Offshore Equity Transfers Subject to China's Tax Jurisdiction
With the increasing prevalence of cross-border investment and offshore holding structures, a growing number of enterprises are investing in the Chinese market through overseas holding platforms. Typical structures involve investment vehicles incorporated in jurisdictions such as the Cayman Islands, BVI, Hong Kong, or Singapore, while the underlying operating entities are in mainland China. The advantages of such arrangements in terms of financing efficiency, governance flexibility, and risk isolation are well recognized.
However, many investors only realize a commonly underestimated risk when they receive inquiries from local tax authorities, an offshore transaction does not automatically fall outside the scope of China’s taxing rights.
This principle is institutionalized in the State Administration of Taxation Announcement [2015] No. 7 (“Circular 7”). Circular 7 has become a cornerstone of China’s cross-border tax regime, with lasting implications for private equity investments, VIE structures, red-chip listings, and internal group restructurings.
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Value matters than the form itself which not only consider the place of transaction
The core principle of Circular 7 is substance over form and the key rationale is as follows:
Although the equity transfer may occur offshore, if the value of the offshore entity is primarily derived from assets located in China, then the substantive rights being transferred are situated within the Chinese tax jurisdiction. Accordingly, China is entitled to assert taxing rights over the transaction. In other words, China’s tax authority looks not at where the contract is signed, but rather at where the underlying economic value resides. This is consistent with the international “source-based taxation” approach and aligns with global anti-avoidance principles such as GAAR and the BEPS framework.
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Definition of “Indirect Transfer” under the Policy Framework
In practice, enterprises seldom dispose of shares of a Chinese company directly. Instead, they typically transfer the shares of an offshore holding company that owns the Chinese entity constituting an indirect transfer.
Circular 7 provides that an indirect transfer of Chinese taxable assets occurs where:
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The value of the offshore company is primarily attributable to assets located in China; or
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The offshore equity transfer results in a change in the effective control of the underlying Chinese enterprise.
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Therefore, offshore-level transactions do not inherently constitute compliance. If the transaction substantively affects the economic interests of Chinese assets, the Chinese tax authorities may intervene.
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Allocation of Tax Responsibilities
Another key component of Circular 7 is its liability framework:
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The buyer bears the withholding obligation.
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The seller is responsible for filing and reporting taxable income.
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The Chinese underlying entity must provide information and assist with tax investigations.
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Notably, the Chinese entity’s obligations arise even if it did not participate in the transaction. This means that any transaction involving offshore structures may trigger domestic tax-risk management duties and disclosure requirements.
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Tax Burden and Exemption Mechanisms: Identifying Commercial Substance Rather Than Simply Levying Taxes
Generally, the applicable tax rate is:
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10% for non-resident enterprises.
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25% in special cases where the actual beneficial owner is deemed to be a Chinese tax resident.
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Importantly, Circular 7 is not a “pure revenue-raising tool”. Instead, it expressly provides for tax exemption where the transaction constitutes a reasonable internal restructuring, there is no substantive change in control, or the transaction has genuine commercial purposes. The policy’s intention is not to penalize cross-border investment, but to distinguish legitimate capital arrangements from tax-avoidance schemes. Thus, for financial institutions and investors, articulating the commercial rationale and economic substance of a transaction becomes a critical compliance function.
A new governance era for cross-border capital, against the backdrop of accelerating global anti-avoidance initiatives, Circular 7 marks China’s transition from procedural tax administration to substantive economic-value examination in cross-border transactions. It sends a clear message that commercial activity may cross borders, but tax obligations follow the location of value creation. When Chinese assets contribute to economic value, China’s taxing rights will not dissipate simply because the transaction is structured offshore. For institutional investors, strategic acquirers, and multinational groups, incorporating Circular 7 assessment into deal structuring, exit planning, and internal reorganization processes is no longer a value-add but it is a baseline compliance requirement.
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