Chinese GPs gear up for transaction taxes

PE firms in China will be taxed on offshore transactions as China strengthens enforcement of tax laws.

China’s Circular 698 is starting to be applied to private equity transactions completed offshore, and private equity firms in China need to prepare for more aggressive tax laws in the coming year, delegates heard at PEI's CFO & COO Conference in Hong Kong.

Circular 698 is going to make Chinese tax law much more like US tax law, according to Bing Bai, director of legal affairs and investment operations at Northern Light Venture Capital. It is like a group of anti-tax avoidance rules that will have jurisdiction over foreign transactions, including private equity.

“When it comes to taxes for a China-related company, expectations should be adjusted,” Bai said at the conference.

Although Circular 698 has been in place since December 2009, what has changed in the past year has been the enforcement of it. Bai said that in the past, most private equity firms and investors were able to ignore the circular because tax authorities didn’t expect it to be enforced, and didn’t know exactly how to enforce it, anyway.

However, 2012 has demonstrated that China’s tax authorities will push very hard to be sure China’s tax laws are enforced, even on transactions completed offshore. What can be frustrating, she said, is that deals or investments that aren’t even completed in China can be taxed in China simply because the company has a China connection.

Previously, only deals completed onshore would incur tax, according to Alvin Lam, managing director of operations at CVC Asia Pacific.

“This has aroused some controversy, as some ask if the arm [of the Chinese tax authorities] is too long,” Bai said. “But we’ll just have to see how that plays out next year.”

Lam said that China’s tax bureau is really looking out for those structures that are set up purely for tax avoidance. “They’re taking this question of taxability much more seriously,” he said. Disclosure to the Chinese government has now become a standard condition of deals, he added.

Lam says that funds need to budget in the offshore tax, but the cost is just 10 percent. “It doesn’t make or break the deal.”

Some tax advisors and lawyers have been trying to come up with ways to mitigate the cost and liability of taxes under Circular 698. However, none of those ideas have been thoroughly tested yet, and it is unclear which ones will actually work at this point, Lam said.

“For now, it’s here to stay,” he said at the conference.