Chinese regulators are tipped to provide clarity within six months on a mooted 10% withholding tax to be applied retrospectively for capital gains made by QFII investors trading A-shares.
Speculation over the tax has been circulating since 2008, when a corporate income tax law came into force. In particular, foreign investors are concerned about how far back such a tax would be applied since it would hit performance of funds that had not fully provisioned for such a liability.
Jane Xue, a partner at PWC China, raised the issue at the Hong Kong Investment Funds Association’s annual conference this week. She described the topic as technically complicated in terms of how the rule would be applied and what impact it might have.
But she added: “Through coordination between the CSRC [China Securities Regulatory Commission] and other government authorities we expect a more transparent and efficient environment to be created for attracting long-term foreign investors.”
Sources say the CSRC is working with the finance ministry, State Administration of Foreign Exchange (Safe) and the State Administration of Taxation to finalise details of implementation.
Certainly, service providers, including foreign custodians servicing qualified foreign institutional investors (QFIIs), have expressed hope that the final details will not wreak administrative havoc either on them or their clients so as to deter QFII hopefuls.
A group of foreign custodians operating in China, foreign dealers and institutional investors have been in close discussion with CSRC over the past year in an effort to determine how the retrospective capital gains tax would be calculated.
While industry views on the likely impact of such a regulatory move are mixed, in general fund managers are optimistic that the CSRC under proactive chairman Guo Shuqing will introduce a user-friendly, light-touch approach.
One industry source based in Beijing, who says he has been involved in discussions with the CSRC, reveals he expects the 10% tax to be applied retroactively back to 2008.
John Gu, a tax partner for KPMG in Beijing, points out that a number of QFIIs have not made provisions for such a tax liability, given that in China there is no rule that specifically deals with income tax for QFIIs.
He suggests that foreign investor attitudes towards their potential tax liability tend to fall into two camps.
Some take comfort from a circular issued in the mid-1990s exempting them from paying dividend withholding tax on H-shares, red-chips and B-shares. They take the view that the same waiver will apply to foreign investors trading RMB-denominated A-shares via the QFII programme, which was started in 2002 well after the circular came into effect.
However, Gu states: “With the new corporate income tax coming into play in 2008 – which effectively took away previous tax incentives to foreign enterprises – all the legal benefits under that circular were also cancelled.”
The other camp have adopted a more prudent approach and have already started to provision for potential tax liability dating back to 2008.
Gu confirms that QFII managers which have not made sufficient provisions will see fund performance hit, which in turn will impact their end-investors.
“The unit price of some of the investment funds trading the A-share market could be affected because if the tax provision is not enough to cover the historical liability incurred by the new tax rules, it would open up the fund to the risk of having to settle such historical tax liability out of the existing assets of the fund,” he notes.
Some leading ETF managers, including BlackRock’s iShares business, say they have not provisioned for such a withholding tax on their synthetic ETFs that track China A-shares.
Sovereign wealth funds with QFII quotas, including Singapore’s GIC and Norway’s Norges Bank, would presumably also be affected, since there is no law in China providing immunity from capital gains tax to government-owned entities, Gu notes.
This issue comes as Chinese regulators have quickened the approvals process for QFII licences and quotas, reducing it to an average of six months, from 18-24 previously. A record $8.3 billion in quotas has been approved by the State Administration of Foreign Exchange (Safe) in the first nine months this year, with a record 53 new licenses approved by CSRC over the period.