QFII investors struggle with taxes as deadline looms

QFII and RQFII tax filings are becoming a major compliance burden for investors, who are being urged to complete the paperwork soon in order to hit the summer deadline.

Collection of the required documentation is being seen as the biggest hurdle for investors, who are having to laboriously assemble certificates from many different companies.

And costs are mounting as accountants charge large fees to assist with the filings, while investors also face government fines if they fail to make the deadline.

Holders of quota in both qualified foreign institutional investor (QFII) and its renminbi equivalent (RQFII) were informed in late February that China’s State Administration of Taxation (SAT) will charge a 10% capital gains tax (CGT). This tax applies to investments made between November 17, 2009 and November 16, 2014, a five-year period before the Shanghai-Hong Kong Stock Connect was launched. QFII and RQFII managers must file tax documents or apply for an exemption before 31 July this year.

The new levy means foreign investors using QFII and RQFII have to pay 10% tax on gross profits made from equity investments. Separately, foreign investors have to prepare dividend tax certificates, which can only be obtained from the companies they invested in by requesting the documentation from each firm individually.

This has become a heavy compliance burden, according to Shanghai-based consultancy Z-Ben Advisors, which said that investors needed to accelerate the collection of documents, particularly dividend tax certificates.

“Nobody’s thinking about that. An actual tax filing is meant to be done. You actually have to deliver the documentation, which is very burdensome,” said Peter Alexander, Z-Ben CEO. “We asked our clients and 90% of them said their custodian or tax adviser was dealing with it.  But when we spoke to some of our local bank adviser contacts, they had no idea.”

While some QFII and RQFII managers enjoy a CGT exemption due to double-tax agreements between China and their domiciled territory, there are no exemptions for the dividend tax.
 
In China, listed firms issue post-tax dividends and make filings to their local SAT bureau, in order to pay dividend tax on behalf of all their shareholders. QFII and RQFII custodians receive net tax dividend payments but do not receive confirmation of tax payments from the SAT.

Z-Ben pointed out that investors, particularly those which have been QFII holders for years, will need a large amount of paperwork to prepare tax dividend certificates, and the process will be difficult. Z-Ben said custodians and brokers had declined to do this work for QFII investors because they were unable to provide proof of tax payment, and they do not see it as part of their tax reclamation role.

The Big Four accountants in China are now charging companies up to $1,000 for tracking down tax dividend certificates, and cannot guarantee successful collection. Z-Ben noted that only about 30-60% of such certificates could be obtained, judging by cases the firm has seen.

To make matters worse, QFII and RQFII investors which fail to provide such certificates by the July deadline will face a financial penalty. Z-Ben said firms which failed to provide proof of tax payment faced having to pay the taxes for a second time.

But despite the compliance burden and the tight three-month deadline, Z-Ben saw a glimmer of hope in the situation. Of the 75 listed Chinese companies which Z-Ben contacted, 80% said they were able to issue dividend tax certificates to QFII and RQFII investors, and local SAT offices said they were willing to provide substitutes for the documents if the originals were unavailable. However, the process will not be fast and there is no guarantee of cooperation from the SAT’s headquarters.

“Right now, the Beijing SAT requires these dividend tax certificates while Shanghai SAT has a more lenient approach to it,” said a tax consultant familiar with the situation.  

Authorities in China had been reluctant to clarify the CGT issue since the QFII and RQFII schemes were launched. The SAT and the China Securities Regulatory Commission (CSRC) has now confirmed CGT exemption under Stock Connect, which launched on November 17 last year, but they have said that the QFII and RQFII tax exemption prior to the trading link's launch was temporary.

Foreign managers welcomed policymakers’ tax clarification this year, which was seen as part of China’s attempts to reform QFII and RQFII. The People’s Bank of China has been vocal in its determination to reform the schemes, and industry observers have discussed the possibility of their merger. For example, the State Administration of Foreign Exchange (Safe) lifted the $1 billion QFII quota cap in late March, and is reportedly set to introduce daily repatriation for QFII holders, as can be carried out under RQFII.

In total, there were 267 institutions holding $72.1 billion QFII quota as of the end of March. There were 111 institutions holding Rmb329.8 billion ($53.2 billion) worth of RQFII quotas.