The Sino-German Double Taxation Treaty (DTT) – Major Implications

7 min.

China’s going global strategy is becoming more and more apparent – especially China’s ambitions for economic cooperation with Europe were once again proven when the taxation treaties with several European countries such as the UK, France or Germany were recently signed. This article will focus on the Double Taxation Treaty (DTT) between China and Germany which was signed by the leaders of both countries on March 28^th 2014.

After the current DTT was issued in 1985, China’s business landscape began to change dramatically and it was therefore high time for another round of negotiations between both countries to begin in 2007. Although the new treaty has already been signed, it is important to note that it will not be valid until all the necessary ratifications and notifications are completed. If all diplomatic procedures are completed by both sides within 2014, the new DTT can become applicable on January 1st 2015. In any case, however, the new treaty will become applicable on the 30^th day after both countries announce the completion of their respective ratification and notification procedures. The main changes of the new DTT are as follows:

Permanent Establishment

A clear definition of a Permanent Establishment (PE) was not included in the old DTT and, as a result, regulations were not applied uniformly which meant that the playing field for German companies in China was uneven. The old treaty counted every “broken-in” month as a whole – even if a project took place for merely a single day, the month would be counted as a whole. Although highly unlikely, it was still possible that in the worst-case-scenario a company would have to register a PE having only spent 7 days overall in China. In other words, a foreign company could initiate a project in China and work for one day in January, two in February, one in March, one in April, two in May and four in June – this would make a total of eleven days but, according to the old DTT, accumulate to 6 months and trigger the requirement to register a PE.

The new treaty defines the time period leading up to the registration of a Service PE as one or multiple periods aggregating to more than 183 days within any 12 month period – the old DTT, however, defined this period merely as 6 months within any 12 month period. Once it becomes applicable, the new definition will offer a clearer and more convenient approach to counting the days when determining the point in time of registering a Service PE. The time period leading up to the registration of a Construction PE was extended to 12 months rather than the 6 months which applied before.

Withholding Income Tax

Withholding Income Tax (WHT) is raised at 10% which is only refunded respectively reduced upon application according to Chinese local CIT Law.

Dividends:

According to the new DTT, the WHT rate on dividends is halved from initially 10% to 5% if the beneficial owner of the dividends is a company which directly holds at least 25% of the shares. This new regulation attracts German investors directly to Mainland China and makes Hong Kong or Singapore based holding companies less attractive with regard to taxation issues on dividends.

Interest:

There are no changes to the WHT rate on the receipt of income from interest. It continues to lie at 10% although interest paid to certain Chinese state-owned commercial banks might be exempt from paying any tax.

Royalties:

The WHT rate levied on income derived from royalties continues to be limited to 10%. The new DTT does, however, reduce the WHT rate applicable to royalties that are paid for the right to use or the use of any industrial, commercial or scientific equipment to 6 % from 7%.

Capital Gains Tax

Under certain conditions, the new DTT provides relief from the Capital Gains Tax – for example when gains are derived from assets of which less than 50% are directly or indirectly represented by immovable property. Also, if the seller directly or indirectly holds at least 25% of the shares of a company during a 12 month period preceding the alienation of the shares, any gains derived from the alienation cannot be taxed in the foreign contracting state.

Independent personal services

Income derived from independent personal services, or from other activities of an independent nature, will also be taxed in the state in which the services are rendered. This does not, however, apply when the person receiving the income has been a resident of that state for one or multiple periods amounting to or exceeding an aggregated 183 days in any 12 month period which commences or ends in the fiscal year concerned.

Whereas in other countries the start and ending dates of a fiscal year are different from those of a calendar year, the Chinese definition of a fiscal year corresponds to the calendar year. Under the former DTT, German service providers had the option of organizing business trips which did not exceed 183 days in one calendar year. They could, for example, stay in China from July until December for just under 183 days and then again from January until June for just under 183 days. In this scenario, the old DTT would not have triggered an Individual Income Tax (IIT) liability.

However, given this above example, the new treaty would immediately lead to a tax liability on the employees’ personal income: Under the new DTT, if any stay exceeds 183 days which start in one fiscal year but end in another, IIT would be levied on income received during both stays and in both fiscal years. The following case study exemplifies this amendment within the new treaty.

The first entry to China is in February but the stay itself lasts for only 15 days. The second entry into China occurs in the beginning of August and the stay lasts for a total of 184 days which are spread over two consecutive fiscal years. According to the new amendment, personal income taxes have to be paid for an overall 168 days in the first year and for 65 days in the second year.

Income from Employment

The changes within the new DTT which were illustrated above in the “Independent Personal Service” paragraph, also apply to income from employment.

All in all, the changes to the new DTT are similar to those treaties recently signed between China and other European countries. It offers better and easier explanations on taxation frameworks as compared to the old DTT – China is, however, still not a tax shelter. For many German enterprises the new treaty offers greater benefits in terms of dividend repatriation and overall business planning. However, with regard to IIT issues, companies and individuals need to be more prudent and apply these changes to their business strategy.

Don’t hesitate to contact us for further information regarding the new DTA and for helpful advice also on how to profit from the new regulations.

with contribution of Brigitte Both (ECOVIS Beijing)

	Richard Hoffmann is a Partner at ECOVIS Beijing China. Richard obtained an honor’s degree in law and worked in Germany, America and China for various prestigious law firms prior to joining ECOVIS. He has published more than fifty articles in international magazines, frequently speaks at high profile events in China and abroad and is often invited as a legal expert by international TV. Contact: richard.hoffmann@ecovis.com
Ecovis Beijing is the trusted tax and legal advisor of several embassies and official institutions in China. It specializes in mid-sized international companies and focused on tax & legal advisory, accounting and auditing. If you’re interested in finding out more about tax and legal, don’t hesitate to sign up to our Newsletter or give us a call +86 10-65616609 (ext 811/806) or contact us directly via Beijing@ecovis.com