Apr. 2014 - New tax treaty between China and France signed in 2013

On 26 November 2013, China and France signed a new Double Taxation Agreement (“new DTA”) and an accompanying protocol in Beijing. Once it enters into force, expected early 2015, it will replace the current tax treaty of 1984 (“the 1984 DTA”). The new DTA will not only provide new treaty benefits but also bring in challenges.

The new DTA offers lower levels of dividend withholding income tax than under the 1984 DTA, clarifies the different taxation approaches under domestic laws with respect to partnership income, and tightens up the permanent establishment provisions. Furthermore, in line with the thrust of tax policy in both China and France over the past years, the new DTA introduces new anti-avoidance provisions, both within the context of the tax treaty and domestic general anti-avoidance rules.


Reduced withholding income tax rates

The withholding income tax rate on dividends is reduced from 10% to 5% if the corporate beneficial owners directly hold at least 25% of the company paying the dividends. In addition, no taxes should be withheld on dividends, interest and capital gains (other than those in relation to immovable properties) derived by qualified sovereign wealth funds. However, the withholding income tax rates remains at 10% on interest and royalties.

The withholding income tax rate on dividends is reduced from 10% to 5% if the corporate beneficial owners directly hold at least 25% of the company paying the dividends. In addition, no taxes should be withheld on dividends, interest and capital gains (other than those in relation to immovable properties) derived by qualified sovereign wealth funds. However, the withholding income tax rates remains at 10% on interest and royalties.

The reduction in withholding income tax rate on dividends would eliminate the benefits of setting up intermediate holding company in jurisdictions which have a preferential withholding income tax rate with China, e.g. Hong Kong and Singapore. This reflects the shift of China’s economic status and global role to becoming a capital exporter alongside being a capital importer. China intends to seek for  lower withholding income tax rate from additional countries.

Updated capital gain provision

The new DTA continues to reserve the exclusive taxing rights on capital gain derived from equity transfer to the residence country, but it  clarifies there are two circumstances where the source country could impose tax:

  • If the company being disposed of was a property-rich company, i.e. a company deriving more than 50% of its value, directly or indirectly, from immovable properties located in the source country, over a 36-month look back period ;
  • If the company being disposed of was a non-property-rich company, at least 25% of its shares were held directly or indirectly at any time during a 12-month look back period prior to the disposition.

Other than the two circumstances above, the taxing rights on capital gain on equity transfer would be given to the residence country, including equity transfer not specified in paragraphs 1 to 5 of the Capital Gain Article. 

Permanent Establishment (“PE”) and business profits

Consistently with China’s newly signed or updated tax treaties in recent years, clearer definition of PE and  PE profit attribution methodology are included in the new DTA. This provides more certainty to French investors doing business in China. 

The changes include:

  • The time threshold for a building site, construction, assembly or installation project to constitute a PE is extended from 6 months to 12 months;
  • The time threshold for constituting a Service PE is changed from 6 months to 183 days within any 12-month period;
  • The exclusion of supervision services in connection with the sale or lease of machinery or equipment from constituting a PE in the current protocol is removed;
  • Under the DTA, an enterprise of a Contracting State, e.g. France, shall not be deemed to have a PE in the other Contracting State, e.g. China, merely because it carried on business in that other State through an independent agent, provided that such an agent is acting in the ordinary course of its business. Under the new DTA, when the independent agent’s activities are devoted wholly or almost wholly on behalf of that enterprise, in order for the agent to be viewed as an independent agent, thus not causing a PE of the principal, the agent must deal with the principal on arm’s length terms.
  • The change from 6 months to 183 days within any 12-month period is a positive measure. For example, under the previous threshold, a service PE  could have been established for services provided between 31 March (1st month) to 1 August (6th month), i.e. 124 days, while under the new treaty it requires another 59 days before the PE  to be established.  This is because in counting the number of months, part of a month would be considered as one month.


Treaty application to partnership or other similar entities

Domestic laws may have different treatments on certain kinds of entities such as partnerships. For example, a partnership is a taxable unit in some countries, but looked through for tax purposes in others, in which case, the income would be taxed on the partners. 

Where partnerships are used for cross-border business and investment activities, unwarranted denial of tax treaty benefits due to contrasting approaches to entity taxation would result in double taxation or means to exploit the tax agreement to obtain double non-taxation.

The new DTA provides a new provision under the Resident Article to clarify treaty benefit for income, profits or gains derived through partnerships under six different scenarios. The complexity came from the ‘quasi-transparent’ French tax law treatment of partnerships where taxable income lies with the partnership while tax liabilities are settled by the partners. A similar issue exists with respect to Chinese partnerships. 

The complication was to determine who should be entitled to the tax treaty benefits: the person  ‘subject to tax’, i.e. the partnership, or the ‘resident’, i.e. the partners? While this is the first tax treaty signed by China, the interpretation issues have been raised  in many tax treaties entered by France, e.g. with the United Kingdom, the United States of America and Japan. 

These rules operate by reference to: 

  • the source of profits; 
  • the state in which the partnership is organised and 
  • whether the income is treated as being that of the partnership or the partners.

For example, if China sourced income arises from a French partnership, the treaty benefits may be granted either to the French partnership, if it is a taxable person under the French tax laws, or to the French resident partners, if they are treated as the taxable persons under the French tax law. 
On the other hand, under this approach, if the China sourced income arises from a Chinese partnership where there are French resident partners, the treaty benefits would not be applicable if either France or China views the Chinese partnership as non-transparent. 
The provision also applies to partnerships formed in a third country. In that case, both France and the third country must view the partnership as transparent before the new DTA can apply to the French resident partners. China would not grant the new DTA benefits to such China sourced income if France views the third-country partnership as opaque.


Addition of Anti-treaty shopping provisions

An anti-treaty shopping provision article is inserted in the new DTA to disregard abusive transactions or arrangements.  In addition, a limitation of benefit clause is added to each of the articles in respect of dividends, interests, royalties and other income to deny the treaty benefits if the main purpose or one of the main purposes is to take advantage of the benefits in the relevant article. 

This limitation of benefit clause is harsher than the beneficial ownership test used by many tax treaties (e.g. the Hong Kong-China Tax Agreement). One would need to prove bona fide business purposes of the ownership structure in order not to be viewed as having the main purpose or one of the main purposes to take advantage of the benefits in the tax treaty.

In addition, the new provision in Article 24 of the new DTA provides that the new DTA will not be applicable if the main purpose for entering into certain transactions or arrangements was solely to secure a more favourable tax position. This would allow China, for example, to apply its domestic General Anti-avoidance Rules to override any tax treaty provision.

With the latest version of the Exchange of Information article from the OECD Model, the information that can be requested from the other treaty party to what is ‘foreseeably relevant’ to administer the domestic tax law has been considerably expanded.

Abolition of tax sparing benefit

The old DTA tax sparing clause, which gave a French foreign tax credit in respect of China sourced passive income regardless of actual Chinese tax paid, has been abolished, though grandfathering for certain passive income is allowed for a limited period.


  • The new DTA, which generally follows the OECD Model Convention but with a number of deviations, is consistent with the approach taken by China with a number of European countries - including Belgium, Finland, Denmark, the Netherlands, Switzerland and the United Kingdom - in the new and recently negotiated double tax agreements.
  • With the reduction of withholding income tax rate on dividends, intermediary holding companies in jurisdictions such as Hong Kong and Singapore may no longer be necessary, with the exception of interest and royalties whereby there may still be benefits in running through these intermediary countries. 
  • It is imperative to note that the new DTA incorporates many anti-treaty shopping provisions as well as specific limitations for treaty benefits. These, combining with the updated Exchange of Information provision, indicate the desire of China and France to combat aggressive tax planning. It is recommended that relevant parties should assess their current structures and arrangements to withstand possible challenges in the future when the new DTA comes into force.