As published on law.asia, Friday 2 December, 2022.
On 25 May 2022, China deposited its instrument of approval for the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) with the Organisation for Economic Co-operation and Development (OECD). The MLI has entered into force on 1 September 2022 for China.
The MLI was developed under the 2013 Base Erosion and Profit Shifting (BEPS) Action Plan 15 as a mechanism to simultaneously update existing bilateral double tax agreements (DTAs) between relevant jurisdictions. The OECD released the MLI on 24 November 2016, and China was one of the jurisdictions that endorsed the MLI. It incorporates many measures proposed by the BEPS action plans, including hybrid mismatch rules dealing with tax-transparent entities and dual-resident entities, treaty abuse rules preventing treaty shopping activities, permanent establishment (PE) rules preventing avoidance of PE status, and measures improving mutual agreement procedure (MAP).
The MLI contains a matching mechanism. Signatory jurisdictions nominate DTAs within their treaty network as covered tax agreements (CTAs) for updates and select updates from a range of options under the MLI. Where two signatory jurisdictions both nominate the DTA they have with each other, and the jurisdictions select the same or compatible updates options, the MLI updates may take effect. To make such matching mechanism work, the signatory jurisdictions deposit their instrument of approval with the OECD, which discloses their choice of updates, or reservations not to update certain articles.
China DTAs to be covered by the MLI. China listed 100 out of its existing 112 DTAs as CTAs for the MLI. As of 30 June 2022, among the 100 CTAs, 47 counterparty jurisdictions have selected their DTAs with China to be covered by the MLI, and have deposited their instrument of approval with the OECD, meaning the MLI will enter into force for the DTAs pursuant to article 35 of the MLI.
China’s MLI positions in its instrument of approval are largely consistent with its positions at the time it signed the MLI in 2016.
As anticipated, China has chosen not to adopt many of the MLI articles that are not required under the minimum standard. However, this is not to say that MNCs can underestimate the implication of the MLI’s implementation in China. MNCs with cross-border transactions should keep the MLI in mind when evaluating their treaty positions.
As discussed, one significant modification to China’s DTAs is the PPT. Although the ultimate impact of the PPT remains unclear, MNCs that wish to claim treaty benefits should expect China tax authorities’ treaty administration to be enhanced to accommodate the change brought by the MLI, thus creating additional burden and risk for MNCs.
Another trend the authors have observed in recent years is that China tax authorities exchange information with their foreign counterparts more frequently. Therefore, MNCs should be mindful that information historically not available to China tax authorities may be disclosed in the context of MLI when assessing their treaty positions.
Although China has opted out of the relevant MLI articles, it has unilaterally developed its own interpretation of PE that aligns with the new principles under the MLI. Therefore, China-based MNCs with cross-border transactions should continue to monitor their PE position in China.