Tax deal with US a win for China, lawyers say
China stands to benefit from a proposed intergovernmental agreement (IGA) with the United States that would enable the mainland to comply with the US Foreign Account Tax Compliance Act (Fatca), which combats tax evasion, lawyers say.
Fatca requires foreign financial institutions to report to the US Internal Revenue Service information about US taxpayers or foreign firms in which US taxpayers hold substantial ownership.
One of the agreement's features is the exchange of tax information between the US and the other signatory jurisdiction.
Beijing and Washington agreed in July to reach an IGA before January.
"If China signs a reciprocal IGA, it could receive significant tax data from the US about the overseas activities of Chinese nationals," said Karl Egbert, a registered foreign lawyer with US law firm Dechert. "That data is potentially tremendously valuable to the Chinese government, so they will not want to jeopardise the agreement.
"If China and the US can agree to an IGA, it means they have found a common cause. Both countries are very interested in what their citizens do offshore; the US because it operates a global tax system, and China because it would like to control the flow of currency and know what's happening with its citizens' offshore money.
"At first, many governments viewed Fatca suspiciously as another US encroachment on their sovereignty. But gradually, they aren't opposing getting more tax information. In fact, they'd love to get more tax information on their own citizens. That's what's happened with Germany and Europe."
Countries that have signed IGAs with the US include Britain, Germany, Japan, Switzerland, Norway, Ireland and Spain, according to King & Wood Mallesons, an Australian-Asian law firm. Hong Kong is negotiating its own IGA.
If Beijing signs an IGA, all mainland financial institutions and many other firms there, such as trust companies and pension fund managers, will have to comply with Fatca's due diligence and disclosure requirements, said Scott Michel, president of US law firm Caplin & Drysdale.
If a non-US financial institution refuses to comply with Fatca, it faces a 30 per cent withholding tax on gains on the US investments in its portfolio, whether the assets are held for US taxpayers or other parties, Michel said.
After an IGA is signed between the US and China, non-compliant mainland banks will be violating not just Fatca but also domestic law, because IGAs require non-US jurisdictions to pass legislation making Fatca part of local law, Egbert said.
"The US has been taking a hard line in IGA negotiations, but if anyone can push them, China can," he said. "China has greater bargaining power than any other country for Fatca."
Most countries could not risk refusing to comply with Fatca, because they would not be able to invest in the US, Egbert said. "But what would happen if China decided it didn't want to invest in the US? That would be very unattractive to the US government."
China has the leverage to negotiate a better Fatca deal with the US than most countries and thus win more favourable exemptions, Egbert said. One example of a possible exemption was for smaller Chinese banks that serve only mainland customers and have no overseas branches to be exempt from Fatca, because it was unlikely US taxpayers would use such banks for tax evasion, he said.
If a country did not comply with Fatca, it would have to operate a financial system that did not rely on major global banks, he said. China, with its huge economy, currency controls and large banks, would be better positioned than most countries to do so but it was unlikely to opt out of Fatca, because it would be too disruptive and costly, he said.