Where this reform leaves investors

On September 1, the Ministry of Finance and the State Taxation Administration issued a notice formally repealing item (8) of Article 2 of the previous individual income tax policy document, eliminating the preferential tax treatment that allowed foreign individuals to receive dividends from foreign-invested enterprises tax-free. Going forward, such income will be uniformly taxed at the 20% rate applicable to interest, dividends, and bonus income.

This 32-year-old "super-national treatment" policy has now been consigned to history, marking a milestone in China's journey toward a fairer, more mature, and more modern tax system.

Why this policy shift matters for fairness and loophole closure

The exemption, first introduced in 1994, played an indispensable historical role in attracting foreign capital and importing technology during the early stages of reform and opening-up when China faced acute foreign exchange shortages. But as the economy has grown and the market environment has matured, preserving this privilege has not only violated the principle of tax fairness but has also encouraged serious institutional arbitrage.

This new tax policy carries multiple layers of positive significance and practical effect. First, it restores the principle of tax equity and reinforces the institutional foundation for a unified national market. Previously, the dividend exemption for foreign individuals created an identity-based disparity in tax burdens, with domestic shareholders and foreign investors operating under different rules that undermined fair competition. The new policy eliminates this identity-based differential treatment, ensuring all market participants invest and operate under identical tax rules. Looking back at China's foreign-related tax reform trajectory, the 2008 corporate income tax reform unified the tax treatment of domestic and foreign enterprises at the corporate level. This latest move extends that same logic to individual dividend income, completing the process of eliminating super-national treatment across major tax categories and achieving equal taxation for equal shares.

Second, it closes cross-border tax arbitrage loopholes and protects national tax sovereignty. In practice, arbitrage has typically taken three forms: changing the de facto controller's nationality, using foreign nationals as nominee shareholders, and illegally structuring offshore round-trip investments. All of these exploited the old exemption to avoid tax on dividends. According to the State Administration of Foreign Exchange's Notice 37, the boundaries between compliant round-trip investment and illegal arbitrage must be carefully drawn. Enterprises that have completed the required foreign exchange registration for their overseas special purpose vehicles, and whose round-trip investments are properly registered, should be legally recognized as foreign-invested enterprises. Only structures that deliberately circumvent registration requirements, change identity, or set up offshore vehicles purely to extract tax benefits should be treated as arbitrage. The policy loophole had encouraged some domestic capital to disguise itself as "fake foreign investment" through identity changes and offshore structures, causing tax leakage and risking abnormal wealth transfers. Cancelling the exemption directly severs this gray arbitrage chain and strengthens cross-border tax source management.

Third, the policy iteration aligns the tax system with the current stage of development. The exemption was born in an era when attracting investment was the top priority. Today, China has shifted from preferential-tax-driven openness to institutional openness. Real foreign direct investment now weighs factors like domestic market size, complete industrial chains, rule of law, and intellectual property protection far more heavily than dividend tax breaks, which have minimal influence on investment decisions in manufacturing or high-tech projects.

Fourth, the adjustment protects the legitimate rights of foreign investors and avoids double taxation. Taxes paid by foreign individuals in China can be credited against their tax liabilities in their home countries under bilateral tax treaties, ensuring that compliant cross-border investment continues to operate smoothly. Importantly, this adjustment applies only to foreign individual shareholders. The withholding tax rules for non-resident enterprises receiving dividends remain unchanged, and the two should not be conflated.

International lessons: moving from tax competition to cooperative rules

Cross-border tax avoidance is a shared global challenge. The international community has developed a body of proven tax governance practices that China should draw upon while adapting them to its own circumstances.

The OECD's "Pillar Two" framework sets a global minimum corporate tax rate of 15%, designed to end the race to the bottom among nations. Controlled Foreign Corporation (CFC) rules have also become an international standard, treating undistributed profits of foreign subsidiaries in low-tax jurisdictions as deemed distributed for tax purposes to prevent profit parking. Meanwhile, transparency mechanisms like the US FATCA and the global Common Reporting Standard (CRS) enable automatic exchange of financial account information, making hidden offshore assets increasingly difficult to conceal. China's recent imposition of full-chain taxation on offshore trusts reflects this same "substance over form" principle, converting trusts from "avoidance tools" back into "wealth management instruments."

China should continue leveraging the CRS multilateral information exchange mechanism while adhering to a substance-over-form approach to investigative oversight. Tax obligations should not be determined merely by registration location or identity labels. Instead, the focus should be on identifying actual controllers and economic substance behind transactions to accurately detect disguised avoidance structures. At the same time, such scrutiny must not negate the legal status of round-trip investment enterprises. Proper coordination with Notice 37 is essential: compliance checks should verify the legitimacy of the structure, the authenticity of capital sources, and the completion of statutory foreign exchange registration. Enterprises that have completed registration in accordance with Notice 37 must be recognized as foreign-invested enterprises; their foreign-invested status should not be denied merely because the actual controller is a domestic resident.

On tax credits, the international standard practice allows taxpayers to claim credits for taxes already paid abroad. This adjustment does not increase the actual tax burden on foreign investors. In most countries that tax worldwide income, foreign shareholders who previously enjoyed tax-free dividends in China would still have had to pay tax in their home countries. Under the new rules, the 20% tax paid in China can be credited against tax due in the enterprise's home country under bilateral agreements, so compliant foreign investors' overall global tax burden will not rise significantly.

Addressing root causes: building a modern tax governance system

Eliminating a single tax exemption is far from sufficient to address the deep-seated problems of "fake foreign investment" arbitrage. Numerous tax arbitrage opportunities based on identity and ownership differences still exist and must be tackled through coordinated institutional, regulatory, and reform measures.

At the implementation level, compliance obligations must be firmly established. All domestic residents establishing overseas special purpose vehicles or undertaking round-trip investments must strictly follow Notice 37 procedures, including complete registration for both the SPV and the returning investment. Material changes such as equity transfers or financing adjustments must also be promptly reported. Foreign exchange compliance registration should function as a prerequisite for cross-border investment and round-trip arrangements, eliminating unregistered and non-compliant activity. Enterprise that follow the rules and register properly will be recognized as foreign-invested enterprises with corresponding legal status; those that fail to register will be treated as violations of cross-border capital regulations.

Supporting systems for worldwide taxation also need refinement. As China strengthens tax obligations on residents' global income, it must simultaneously develop matching rules for tax credits, loss carryforwards, and tax deferral to reduce compliance costs and avoid inadvertently harming legitimate cross-border investment. Information sharing between tax authorities and foreign exchange regulators should be enhanced, with Notice 37 registration data serving as essential reference documentation for identifying corporate structures and distinguishing arbitrage from legitimate activity. Cross-departmental coordination among tax, foreign exchange, and market regulation authorities must break down data silos to achieve full-chain monitoring of cross-border capital flows. China should also deepen its participation in international tax rule-making and use multilateral mechanisms like CRS to shrink the space for cross-border tax avoidance.

Market-oriented reforms should be advanced toward "competitive neutrality," thoroughly cleaning up discriminatory or preferential tax policies based on ownership type, identity, or region so that all market participants compete under unified rules.

Balancing policy objectives: nurturing patient capital for high-quality development

While standardizing the tax order, policymakers must also consider how to cultivate a capital ecosystem that serves long-term national development. As China's economy transitions from factor-driven to innovation-driven growth, it needs substantial "patient capital" willing to invest early, invest small, invest for the long term, and back hard technology.

The impact of this policy shift varies by market participant. Real FDI enterprises in manufacturing and high-tech sectors base their investment decisions on market size and supply chains rather than dividend tax breaks, so while after-tax dividend cash flows for foreign individual controlling shareholders will decline slightly in the short term, long-term location decisions remain unaffected. For non-compliant round-trip investment entities that relied on identity arbitrage, the tax avoidance model becomes directly ineffective, making them the primary target of this policy. Small and medium-sized foreign-invested enterprises and asset-light trading companies will see reduced after-tax dividend income and will need to revisit their dividend distribution schedules and cross-border fund arrangements.

Policy design should differentiate between "arbitrage capital" and "patient capital." Short-term speculative capital exploiting identity advantages should be firmly regulated, while patient capital that genuinely serves national strategies, accepts long investment cycles, and tolerates higher risk should receive clear institutional expectations and positive incentives. For example, preferential capital gains treatment for qualifying long-term equity investments or allowing venture capital funds to be taxed on a single-fund basis could be explored. Domestic residents who build red-chip structures through strict compliance with Notice 37, raise funds overseas, and then invest back into domestic science and technology innovation represent a classic patient capital model deserving institutional support and protection. The regulatory focus should remain on speculative behavior that avoids compliance registration and merely exploits identity changes for tax benefits.

Tax leverage should also guide capital toward innovation, green development, and livelihood improvement. Enterprises making breakthroughs in core critical technologies, along with their long-term investors, could receive support through additional R&D expense deductions and investment credits. These tools should direct capital toward tackling "bottleneck" technologies and green transformation, aligning capital returns with national development priorities.

Entrepreneurship also deserves cultivation. Policies should protect legitimate property rights, stabilize market expectations, and enable entrepreneurs to focus on long-term investment rather than tax planning. A fair, transparent, and predictable legal environment is the best soil for nurturing great enterprises. Keeping tax policies stable and predictable reduces short-term risk-avoidance behavior and redirects entrepreneurial energy toward technological innovation and industrial upgrading rather than tax structuring. Enterprises themselves should also strengthen their financial and tax management capabilities accordingly.

Where this leaves a treaty-based arena

The fundamental purpose of this reform is not to increase fiscal revenue but to implement tax neutrality: internally, eliminating identity-based tax privileges; externally, sending a clear signal that while China's commitment to opening-up remains unchanged, it will no longer use special tax preferences as a bargaining chip for attracting investment. The modernization of China's tax system represents a profound self-reform requiring careful balancing between fairness and efficiency, regulation and development, and oversight and service. Repealing an outdated exemption is just the beginning; a fairer, more transparent, more law-based, and more internationalized modern tax system is the fundamental guarantee for China's long-term economic stability and growth.