Key trends in cross border taxation

In the past couple of years, there have been dramatic developments in cross border taxation from PRC tax perspectives. Changes in both legislation and tax administration are deeply affecting relevant transaction plannings and historical compliance. We aim to focus on a few of the key issues for cross-border M&A and investments.

Reinvestment tax credit

To promote long term cross investment, PRC government launched a tax incentive for reinvestment in June 2025. The tax incentive (“Circular 2”) is jointed issued by Ministry of Finance (“MOF”), State Administration of Taxation (“SAT”) and Ministry of Commerce (“MOFCOM”). Its core value is to provide tax credit for reinvestment of dividend income by foreign investors into China. Basically, qualified reinvestment will bring a 10% (or relevant treaty tax rate) tax credit for future withholding tax (“WHT”) liability incurred by the concerning investor against revenue/payment from the same invested company. This rule could be considered as a surplus to the previous tax incentive (originated from Circular [Caishui] 2017 No.88 and supplementary circulars) which provides only tax deferral treatment for reinvestment.

For example, if a US based Company A generates 3 million USD dividend from its PRC subsidiary Company B. The following PRC tax treatments will be applicable in different scenarios:

Scenarios PRC tax treatment Regulatory reference
Direct dividend repatriation ⬤ 10% PRC WHT due before dividend repatriation ⬤ PRC CIT law and supplementary rules
Reinvest in general industries ⬤ 10% PRC WHT but the tax liability will be deferred until reinvestment is transferred/redeemed etc. ⬤ Circular [Caishui] 2017 No.88 and supplementary rules
Reinvest in encouraged industries ⬤ 10% PRC WHT deferred as above, and

⬤ Tax credit at 10% of dividend income (equivalent to PRC WHT deferred)

 ⬤ Circular 2 and supplementary rules

Comparatively speaking, Circular 2 offers the best tax position to overseas investors especially when those investors do not have to pay tax for the dividend earned from overseas investment at their home jurisdiction e.g. Hong Kong, Singapore etc.

As for how Circular 2 is applied, let us give another example:

  • Suppose a foreign Company C receives RMB 10 million in dividends from a domestic Company D;
  • When Company D distributes the RMB 10 million to Company C, a PRCWHTof RMB 1 million must be withheld and remitted;
  • If Company C chooses to reinvest the RMB 10 million into a domestic Company E (engaged in encouraged industries), and the relevant conditions are satisfied, the RMB 1 million WHT can be temporarily deferred;
  • After Company C completes its investment in Company E, a tax credit will be available in respect of future payments from Company D. The amount of such credit equals to the PRC withholding tax temporarily deferred, i.e., RMB 1 million；
  • Subsequently, when Company D pays RMB 7 million in royalties to Company C, which would normally trigger RMB 0.7 million in PRC WHT, the prior RMB 1 million tax credit can be used to offset such WHT. In other words, Company D can pay the RMB 7 million royalty to Company C without WHT. After this offset, Company C still has RMB 0.3 million in unused credit;
  • At a certain point after Company C has held its investment in Company E for five years, if Company C elects to exit by transferring its equity interest, the previously deferred WHT obligation of RMB 1 million on the dividends from Company D will be resumed. After offsetting the remaining RMB 0.3 million tax credit, Company C will be required to make a supplementary payment of RMB 0.7 million in WHT on such dividends.

However, it is not easy to get qualified for the tax incentive under Circular 2. A primary requirement is that the reinvestment shall last at least for 5 years (60 months). It is therefore not an ideal choice for some of the PE/VC funds who have investment in China as they normally have limited investment period.  Also, the tax credit is only applicable for the payment from the same PRC company. In the example above, the RMB 1 million tax credit can only be used to offset the tax payable arising from Company D’s payment obligations to Company C, and cannot be used to offset taxes arising from payments from Company E or any other Chinese domestic companies. Of course, at the very least, such credit can be applied to offset the WHT on initial dividends when Company C recovers the aforementioned reinvestment in the future.

Finally, since this policy has only recently been introduced and involves coordination between the State Administration of Taxation (which may include different local tax bureaus) and the Ministry of Commerce (as the authority for reinvestment filing); and given the long investment cycle with multiple time lines where tax liability, tax credit, or supplementary tax payment may be triggered; the regulatory stance of the tax authorities—particularly the risk of retrospective adjustments—requires special attention.

Retroactive review on treaty benefit application

Another key tax administrative change is treaty benefit review of dividend repatriation which also has some connection with the above-mentioned reinvestment policy. Let us first look at the treaty benefits policy applicable to outbound dividends: as previously discussed, under PRC law, outbound dividends are subject to a 10% WHT. However, under tax treaties with certain countries and regions, qualifying dividends may enjoy reduced WHT rates, e.g., from 10% to 5% under the PRC–Hong Kong treaty.

The eligibility request  generally involves two elements: first, compliance with the basic requirements of the bilateral tax treaty; second, passing the beneficial ownership test:

  • Under bilateral tax treaties, a foreign investor is generally required to hold at least 25% of the equity interest for a minimum of 12 consecutive months; these requirements are relatively easy to satisfy and involve little uncertainty.
  • The beneficial ownership test, however, is much more complex, and many foreign investors fail to obtain treaty benefits because they cannot pass it. The test is primarily guided by SAT Public Notice [2018] No. 9 on the determination of ‘beneficial ownership.’ According to this regulation, if the recipient of dividends, interest, or royalties from China lacks substantive business operations, is required to pass on the income within a short time, or is located in a jurisdiction where no or low taxes are levied, its entitlement to treaty benefits will be negatively affected. In other words, if most or all of these factors are met, the foreign recipient will likely be denied treaty benefits. In practice, PRC tax authorities often require the foreign recipient to prove that it functions as a group headquarters or performs equivalent functions to indirectly demonstrate that it is not a conduit company. To meet this requirement, foreign companies often need to relocate a significant number of executives or managers to the jurisdiction of the claiming entity and hold board meetings locally. The cost of establishing such substance is often three to five times higher than in an ordinary share transfer scenario, or even more. Nevertheless, once these costs are incurred and supporting documentation is prepared, the foreign investor’s application for treaty benefits is often approved by the PRC tax authorities.

In recent cases, however, we have observed that PRC tax authorities have adjusted their position. They now conduct more substantive reviews and challenges as to whether a foreign company qualifies as the group’s overseas headquarters. Many overseas companies (i.e., the first-tier holding companies directly investing into China) are not in fact the ultimate controlling entities of the group (such as Cayman entities or similar structures). Typically, the group’s top executives are not employed by these overseas companies. When questioned by the tax authorities, such overseas companies may be able to demonstrate some level of substance in terms of headcount, but they are unable to prove that these personnel are independent of the control of the parent group or the listed company. In such circumstances, the tax authorities tend to retroactively deny the relevant foreign company’s treaty benefits and require it to make tax payments at the full amount e.g. 10%. This is especially true for the primary listed companies, where CEOs, CFOs, and board members, for various reasons, are usually not staying at the first-tier foreign company (e.g., a Hong Kong entity), which has become one of the main points of challenge by the tax authorities.

The stricter review of treaty benefits for dividend WHT is related to the implementation of the reinvestment tax exemption policy. From an economic development perspective, the government intends to encourage investors to reinvest dividends within China rather than distributing them abroad. In this sense, the review of dividend WHT treaty benefits will inevitably remain under a regime of heightened and continuous scrutiny. Two recommendations could be considered:

  • For listed companies with Cayman or similar structures, strategically position the first-tier foreign company (i.e. the one that directly invests into China) as the group headquarters and make it the primary operating entity, while relocating group executives there to strengthen substance and decision-making power;
  • Non-listed overseas companies (e.g., European headquarters), consider leveraging the ‘safe harbor’ mechanism under SAT Public Notice [2018] No. 9 by supplementing substances through the parent or upper-tier companies, thereby optimizing treaty benefit applications and reducing the likelihood of challenges by the tax authorities.

Indirect share transfer

An indirect share transfer refers to the situation in which a non-resident enterprise transfers equity or similar interests in a foreign company, thereby indirectly transferring the equity of a PRC company. The current regulatory framework is primarily established under SAT Public Notice [2015] No. 7, with supplementary provisions on matters such as the timing of tax obligations and applicable exchange rates under SAT Public Notice [2017] No. 37.

According to the provisions of Circular 7, if the arrangements of an indirect equity transfer transaction lack a reasonable commercial purpose and have the main purpose of avoiding PRC income tax obligations, the transaction shall be recharacterized as a direct transfer of PRC taxable property, and the relevant tax shall be paid in China pursuant to Article 3 of the PRC CIT Law. Such taxation arrangement is of anti-avoidance nature and could be considered as an extension of the existing tax jurisdiction of China as normally tax authorities only charge tax on the direct transfer of PRC based entities.  As for the determination of reasonable commercial purpose, Circular 7 also provides a relatively comprehensive assessment framework (Articles 3 to 6), and each transaction must be evaluated based on its specific circumstances.

The income derived from an indirect transfer transaction that is recharacterized as a direct transfer is generally subject to PRC enterprise income tax at a rate of 10%. The tax calculation logic is essentially the same as that for a direct transfer of equity in a PRC company. The factors that ultimately affect the transferor’s potential tax burden are the transfer income attributable to PRC taxable property and the deductible investment cost.

At the early stage of Circular 7 implementation (2021 and earlier), the tax administration for indirect transfer transactions mainly relied on voluntary reporting by taxpayers (the transferors). It was uncommon for local tax authorities to proactively identify unreported transactions and pursue tax collection. Many non-resident enterprises also did not voluntarily report to the PRC tax authorities. On the one hand, this was because Article 9 of Circular 7 stipulates that the parties to the transaction and the PRC enterprise whose equity is indirectly transferred “may” rather than “must” report the transaction to the tax authorities. Some parties assessed that the main purpose of the transaction was not the transfer/acquisition of PRC taxable property and thus decided not to report. On the other hand, both the legislation and local administrative practices did not set out clear penalties (such as late payment interest) for delayed reporting. At least at the current stage, the risk of uncontrollable negative consequences for failing to voluntarily report is relatively low, resulting in some taxpayers  opting for postponing or deferring the reporting.

In the meantime, there was a lack of uniformity in local administrative practices. Many detailed issues relating to tax payment had to be specifically confirmed with the competent tax authorities, including but not limited to the exchange rate used for filing, the documentation requirements for tax filings, and the source of funds for tax payments.

After the initial exploration period and under the influence of the complex economic conditions, the tax administration of indirect transfers has shown some new characteristics:

  • Tax authorities have become more proactive in identifying indirect transfer cases, especially through third-party information sources such as big data screening, listed company disclosures, and changes to the industrial and commercial registration of underlying entities. We have observed actual cases where potential unreported indirect transfers were detected through minor clues such as changes in the legal representative of the underlying PRC company or changes in the overseas parent company’s registered name. Indirect transfers have also begun to fall within the scope of systematic tax audits.
  • Tax authorities have tightened control over the calculation of tax liabilities. As noted earlier, the main factors affecting the final tax amount are transfer income and deductible amounts. Among these, determining the transfer income attributable to PRC taxable property is the most critical issue. In the early stage, tax authorities rarely questioned the fairness of transfer income, partly because many early transactions involved premium exits by large investment funds, and partly because Circular 7 did not include explicit provisions on income assessment. However, in recent practice, an increasing number of local tax authorities have begun to refer to the experience from direct transfers and they are focusing on reviewing the fairness of transfer income in indirect transfer cases.
  • Local tax authorities are becoming increasingly clear about the content and format of filing materials, as well as the requirements for tax reporting and tax payment methods. This not only reflects that tax authorities have accumulated more systematized experience in administration but also indicates that some of the ad hoc practices previously adopted in filings will be gradually phased out.

In our view, under the current circumstances, overseas investors should:

  • Move away from the previous wait-and-see approach, carefully assess the tax risks of indirect equity transfers, prepare documentation, and select a more favorable filing strategy. For example, under the current tax administration environment, overseas nominal price buybacks or similar commercial arrangements may face increased tax exposure. Accordingly, transferors may seek advice from professional advisors prior to filing and prepare a response plan by organizing transaction documents and tax procedures in advance.
  • Take a holistic approach in selecting investment structures and methods considering the risks of indirect transfers. Different participants in the same indirect transfer transaction may have differing compliance positions, and an investor’s control over tax risk can even influence its choice of transaction structure. For example, if Investor A transfers existing shares to new Investor B, compared with a structure where the company repurchases shares from Investor A and then issues new shares to Investor B, the resulting equity structure may be identical, but the tax implications for the parties involved—particularly for Investor B and the company—differ significantly.
  • Reassess the available tax policies prior to exit to reduce the potential future tax burden; where necessary, consider restructuring to preserve the possibility of enjoying tax treaty benefits. It should be noted that the review process for claiming treaty benefits in indirect transfer transactions is in practice more stringent than in direct transfer cases, which imposes higher requirements on the transferor’s documentation preparation and related work.
  • For historical transactions that have not been filed with Circular 7 tax filing, investors shall consider taking an active approach to report tax so that they may have more time/be in a better position to agree on a favorable tax payable amount. Even if the investors choose to not file tax returns, they shall prepare more documentation, especially valuation report for the underling Cayman company.

Taxation on QFLP

Qualified Foreign Investment Partnership (QFLP) has become a common investment model into China in recent years. Under this model, overseas investors establish a limited partnership in China together with domestic institutions (or possibly other overseas institutions), and the limited partnership makes investments into PRC target companies or private equity funds. QFLP or similar structures making domestic investments can be found in cities such as Shanghai, Chongqing, Tianjin, Wuxi, and Xiamen.

Up to now (September 2025), Chinese tax authorities have not issued formal, targeted tax regulations for QFLPs. In theory, there are two possible approaches:

  • The first approach is to treat the limited partnership as an untransparent structure. Tax authorities may consider that a limited partnership registered and established in China constitutes a “place of management” for the overseas investors, thereby creating a permanent establishment. In this scenario, overseas investors are required to pay 25% PRC enterprise income tax on income derived from the domestic limited partnership.
  • The second approach is to treat the limited partnership as a transparent or pass-through entity. In this case, the income derived by overseas investors from China can still be taxed according to its nature (e.g., dividends, capital gains) at 10% PRC enterprise income tax or enjoy lower treaty rates or exemptions.

In practice, for a considerable period, Chinese tax authorities have adopted a position somewhere in between: on one hand, allowing overseas investors to enjoy the 10% tax rate (i.e., not recognizing a permanent establishment), while on the other hand, declining overseas investors to claim treaty benefits—a compromise stance.

Even if only the 10% tax rate is available, QFLPs still offer certain tax advantages compared to direct overseas investment or domestic investment companies. For direct overseas investment, taxes must be paid on each investment project individually, i.e., upon exit of each project, profits are recognized, and PRC enterprise income tax is paid based on the difference between revenue and investment cost. Cross-project losses and project expenses (such as financial advisory fees) are not deductible. Domestic investment companies (foreign company-domestic investment company-domestic investee) face double taxation: enterprise income tax at the domestic investment company level (25%) and WHT at the foreign company level (10%). Under QFLP, there is an opportunity to pay only one layer of tax at 10% while also potentially offsetting profits and losses and expenses across different projects, theoretically achieving a more favorable tax outcome.

However, there has recently been extensive discussion/debate on QFLP tax treatment. A significant possibility is that overseas investors in QFLPs may be deemed to have a PE in China due to the existence of the limited partnership (i.e., “place of management”) and may be required to pay 25% PRC enterprise income tax. Although tax authorities have yet to issue systematic nationwide guidance, grassroots tax bureaus have already begun communicating with taxpayers, requiring them to file and pay enterprise income tax at 25% starting from 2026.

Han Kun’s observation: At present, overseas investors should review the tax validity and safety of the QFLP investment structure and, considering their circumstances, consider necessary restructuring or alternative transaction plans. This includes assessing the possibility of enjoying treaty benefits through the overseas structure, whether current investments are direct (some QFLPs invest in domestic RMB funds), the profitability range of current investment projects (and whether restructuring would result in high tax), and whether current projects are single high-premium investments (to manage tax exposure through transaction design).

Other developments

In addition to the major cross-border tax matters discussed above, we have also noted the following issues worthy of attention:

  • In some projects that migrate from a domestic structure to a Cayman structure with plans for overseas listing, a typical arrangement involves the founders (individuals) selling their equity in the domestic company to a Hong Kong company within the Cayman structure. In past transactions, tax authorities could accept filings and tax payments based on the net asset value of the domestic company; however, in recent cases, tax authorities have relied more heavily on the company’s valuation (significantly higher than net assets), which may result in tax liabilities for founders or the company far exceeding expectations. For companies who get listed right after the restructuring, they may face more intensive investigation as the restructuring price is usually far below the listing price.
  • Tax compliance issues when foreign-invested enterprises (i.e., Chinese subsidiaries of multinational companies) are deregistered. In recent years, many foreign companies have transferred or closed their China operations. During the deregistration of a Chinese subsidiary, various tax audits are often triggered. A common issue arises when the overseas parent company has amounts payable to the Chinese company that cannot ultimately be settled, potentially resulting in debt restructuring income in China and a corresponding 10% PRC withholding tax. Also, related party payment to overseas companies will also be careful examined before deregistration even if the amount is not material. Failor to justify the reasonableness of the inter-company charge may result in extra tax payment at the PRC company level.
  • In addition, if a foreign company receives substantial service fees from China, tax authorities may challenge whether it constitutes a permanent establishment in China, which would lead to payment of PRC enterprise income tax at 25% as well as complicated PRC individual income tax issues.

Overall recommendations

  • First, given the continuous evolution of international and domestic Chinese tax rules and the frequent emergence of special tax administration cases, previously completed M&A, restructuring, and cross-border dividend arrangements—particularly those occurring in recent years (e.g., since 2020)—should be reassessed internally at the seller and other key player’s level. Such assessment should be conducted reflecting the latest domestic and international tax practices, especially for arrangements claiming treaty benefits or domestic tax exemptions (e.g., the “safe harbor” mechanism under indirect equity transfers).
  • Second, for upcoming major transactions, careful pre-assessment should be conducted, and transaction structures should be chosen based on professional advice. Notably, in major cities such as Beijing, Shanghai, and Shenzhen, tax authorities offer a pre-filing review mechanism, whereby planned transactions can be submitted for confirmation, providing clarity and certainty on the relevant tax positions.
  • In addition, if investment institutions hold existing QFLPs in China or plan to establish such structures, they should promptly consider alternative structures and restructuring arrangements to avoid potential substantial additional tax liabilities and prevent disputes between GPs and LPs.
  • Lastly, in case all the tax planning initiatives failed or cannot work due to various factors, investors shall seek contractual remedy to shift tax burden/liability to the counterparties.