China Takes Hard Line on Taxing Foreigners on Share Gains: An Article Authored by Paul Oliveira, CPA from KLR - Accounting Firm Boston, Massachusetts, Providence, Rhode Island

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China Takes Hard Line on Taxing Foreigners on Share Gains

posted Apr 30, 2015 by Paul Oliveira, CPA

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China alarmed foreign investors with a proposed capital gains tax that would take 10% of their share trading profits without taking into account any of their trading losses, Reuters reported.

he plan would apply to investors who have traded stocks and other equity-based instruments through China’s two largest portfolio investment schemes for foreigners, and would be levied retrospectively on profits made over the past five years.

The details of the tax plan were disclosed in Beijing by officials of China’s State Administration of Taxation.

The tax applies to investors in the Qualified Foreign Institutional Investor (QFII) program and the renminbi-denominated version of the same program (RQFII) between Nov. 17, 2009, and Nov. 16, 2014. A slide shown at the briefing stated:

“Transactions of equity investments are taxed based on gains from each transaction, and the applicable tax rate is 10 percent. Netting of multiple transactions is not allowed.”

“It is likely that the majority of QFII investors will find themselves underprovisioned not least because the agreement appears not to include netting and most QFIIs have provisioned based on netting,” said Michael McCormack, executive director at Shanghai-based research firm Z-Ben Advisors. “We expect a wave of net asset value clawbacks by fund managers and also a short-term wave of redemptions from QFII funds as investors attempt to escape prior to the tax clawbacks,” he said.

Investors in such transactions, representing a total $116 billion in investment, have long been expecting a retrospective tax to be imposed and had set aside some of their profits in anticipation. But many of them assumed it would be levied on net rather than gross gains, in keeping with international tax norms. That means the money they have set aside over the past few years is likely to fall short of their actual tax bills, possibly by as much as $4 billion, according to Z-Ben Advisors.

Since the rollout of the $30 billion QFII scheme in 2002, Beijing has been vague about whether it will impose a capital gains tax on foreign investors under the program. The uncertainty has prompted many investors to make special tax provisions, typically based on an assumed tax rate of 10%, over the years.

Profits made before Nov. 17, 2009, in the QFII program won’t be subject to the capital gains tax, according to the authorities.

Steps ahead

Investors affected by the proposed rule need to file relevant documents by July 31, while the tax authorities will review the records from March 1 to Sept. 30.

Once the new tax is in place, the so-called QFIIs may have to claw back $1.2 billion from investors to pay taxes, according to Z-Ben Advisors. However, the firm said the cost could triple or more if China doesn’t allow investors to factor in losses against gains when calculating their taxes.