Beijing Tax Bureau to levy 10% tax on QFII investors, with no deductions for losses

This article originally appeared in International Tax Review, a sister publication of China Law & Practice


The Asset Management Association of China (AMAC), a mutual fund regulatory agency, and the Beijing Municipal State Tax Bureau (BSTB) laid out their tax plan at an informal meeting of investors on February 26, though neither has yet made a formal announcement on the tax details.

Advisers and investors have been waiting for clarity on the taxability of gains made through China's Qualified Foreign Institutional Investor (QFII) scheme and RQFII - a similar renminbi-denominated scheme - since the programmes opened in 2003 and 2011, respectively. Though China reserved the right to tax gains, it never explained how it would do this.

Locational approach

"Rather than something uniform from the central tax authority, they're letting the local tax bureaus deal with it. Obviously the potential for different treatment is of concern to our members," said Eugenie Shen, managing director and head of the asset management group at Asia Securities Industry & Financial Markets Association based in Hong Kong.

"We don't know if the Shanghai or another local tax bureau is going to take a position that is inconsistent with Beijing."

The disjointed taxing methodology may mean that funds with custodians in Shanghai may face different tax rules to those whose custodians operate in Beijing or Shenzhen.

Glen Wei, a tax attorney with Yingke Law Firm, is confident that other jurisdictions will follow Beijing's model on taxation of the earnings.

"A March 3 Shanghai Securities News report said the tax authorities would apply the same method. The report also said that the capital gains must be calculated on a transaction basis and that a capital loss from a transaction cannot be used to set off capital gains from another transaction," said Wei, who pointed out that the tax treatment was similar to that proposed by the BSTB.

Rather than accepting taxes based on aggregate gains and losses, China is requiring that taxes be paid on a transaction-by-transaction basis, disallowing the netting of gains & losses from multiple transactions. "They're basically ignoring your losses," said Shen.

Shen also noted that the tax rules would take into consideration the application of tax treaties, though there remained discrepancies on beneficial ownership and how this would factor into determining treaty benefits.

"The good news out of Beijing is that QFIIs/RQFIIs only have to pay tax on gains for the five year period from November 17 2009 to November 16 2014, that is, a five year look back," said Shen. Any gains made before November 17 2009 will be exempt from the tax, and any gains after November 16 2014 are temporarily exempt to prevent arbitrage on the tax-exempt Shanghai-Hong Kong Stock Connect.

Though fund managers only owe taxes over five years, Beijing tax authorities have told investors to report on earnings from the beginning of the scheme. Institutions are required to register for taxpaying before July 31 this year and settle tax liabilities by September 15.

The tax only applies to equities investments, not bonds, and domestic investors are not liable for the capital gains tax.

Gaining certainty, losing revenue

"From a gaining certainty point of view, this is a welcome development," said Christopher Xing, leader of international tax for KPMG in China. He noted that taxpayers under the QFII scheme had long been aware they owed taxes, but were simply in the dark on the details.

However, funds may have under-provisioned for the taxes. The inability to deduct any losses means these firms will have to somehow recoup money to pay taxes on their losses.

"There certainly is a possibility that some QFIIs may have underprovided for capital gains tax," said Xing.

Z-Ben Advisers, an independent research company in Shanghai, warned that under provisioning for the taxes will require investors to raise funds quickly. "Many QFIIs will be forced to claw back funds from NAV [net asset value] in order to pay tax bills, a step that could seriously discourage investors' interest in QFII-backed funds for the remainder of the year," the firm said in a statement.

China also announced its intention to launch a programme similar to the Shanghai-HK stock connect, linking the Shenzhen stock exchange with Hong Kong. Z-Ben Advisors believe the scheme could be approved before the second half of the year.


By Meredith McBride, International Tax Review