UK and China update double taxation agreement before it comes into force

The amendment (3-page / 14KB PDF) changes some of the provisions in relation to dividends in the original treaty (24-page / 79KB PDF), which was finalised and signed on 27 June 2011. According to the document, its provisions will not come into force until each country has "completed the procedures required by law" and notified the other that it has done so "through diplomatic channels in writing".

Shanghai-based tax expert Robbie Chen of Pinsent Masons, the law firm behind Out-Law.com, said that the Chinese Government had not given any indication of the reason for its delay in ratifying the treaty. Current thinking in China is that the treaty will be ratified during the first half of 2013, allowing it to become effective from 1 January 2014 in China and from April 2014 in the UK, he said. The UK Government completed the necessary legislative arrangements in November 2011.

Once in force, the 2011 treaty will replace the existing double taxation convention between the UK and China, which came into force in 1984. It is largely consistent with the model double tax convention produced by the Office for Economic Co-ordination and Development (OECD). It updates provisions in relation to capital gains, and introduces more modern information exchange arrangements.

One of the major changes introduced by the 2011 treaty is a reduction in the amount of withholding tax payable to the Chinese tax authorities when dividends are paid to UK investors with shares in Chinese companies. The treaty reduces the maximum dividend withholding tax rate from 10% to 5% where the investor beneficially owns at least 25% of the capital of the dividend paying company.

As originally agreed, the treaty extended this tax reduction to investors that owned the 25% minimum share either directly or indirectly. The new protocol amends this provision, so that the reduction is only available to UK shareholders that own 25% of the Chinese company directly.

"When the tax treaty was signed in 2011, it was interesting and surprising to see that it included 'indirect shareholding' for the dividend treatment as this has only appeared one in other tax treaties concluded by China: the treaty with Trinidad and Tobago," Chen said. "It was uncertain how the Chinese tax authority would interpret 'indirectly' in practice, as the domestic Chinese rules interpreting articles of double tax treaties were drafted based on the China-Singapore tax treaty, which also does not include the 'indirectly' requirement for the dividend article."

"Now it seems that the Chinese tax authority has reconsidered the 'indirectly' requirement, and has decided to delete it in the tax treaty through negotiation with the UK Government," he said.

Shanghai-based corporate law expert William Soileau of Pinsent Masons called on the Chinese Government to provide more information on when it was likely to ratify a "truly significant" treaty.

"The treaty will be a boon for British business, allowing British investors in China to enjoy tax rates on par with those of China's most favoured treaty partners," he said.