Last Friday, the Dutch State Secretary of Finance announced the signing of a new tax treaty (including protocol) with China (the "2013 Treaty"). The Secretary of Finance noted: "In recent years, China's economy has grown enormously and I am very satisfied that we have now put into place a modern tax treaty with such an important trade partner. There are many Chinese companies which are active in the Netherlands and I hope that the new tax treaty will further stimulate Chinese investments in the Netherlands."
In this Tax Alert, we will elaborate on the key features of the 2013 Treaty which will replace the currently applicable 1987 tax treaty with China (the "1987 Treaty"). Our analysis below is subject to further clarifications which may be made during the ratification discussions in the Dutch Parliament.
2. Key features new tax treaty with China
Indeed – and as indicated by the Dutch Secretary of Finance in the press release accompanying the new treaty –, the 2013 Treaty is a modern tax treaty which is generally based on a mixture of the 2005 – 2010 OECD Model Tax Conventions (the "OECD Model") and the 2001 – 2011 UN Model Tax Conventions (the "UN Model").
The 2013 Treaty's residency article follows the OECD Model's residency article. Under such article, a person is eligible for the benefits of the Treaty if it is liable to tax in a Contracting State.
The Protocol to the 2013 Treaty provides that a tax exempt investment institution (vrijgestelde beleggingsinstelling) shall not be entitled to the benefits of the 2013 Treaty. As technically a fiscal investment institution (fiscale beleggingsinstelling) is – albeit at a corporate income tax rate of 0% – liable to tax in the Netherlands, it should be eligible for the benefits of the 2013 Treaty, which is in line with the Dutch tax treaty policy as reflected in the 2011 Memorandum on Dutch Tax Policy (see also our 31 May 2013 Tax Alert).
The 2013 Treaty provides for the OECD standard corporate residency tie-breaker by reference to the place of effective management.
The permanent establishment article of the 2013 Treaty is still based on the UN Model. Under the 2013 Treaty, the scope of the permanent establishment article is extended in that the provision of services (including consultancy services) by an enterprise through employees or other personnel engaged by the enterprise for such purpose may be deemed to constitute a permanent establishment if such activities continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than 183 days within any twelve-month period.
Under the 2013 dividends article, the tax rate in respect of dividends is under all circumstances limited to 10%, provided the recipient of such dividends is the beneficial owner of the dividends (please note that under Dutch domestic law dividend withholding tax is levied at a rate of 15%). This rate is equal to the reduced rate which currently applies under the 1987 Treaty. Under the 2013 Treaty, however, such rate may be further reduced to 5%, again provided the recipient is the beneficial owner of the dividends, and provided further such recipient holds a direct interest of at least 25% of the capital in the distributing company. This 5% rate is the lowest rate available under Chinese tax treaties (although many other Dutch tax treaties provide for a reduction to 0%).
If the beneficial owner of the dividends is the Government of the other Contracting State, any of its institutions, or any other entity the capital of which is directly or indirectly wholly owned by the other Contracting State, the rate may even be further reduced to 0%. Prima facie, it seems that under this provision e.g. Chinese sovereign wealth funds may benefit from an exemption from Dutch dividend withholding tax (compare our observations under "Interest"). As discussed, this may be further clarified during the parliamentary approval process in the Dutch Parliament.
The 2013 Treaty's interest article provides for a reduction of the tax rate in respect of interest to 10%, which is the same rate as the reduced rate which currently applies under the 1987 Treaty.
Also under the 2013 Treaty, the tax rate in respect of interest may be further reduced to 0% if the beneficial owner of the dividends is the Government, a Central Bank or a financial institution the capital of which is directly or indirectly wholly owned by the other Contracting State (please note that the Netherlands does not levy a withholding tax on interest). Under the 2013 Treaty, financial institutions for purposes of this article include China Development Bank Corporation, Agricultural Development Bank of China, China Investment Corporation, etc. This list may already provide an indication of the type of Government-owned entities that fall within the scope of the exemption from Dutch dividend withholding tax (see under "Dividends" above).
The 2013 Treaty's royalty article provides for a reduction of the tax rate in respect of royalties to 10%, which is the same rate as the reduced rate which currently applies under the 1987 Treaty.
In addition, the 2013 Treaty provides for a further reduction of tax to effectively 6% if the royalties are paid in consideration for the use of, or right to use, industrial, commercial or scientific equipment (please note that The Netherlands does not levy a withholding tax on royalties). This rate applies under the 1987 Treaty as well pursuant to the protocol to such 1987 Treaty.
Under the 1987 Treaty, if a Dutch resident person realizes a capital gain in respect of the disposal of shares in a Chinese resident company, such gain is taxable in China as for Chinese tax purposes these shares are considered to be situated in China.
Under the 2013 Treaty, if a Dutch resident person realizes a capital gain in respect of the disposal of shares in a Chinese resident company, such gain is only taxable in China if:
- these shares derive more than 50% of their value directly or indirectly from immovable property located in China; or
- the Dutch resident person at any time during the twelve-month period preceding the share disposal directly or indirectly held a participation of at least 25% in the Chinese resident company,
The above also applies mutatis mutandis in the opposite situation, i.e. if a Chinese resident company disposes of shares in a Dutch resident company.
However, the Contracting State of the company in which the shares are disposed will have to refrain from taxing any capital gains triggered upon such disposal if (a) the disposed shares are listed on a recognized stock exchange and not more than 3% of the shares in the company are disposed of by the alienator during the relevant tax year; or (b) the shares are held by the Government of the other Contracting State, any of its institutions, or any other entity the capital of which is directly or indirectly wholly owned by the other Contracting State (compare our observations in this respect under "Dividends" and "Interest" above).
The 2013 Treaty provides for the following anti-abuse provisions which are not provided for under the 1987 Treaty:
- a main purpose test under each of the dividends, interest and royalties articles. Pursuant to such main purpose test, the benefits provided for under the relevant article are not available if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the relevant shares, debt-claims or rights in respect of which the dividends, interest or royalties, respectively, are paid is to take advantage of the benefits of these articles by means of the aforementioned creation or assignment. This is a subjective test. Absent any guidance, it remains unclear under which circumstances a creation or assignment could fall within the scope of this test. Further guidance may be given during the discussions in the Dutch parliament; and
- a general anti-abuse provision which allows the Contracting States to apply their domestic anti-abuse provisions against tax evasion and tax avoidance insofar as application of these provisions does not give rise to taxation contrary to the 2013 Treaty. Also with respect to this test, it remains unclear under which circumstance domestic anti-abuse provisions may be invoked by a Contracting State. Prima facie, it seems that under this provision China may under certain circumstances still apply e.g. Circular 698 and thus tax capital gains triggered upon share disposals in Chinese companies by Dutch resident companies. Also here, further guidance may be given during the discussions in the Dutch parliament.
Tax sparing credit
In accordance with the policy expressed in the 2011 Memorandum on Dutch Tax Policy (see also our
31 May 2013 Tax Alert ), the 2013 Treaty no longer contains a tax sparing credit. The 1987 Treaty provides for such tax sparing credit with respect to interest and royalties.
Exchange of information
Under the 2013 Treaty, the more limited exchange of information article of the 1987 Treaty is replaced by an OECD Model based exchange of information article. The 2013 Treaty does not provide for spontaneous or automatic exchange of information between the tax authorities of the Contracting States.
Entry into force
The entry into force of the 2013 Treaty is subject to the respective domestic approval procedures of the Netherlands and the People's Republic of China.
3. Concluding remarks
The signing of the 2013 Treaty with the People's Republic of China evidences the continued Dutch approach to maintain and further enhance its attractive tax and investment climate for international investors.
Compared to the 1987 Treaty, the 2013 Treaty significantly improves the position of investors with respect to protection from:
1. dividend tax through the introduction of the reduced 5% rate which is the lowest rate provided for under Chinese tax treaties; and
2. capital gains tax in respect of share disposals.
Through the introduction of the subjective anti-abuse measures, however, the 2013 Treaty provides less legal certainty with respect to the tax treatment of cross-border investments.
Once the 2013 Treaty is submitted to the Dutch parliament for approval, we will report back with further details.