Meaning
Tax regulation in China governs the indirect transfer of assets by non-resident enterprises. Under bulletin 7, the State Administration of Taxation claims the authority to tax offshore transactions that lack reasonable commercial purpose. The rule applies when an offshore entity sells shares in another offshore entity that holds Chinese taxable assets.
It targets capital gains that would otherwise escape local jurisdiction by treating the sale as a direct transfer of the underlying Chinese equity. This jurisdiction extends to real estate and the assets of a permanent establishment.
Reporting Requirement
Parties involved in the transaction must assess whether the deal meets the safe harbor criteria. If a bulletin 7 assessment indicates a taxable event, the seller or the buyer should voluntarily report the transaction to the Chinese tax authorities. Delay leads to interest penalties.
Commercial Purpose
Factors considered under bulletin 7 include the duration of the holding, the number of employees in the offshore entity, the tax residence of the directors and the economic substance of the intermediary. A structure with no business activity is highly vulnerable to reassessment.
Buyer Liability
Purchasers often hold the obligation to withhold tax from the sale proceeds. When bulletin 7 applies, a buyer who fails to withhold tax faces potential liability for the unpaid amount. This risk drives the inclusion of specific indemnity clauses in share purchase agreements.
