The new tax treaty between the Netherlands and China was signed in May 2013. The formalities in China and the Netherlands have now been completed and the treaty will enter into force on August 31, 2014. The treaty will apply to income received after January 1, 2015.
The new treaty replaces the current treaty, which was signed in 1987, and updates a number of elements.The tax treaty focuses on further strengthening mutual investment and the trade relationship between both 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 includes a number of anti-abuse provisions aimed at combating tax evasion, a new provision on the exchange of information between China and the Netherlands and rules on reciprocal assistance with regard to the collection of taxes. A number of changes that have been made to the current treaty are discussed in more detail below.
Permanent establishment - changes to the conditions for permanent establishment service activities
The new treaty is, for the most part, 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, However, slight changes have been made to the conditions for determining whether such a permanent establishment is present.
Dividends - reduction of withholding tax on participation dividends and introduction of main purpose test
Dividends paid to a resident of the other contracting state that is the ultimate beneficiary of the 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 (other than a partnership) that directly holds at least 25% of the shares in the dividend distributing entity.
This reduction in withholding tax on participation dividends to 5% means that it may be worthwhile waiting until after January 1, 2015 before making dividend distributions. The treaty contains an anti-abuse provision, according to which the Article on dividends will not apply if the main intention of one of the relevant parties is to profit from the benefits of this Article. In this respect, we recommend that you first check to see whether the treaty benefits apply before making a dividend distribution.
Interest and royalties - withdrawal of tax sparing credit and introduction of main purpose test
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% or 10% depending of the type of royalties involved. An anti-abuse rule similar to that applying to dividends also applies here.
Unlike the current treaty, the new treaty no longer provides for a tax sparing credit for interest (currently 10%) or for royalties (currently 15%).
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 shareholder’s 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 state other than the one in which the shareholder is resident.
We would be pleased to contact you to discuss the opportunities offered by the new treaty or to explain them in more detail.
KPMG Meijburg & Co
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