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China’s currency plans appear good news for offshore dim sum bonds and foreign investors, but greater clarity on tax issues is needed, say Matthew Wong and Ellen Sheng

This article was first published in the November 2012 China edition of Accounting and Business magazine.

RMB bonds have become an important financial instrument to China-focused corporate treasurers who aim to allow their corporate surplus cash to enjoy the prospective RMB appreciation against the US dollar.

Since RMB is not a freely convertible currency, there are currently two broad categories of RMB bonds, namely:

  1. CNY bonds, traded in the China domestic market;
  2. CNH bonds traded in the offshore market, say Hong Kong (also known as ‘dim sum bonds’).

Foreign investors only have very limited access to the China domestic CNY bond market unless they can secure a special licence from the Chinese authorities as a Qualified Foreign Institutional Investor (QFII). On the other hand, the offshore dim sum bond market, which is targeted at foreign investors, is expected to grow exponentially over the next couple of years as a result of China government’s policy to internationalise its currency.

Uncertain tax position

China’s tax regime governing onshore CNY bonds and offshore dim sum bonds are still in a state of flux. Existing China tax rules grant a corporate income tax exemption on coupon interest received from government bonds issued by China’s Ministry of Finance. However, China is silent on whether this favourable treatment can further be extended to: (a) capital gains arising from trading of Chinese government bonds; and (b) accrued interest arising from amortisation of discounts on purchase prices of the bonds.

So far, Chinese tax authorities have not attempted to collect tax from foreign investors on capital gain arising from the trading of Chinese government bonds. As a result, foreign investors are struggling with whether to recognise Chinese tax provision on capital gains and discount income from trading of government bonds through QFII or the offshore market. There is also uncertainty as to whether a 5% business tax should be imposed on interest and capital gain arising from investment in Chinese government bonds.

For non-government corporate CNY bonds or CNH bonds, clear-cut Chinese tax rules have required the Chinese bond issuers to deduct 10% interest withholding tax at source when the relevant payments are made to offshore investors or QFIIs. Recently, non-Chinese overseas multinationals such as McDonald’s were also permitted to issue dim sum bonds in the offshore market.

It appears that interest paid from offshore CNH bonds issued by overseas multinationals outside of China should fall outside of the Chinese tax net. Foreign investors may find that the after-tax yield rate on investment of Chinese corporate bonds (with same credit risk and tenor) may be higher where the bond issuer is an offshore corporation.

As far as capital gains taxation is concerned, foreign investors trading CNY bonds in the Chinese domestic market through QFIIs have faced uncertain tax positions, similar to the those on A-share trading, as the QFII taxation regime has not been confirmed.

Another grey area is whether the capital gain derived from trading of dim sum bonds in the offshore market should be subject to Chinese taxes. It is not uncommon to see this Chinese capital gains tax risk factor be thoroughly disclosed to investors in the offshore dim sum bond prospectus.

Again, the use of a suitable tax treaty-based platform to trade dim sum bonds may mitigate the potential Chinese capital gains tax risk. It is important to note that matters like treaty shopping and beneficiary ownership test are ‘on the radar screen’ for the Chinese tax authorities. Therefore, great care is required in structuring the right treaty-protected platform for dim sum bond trading.

Borrowers’ China concerns

Multinational corporations (MNCs) expanding in China also see dim sum bonds as an emerging financing model for their China operation.

So far, MNCs like McDonald’s, Volkswagen, Caterpillar and Unilever have tapped the dim sum market. MNC borrowers in need of RMB funding generally have two options to raise capital directly in the currency: access the mainland China bank loan market, where rates are regulated by the People’s Bank of China; or issue dim sum bonds in the offshore market, where rates are market-driven and thereafter remit the proceeds to China. So far, the offshore RMB market appears to be the cheaper alternative.
When dim sum bond issuers bring the proceeds to their China operation, great care should be taken by the offshore issuers in pushing debts to their China operating entities. The latter normally take the form of foreign investment enterprises (FIEs), which have to observe their limit on crossborder borrowing.

A normal FIE’s crossborder borrowing cap is determined by the difference between its approved total investment and registered capital, and there is a statutory limit on the ratio between the two (see table). For instance, an FIE with registered capital of US$12m can have an approved total investment of US$36m, thus translating to a crossborder borrowing cap of US$24m. A dim sum bond issuer should observe the above crossborder debt capacity of its China operating entities to determine the extent that bond proceeds can be pushed into China by way of debt.

MNCs that have set up a special investment holding vehicle in China with paid-up registered capital of at least US$30m have a more relaxed statutory ratio of 4:1. In other words, offshore dim sum bond issuers with Chinese investment holding company structure should have more capacity and flexibility to push debts down to China.  

One of the reasons for the offshore dim sum bond issuers to use cross-border loans to bring proceeds to their Chinese entities is to enable the latter to ultimately bear the interest expenses and claim tax deduction thereon, thus ensuring tax efficiency at China level. However, tax deductibility of crossborder-related party interest payments is subject to close scrutiny by the Chinese tax authorities. In particular, the China Tax Law has a specific ‘thin-capitalisation’ tax rule which empowers the Chinese tax authority to deny deductions on excessive interest paid to related parties if the related party debts of the taxpayer exceed certain prescribed ‘safe-harbour’ debt-equity ratios (ie 2:1 for on non-financial institutions). Such related party debts include not only loans from related parties, but also back-to-back arrangements and loans guaranteed by related parties and with joint and several repayment obligations.

The thin-capitalisation rule aims to counter tax-avoidance schemes of pushing debts from overseas groups to their Chinese subsidiaries in order to generate more interest expense deduction and to reduce China income tax burden. Where the taxpayer’s ratio exceeds the 2:1 safe harbour, further analysis and documentation would be required to refute the challenge from the tax authorities to disallow related party interest payments. The key is to develop robust transfer pricing documentation to support that the taxpayer’s related party financing arrangements comply with the arm’s-length principle and there are genuine business reasons to borrow beyond the safe-harbour ratio. 

The way forward

The trading volume of dim sum bonds continues to explode in the offshore market as foreign investors have a strong appetite to Renminbi asset class given the prospect of currency appreciation. Meanwhile, dim sum bonds are also gaining traction with MNC issuers, which have a funding need for their growing Chinese operation. Borrowers and lenders of dim sum bonds must understand their Chinese tax and regulatory exposure if they are to unlock the opportunities in the market.

Total investment

Under US$3m ($3m inclusive)



Min. registered capital

70% of total investment

US$3 - US$10m ($10m inclusive)2:1US$2.1m
US$10m - US$30m ($30m inclusive)5:2US$5m
More than US$30m3:1US$12m

Matthew Wong is a tax partner and Ellen Sheng is a senior tax manager, of PwC China, based in Shanghai

The information presented is not intended to be comprehensive or final. Professional advice is strongly recommended before entering into any arrangements based on these notes.


Last updated: 8 Apr 2014