provides for the possibility of taxation of dividends using a special reduced rate of 5% if a number of conditions are met:
- the Russian (parent) company has the actual right to dividends;
- she owns at least 25% of the capital of a Chinese company paying dividends;
- the share of its participation in the capital of the latter is not less than 80,000 euros (or the equivalent amount in any other currency) <14>.
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<14> Note that unlike most similar tax agreements, Article 10 of the Agreement with Hong Kong does not contain a condition on the minimum amount of investment for applying a reduced rate. This means that preferential taxation does not depend on the size of investments, which may be in the amount of the minimum authorized capital.
At the same time, paragraph 2 of the Protocol dated October 13, 2014 to the Agreement with the People's Republic of China clarifies that the specified amount of 80,000 euros should be the gross volume of a one-time investment or a series of consecutive investments in the company or a one-time acquisition or a series of consecutive acquisitions of shares of the company.
At the same time, at present, the application of double taxation agreements should be carried out taking into account the Multilateral Convention on the Implementation of Measures Related to Tax Agreements in order to counteract the erosion of the tax base and the withdrawal of profits from taxation (hereinafter - the Convention). To date, both Russia and China have signed this Convention <15>, mutually extending its effect to the agreement on the avoidance of double taxation concluded by them <16>.
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<15> China ratified the Convention in May 2019 (at the same time, the date of entry into force of the Convention for China is indicated on 01.09.2022 on the OECD website). Russia ratified the Convention in 2019. To date, Russia has announced the completion of the internal procedures necessary to begin its application to a specific bilateral agreement, with respect to a fairly limited number of States. As for China, information on the completion of such procedures was published in February 2023.
<16> The combined text of the Convention and the Agreement with the PRC.
Compliance with the requirements of the Convention implies mandatory compliance with an additional condition for the application of benefits under the Agreement with the People's Republic of China regarding the period of ownership of an equity interest. We are talking about the permissibility of applying a preferential (reduced to 5%) dividend tax rate if the conditions of ownership of such a share were observed during a 365-day period, which includes the day of payment of dividends. For the purpose of calculating this period, changes in the ownership structure that will be directly related to the reorganization, for example, as a result of a merger or separation of a company that owns shares or pays dividends, are not taken into account.
Thus, in addition to the actual right to income, the size of the share and the volume of investments, the period of ownership of the parent Russian company's share in the capital of the Chinese enterprise will be important.
Despite the fact that the access of a Russian organization to preferential taxation of dividends is possible only if it complies with the parameters of its investment presence in the Chinese jurisdiction, it becomes fundamentally important to take into account the availability of real opportunities for this. This is becoming especially relevant in the situation of increasing large-scale economic sanctions against the Russian Federation. The practice that has developed in China over the past year and a half shows that when opening a special account to pay for the authorized capital (the so-called capital account, or (ziben (jin) zhanghu)), banks pay close attention to the final beneficiary of the company. In case of doubt that the final beneficiary is (or in some cases may even theoretically be) a person from the sanctions list, banks prefer not to take on possible risks, and therefore do not agree to open the mentioned special account. From the point of view of the corporate and civil legislation of the People's Republic of China, being included in such lists does not prevent the further establishment and functioning of a legal entity in China, although it may entail certain private legal consequences (subsidiary liability of the founder, corporate responsibility, etc.). At the same time, it makes it impossible for Russian companies to comply with the requirements for fulfilling the parameters of investment presence provided for by international agreements in the Chinese jurisdiction, which ensure its right to preferential taxation of dividends, since it becomes very difficult to open a special account, ensure payment of the authorized capital in cash <17> and carry out planned investments.
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<17> The Law of the People's Republic of China "On Companies" does not exclude the possibility of paying the authorized capital with non-monetary funds, however, such methods, as a rule, do not satisfy the interests of investment entities.
Nevertheless, despite the problems that Russian business has in some cases, it should be noted that, on the whole, it is quite successful in overcoming the consequences of sanctions pressure on the Russian economy, confidently developing cooperation with the Chinese jurisdiction. This is achieved both in the optimization of corporate structures and in the search for optimal mechanisms for trade interaction and banking services, in which the Chinese jurisdiction shows itself to be quite effective and to a certain extent friendly, maintaining the necessary conditions for the development of business processes between Russian and Chinese companies.