The Netherlands and China sign new tax treaty
Publication date 12 June 2013
On May 31, 2013, the Deputy Minister of Finance, Mr. Weekers, and Mr. Wang Li, the Deputy Commissioner of the State Administration of Taxation of the Peoples Republic of China, signed the new tax treaty with China in Beijing. The new treaty replaces the current treaty, which has been in force since 1987, and updates a number of issues. The treaty will apply to income received on or after January 1 of the year following the year in which all the formalities between China and the Netherlands have been finalized. It is expected that this will be January 1, 2015, at the earliest.
The tax treaty focuses on further strengthening mutual investment and the trade relationship between the treaty partners. Its most salient feature is allowing participation dividends to be distributed to a parent company resident in the other country at a reduced rate of 5%. The treaty also focuses on the prevention of tax avoidance. To achieve this, the new treaty contains a number of anti-abuse provisions, as well as a new provision on the exchange of information between China and the Netherlands.
Departure from treaty policy
The treaty is generally in line with the usual structure and wording of recent treaties concluded by the Netherlands. However, some parts of the treaty deviate from Dutch treaty policy. In particular:
· regarding service activities as a permanent establishment if these are carried out for more than 183 days within a 12-month period;
· limiting the tax levied by the source state on royalties to a maximum of 6%-10%; the source state may tax interest at a maximum rate of 10% (as per the current treaty);
· a provision that provides for capital gains on shares of qualifying shareholdings (? 25%) to be taxed in the state of residence of the entity whose shares are being sold;
· a provision on real estate entities that provides for the capital gain on the sale of shares in such entities to be taxed in the state where the real estate is located;
· specific anti-abuse provisions in respect of dividends, interest and royalties.
Scope of the treaty
For the purposes of the treaty, China is defined as the Peoples Republic of China. Although Hong Kong became a Special Administrative Region of China after the transfer of sovereignty in 1997, Chinas tax law does not apply to it. This means that, just like the current treaty, the new treaty will not apply to Hong Kong. The Netherlands concluded a separate tax treaty with Hong Kong in 2010; this treaty entered into force on January 1, 2012.
For the purposes of the new treaty, the Netherlands is defined as the country the Netherlands including the special Carribean island administrations of Saba, Sint-Eustatius and Bonaire. The treaty will not apply to Aruba, Curaçao and Sint-Maarten.
The new treaty is in line with the current treaty in respect of its definition of permanent establishment. This means that service activities can also qualify as a permanent establishment, subject to the condition that the activities are for the same or a related project and are carried out for more than 183 days within a 12-month period.
Dividends paid to a resident of the other treaty state that is the ultimate beneficiary of those dividends, may be taxed by the source state up to a maximum of 10% of the gross amount of the dividends. An improvement on the current treaty is the fact that taxation in the source state is limited to a maximum of 5% if the ultimate beneficiary is an entity (not a joint venture) that directly holds at least 25% of the shares in the dividend distributing entity. This is the lowest tax rate approved by China in its tax treaties for dividends on shares in private hands. Dividends paid to the other State, its institutions or any other entity owned by that State are exempt in the source State.
An important condition to the above is the main purpose test. Pursuant to this test, the provisions of the article on dividends will not apply if a partys primary objective or one of its primary objectives in issuing or allotting the shares is to profit from the benefits of this article.
Interest and royalties
Under the treaty, the maximum tax rate that the source state can apply to interest payments is 10%; the maximum tax rate for royalty payments is 6%-10% depending of the type of royalties involved. As the Netherlands does not tax outgoing royalties, it will not make use of this right to tax.
The provisions on interest and royalties also provide for a main purpose test, whereby these provisions will not apply if a partys primary objective or one of its primary objectives in acquiring receivables or transferring the rights for which interest or royalties are paid is to profit from the benefits of these provisions.
Unlike the current treaty, the new treaty no longer provides for a tax sparing credit for interest and royalties.
Capital gains on shares
The new treaty generally allocates the right to tax capital gains on the sale of shares in an entity that is a resident of one of the contracting states to the shareholders state of residence, unless the shareholder held a participation of at least 25% in that entity at any time during the twelve months preceding the sale. In that case, the right to tax is, in principle, allocated to the state of residence of the entity of which the shares are being sold.
Under the new treaty, the capital gain on shares in a real estate entity can be taxed in the state in which the real estate is located if more than 50% of the assets of that entity consist of real estate that is located in the other state than the one in which the shareholder is resident. For the time being, this right cannot be exercised under Dutch domestic tax law.
Mutual agreement procedure
The new treaty provides for a mutual agreement procedure between the states. This procedure can be initiated at the request of a taxpayer, if it considers that the measures in one of the states results in taxation that is not in accordance with the treaty. The mutual agreement procedure is comparable to that in the current treaty and offers no assurances for the taxpayer, because the states only have a best efforts obligation; the treaty does not contain an arbitration provision.
Exchange of information
The new treaty also provides for the exchange of information if requested by one of the states. Like the current treaty, the new treaty only allows requests for the exchange of information to be refused in certain cases. We would like to specifically point out that information cannot be refused if the state that must provide the information does not have the information, because it is not relevant to domestic taxation. The fact that the information is held by, for example, a bank or other financial institution is also not a valid ground for refusal.