On 28 December 2017, the Ministry of Finance, the State Administration of Taxation (SAT), the National Development and Reform Commission, and the Ministry of Commerce jointly released Cai Shui  No. 88 (Notice 88). Notice 88 allows a non-resident enterprise to defer payment of tax on dividends derived from a Chinese enterprise if, among other things, the non-resident enterprise directly reinvests the dividends into industries encouraged by the Chinese government.
The concept of the dividend tax deferral regime was first introduced by the State Council in a circular (i.e., Guo Fa  No. 39) dated 8 August 2017 as a measure to attract foreign investment. After four months of silence, the four ministries released the dividend tax deferral implementing rules on the last working day of 2017.
When a US MNC considers whether to repatriate earnings from Chinese operations under the new US tax law, Notice 88 complicates the decision process by adding a Chinese tax factor to the equation
The timing does not appear to be coincidental, given the recent conclusion of the legislative process on US tax reform. While the US tax reform may have removed a principal disincentive of US multinational companies (MNCs) to repatriate earnings from their Chinese subsidiaries back to the US, Notice 88 appears to encourage MNCs to keep those earnings in China.
In this alert, we will first examine what benefits MNCs can obtain from the Notice 88 tax deferral regime. We will then discuss the substantial requirements to receive the tax deferral. Finally, we will share some views about how MNCs may be impacted by this new regime.
As we discuss below, Notice 88 creates some uncertainties or issues that need to be clarified or managed. We expect the State Administration of Taxation will soon issue a bulletin to provide implementing guidelines for Notice 88, and such a guideline could clear up some of these ambiguities.
Also, MNCs should carefully manage the transaction structure and documentation in order to avoid pitfalls created by Notice 88.
Deferral regime overview
Under the Chinese tax rules, dividends distributed from a Chinese subsidiary to a non-resident enterprise shareholder are subject to 10% income withholding tax, subject to possible treaty relief.
According to Notice 88, when a non-resident enterprise meets certain conditions as discussed below, it can defer tax payments on dividends from a Chinese resident enterprise if it directly uses the dividends to fund equity investment into industries encouraged by the Chinese government. That is to say, the non-resident enterprise does not need to pay the 10% (or less under an applicable tax treaty) dividend withholding tax at the time of dividend distribution.
The dividend tax deferral under Notice 88 applies to dividends derived on or after 1 January 2017. A non-resident enterprise that has paid withholding tax on dividends distributed after this date but prior to the issuance of Notice 88 may claim a tax refund within three years from tax payment if the dividends qualify for tax deferral.
The tax deferral regime is reminiscent of the pre-2008 dividend withholding tax exemption rules, which permanently exempted a foreign investor from withholding tax on dividends received from a foreign-invested enterprise.
However, unlike the pre-2008 rules, Notice 88 requires the non-resident enterprise to pay back the deferred dividend withholding tax after the non- resident enterprises recovers the reinvestment by way of share transfer, redemption, liquidation, etc.
An exception is provided for a recovery of reinvestment due to a restructuring of the reinvested enterprise, if the restructuring qualifies for and actually enjoys the Notice 59 special tax treatment.
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