China tax loophole exposed

CHINA stands to lose billions of yuan in revenue because of a gaping loophole Hong Kong accountants and legal experts believe they have found in an unpopular new property gains tax.

A property company wanting to sell mainland property to another company can avoid the tax by selling only its shares to the buyer, who will in turn assume ownership of the property concerned.

Robert Lee, a partner of law firm Deacons, said the method was workable because when it came to properties, there was no distinction in the Chinese laws between the legal title and the beneficial interest.

He said this could be a way for companies to avoid the tax which had an effective rate of more than 50 per cent.

'As far as China is concerned, one cannot keep the beneficial interest [of the property] through a declaration of trust.' The question is, now the loophole has been publicly exposed, will the authorities in Beijing quickly take measures to remove it.

Developers have also noted that another way to avoid the tax was to set up a paper company to sell a property to, then sell the shares of the paper company to an independent buyer.

As the paper company acquires the property at cost price, the seller avoids the gains tax. The paper company then sells its shares, avoiding the tax in the share transaction.

The independent buyer buys the shares of the paper company, not the property.

Mr Lee said as a result, the tax was only effective in the transaction of private property ownership and not for company transactions.

'You can change the owners of the property-owning company but the owners of the property remain unchanged.' Alfred Shum, a partner at accounting firm Ernst & Young, said unless the investor was very sophisticated and had the ability to choose the correct company and its shares to buy from, it was very difficult for this method to work.

'You never know what happens within the company,' he said.

He did not believe it would be a common event unless investors were very clear about the properties they would own when the companies' stocks were bought.

Under the law, gains on property transactions are taxed at rates between 30 per cent and 60 per cent.

Detailed regulations of the tax include a five-year exemption period for transactions entered into before January 1 last year. These will be exempted from the new tax for the first transfer.

Expense deductions and an allowance equal to 20 per cent of the development cost incurred will also be allowed.

All government taxes including business tax, city maintenance and development tax, stamp duty and education surcharge payable in relation to the property transfer are also allowed as deductions.

Mr Lee said: 'The tax will take away super profits but still allows for very reasonable returns of investment.' He said many people, while calculating the effective tax rate, neglected the return on investment.

The local government tax was first introduced by the central government more than a year ago to dampen feverish property speculation but was put on hold until last month.