China will scrap a system that exempted foreign individuals from income tax on dividends, a benefit not extended to Chinese nationals. Introduced in 1994 as part of the country's reform and opening drive to attract large-scale foreign investment, the exemption has drawn growing criticism for being used as a channel for tax avoidance.
The Chinese government has decided to impose a 20% personal income tax on dividends paid by foreign-invested enterprises to foreign individuals, the same rate applied to Chinese nationals, Bloomberg reported on the 1st. Experts said the measure effectively equalizes dividend taxation between foreign and domestic investors.
Criticism had been mounting within China that Chinese companies were exploiting the exemption. Some firms converted into foreign-invested enterprises and transferred assets before paying large dividends in order to claim the tax break, China Central Television reported.
Xing Zhaopeng, senior China strategist at Australia and New Zealand Banking Group, said the previous system benefited variable interest entity, or VIE, and red-chip structures. A VIE is an arrangement in which an overseas-listed company effectively controls a mainland Chinese operating entity through contracts. A red-chip structure refers to a mainland-based company listing on the Hong Kong Stock Exchange through an entity established offshore, such as in the Cayman Islands. Once widely used by Chinese companies including Alibaba Group Holding to list abroad, such structures have been phasing out as Beijing has cracked down on complex offshore entities.
Analysts said China, facing deteriorating fiscal conditions, abruptly ended the 32-year-old exemption to shore up tax revenue. The move is also intended to level taxation between domestic and foreign investors and to create a fairer market environment by reducing discriminatory tax benefits.
Experts said the measure could weigh on foreign investment sentiment in the short term but would help build a more mature and stable market economy over the longer run. Even if capital outflows accelerate immediately, they said, China's strategy for attracting foreign capital is shifting from quantitative expansion to qualitative growth.
Foreign-invested enterprises will be required to withhold the tax when paying dividends and remit it by the 15th of the following month. Annual dividends at the affected companies are estimated at several hundred billion yuan.
