(Sept 2): China has ended a decades-long exemption on the individual income tax paid by foreign-invested firms on some dividend payments, the latest in a series of sweeping changes to the country’s tax system.

The government said Tuesday evening that it will impose a 20% individual income tax on dividends paid by foreign-invested enterprises to foreign individuals, ending an exemption that had been in place since 1994. The move essentially brings dividend taxes applied to foreigners and locals in line, said analysts.

The change is part of Beijing’s widening effort to boost tax revenues and close loopholes. The country has started taxing offshore trusts established by its citizens, as well as widening the dragnet to the overseas trading profits earned by their citizens.

The new rule effectively removes an avenue for foreign investors in some Chinese firms to reap the benefit of big dividend payments while paying only minimal tax. 

The previous exemption benefited variable interest entities and red-chip structures, said Zhaopeng Xing, senior China strategist at Australia & New Zealand Banking Group. The two structures were once popular routes for Chinese companies such as Alibaba Group Holding Ltd to sell shares overseas, but are being phased out as Beijing pushes back against complicated offshore vehicles.

“It will affect a broad universe of Chinese businesses registered offshore but operating primarily onshore, including both listed and unlisted companies,” said Xing, adding that the combined annual dividend distributions from the impacted firms are estimated to run into the hundreds of billions of yuan.

Under the new rules, foreign-invested enterprises must withhold the tax when paying dividends and remit it by the 15th of the following month. If the tax is not withheld, foreign individuals are required to pay it directly by June 30 of the following year, according to a joint statement from the Ministry of Finance and the State Taxation Administration. The policy took effect from Tuesday.

Citing unnamed experts, state broadcaster China Central Television reported that some companies exploited the policy by converting into foreign-invested enterprises before making large dividend payments to transfer assets and benefit from the exemption.

“Taxing such income in China helps ensure that income connected to China does not escape the domestic tax base simply by passing through an offshore structure,” said Xing. He said the practical impact will primarily target aggressive cross-border tax planning and profit repatriation for high-net-worth individuals, rather than the broader market.

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