Foreign investors get China bond tax waiver

Nov 2, 2016

International fund houses have received further clarity on investments into China's interbank bond market, say sources, but central banks remain the biggest drivers of fast-rising inflows.

Foreign investors get China bond tax waiver

Foreign asset managers will be temporarily exempt from capital gains tax (CGT) on their holdings in the China interbank bond market (CIBM), AsianInvestor understands. But they will need to pay 10% withholding tax for coupon interest income tax on policy bank and corporate bonds, though not government securities.

The guidance comes as the market awaits the official rules from mainland tax authorities. In the meantime, central banks are seen to be driving big flows into the CIBM.

The People’s Bank of China provided the informal clarification on tax treatment in recent weeks to foreign fund house clients of Shanghai-based law firm Llinks, said partner Elva Yu.

Foreign official institutions, such as central banks and sovereign wealth funds, are also exempt from the CGT and may not have to pay the 10% withholding tax, said Tony Chao, head of securities services for China at Standard Chartered, one of the four foreign settlement banks for the CIBM. The 10% withholding tax reflects the tax arrangement for the exchange-traded bond market, he noted.

China relaxed quota restrictions under the CIBM in February, but the tax arrangement remains an issue for foreign investors.

When the official rules are announced, the PBoC is expected to provide clarification on the tax-related questions in the Q&A it releases, said Chao, who is based in Shanghai.

But it may be that the State Authority of Taxation (SAT) has to issue the official clarification, said Llinks’ Yu. She added that the CIBM tax arrangements would be aligned with those for other mainland cross-border schemes, namely the qualified foreign institutional investor (QFII) programme and its renminbi equivalent (RQFII).

SAT and the China Securities Regulatory Commission jointly clarified tax arrangements for both QFII and RQFII in March 2015, saying CGT on domestic equity and bond securities would be waived temporarily from November 17, 2014; while foreign investors would still need to pay 10% interest income tax. Government bonds were already exempt from these levies.

PBoC did not respond to AsianInvestor requests for comment by press time.

CIBM volumes soar

While foreign asset managers have been cautious about investing into the CIBM until certain issues are cleared up, official institutions have apparently been less timid.

So far more than 50 accounts have set up to trade the CIBM, said Chao (pictured below). This suggests that up to 20 accounts – which can be for institutions and products – have registered in the five weeks since the State Administration of Foreign Exchange announced that at least 30 accounts had been set up.

Foreign purchases of government and policy-bank bonds stood at Rmb174 billion ($26 billion) this year as of September 30, a five-fold increase on the Rmb35 billion total for the whole of 2015.

Chao estimated that the volumes were largely driven by central banks buying renminbi bonds ahead of the currency entering the International Monetary Fund’s special drawing rights basket of currencies on October 1.

It is still early days for asset managers, whose demand for RMB bonds is uncertain, he added. Fund houses need time to amend their prospectuses or prepare new products, Chao explained.

Potential renminbi depreciation is also a consideration, as it would affect mainland bond returns, he noted. Some industry observers, such as Goldman Sachs' US forex team, predict that the currency will weaken further against the dollar.