Under a VIE structure, how do domestic shareholders pay income tax? Here are the key issues you need to understand

Recently, the topic of Chinese companies' offshore listing structures has once again drawn attention. As several tech firms restart their plans for IPOs in the U.S., and Hong Kong continues to open its market to new-economy enterprises, more and more companies are reevaluating their capital-raising strategies. Behind these strategic decisions, however, lies a long-standing but often overlooked issue the income tax obligations of domestic shareholders under the VIE structure.

VIE, or Variable Interest Entity, is a special arrangement that enables offshore listings through contractual control rather than direct equity ownership. First adopted by Sina when it went public in the U.S. in 2000, this model later became the go-to choice for internet, education, media, and other industries restricted from foreign investment. Simply put, instead of being directly owned by an overseas listed company, the actual operating entity in China uses a series of contracts to channel profits to the offshore parent, enabling access to international capital markets. While the VIE structure helps bypass regulatory barriers on foreign ownership, it also brings complex tax challenges-especially for the actual controllers based in mainland China. For these domestic shareholders, figuring out how to comply with tax rules has become an unavoidable headache.

Take a real-world example at the end of 2025, after a well-known online education platform completed a secondary listing in the U.S., its founder was summoned by tax authorities over unpaid individual income tax related to overseas dividends. Though the situation was eventually resolved through compliance adjustments, the incident sent shockwaves through the industry. Many entrepreneurs suddenly realized receiving money via a VIE doesn’t mean getting a free pass on taxes.

So why does dividend distribution under a VIE trigger tax liabilities in China? The answer lies in the tax principle of “substance over form.” Even though the offshore listed entity-say, a Cayman Islands company-doesn't legally own shares in the onshore operating company, the existence of VIE agreements allows the actual controller to effectively manage and distribute the profits of the domestic business. Tax authorities are increasingly treating such arrangements as functionally equivalent to equity ownership.

When the offshore company pays dividends to a Chinese individual shareholder, that income may still be considered sourced from within China. Under China’s Individual Income Tax Law, residents must pay taxes on income earned both inside and outside the country. If the domestic shareholder is a resident of mainland China and hasn’t properly planned for tax compliance, the dividends received through offshore accounts could theoretically be subject to a 20% personal income tax rate.

It gets even trickier because the funds often remain overseas, many shareholders fail to report them altogether, creating significant hidden tax risks. In recent years, with the global rollout of the Common Reporting Standard CRS, Chinese tax authorities have gained access to vast amounts of financial account information about Chinese residents held abroad. This means the old strategy of “hiding money overseas to avoid taxes” is rapidly becoming obsolete.

In early 2025, the State Taxation Administration released guidance on cross-border related-party transactions, further tightening oversight of profit shifting under contractual control models. While the document didn’t explicitly name VIEs, it clearly requires businesses to justify the commercial rationale behind cross-border deals and prevent using structural design solely to evade tax obligations.

So what should domestic shareholders do in response?

First, conduct a proactive tax compliance review. When setting up or maintaining a VIE structure, companies should work with experienced tax advisors to map out the entire fund flow chain and identify potential tax exposure points. For firms planning to list-or already earning income offshore-getting tax filings and disclosures in order ahead of time is critical.

Second, make smart use of tax treaties. Some companies set up intermediate holding companies in places like Singapore or Hong Kong precisely to benefit from favorable tax arrangements with China. For instance, under the mainland-Hong Kong tax agreement, qualifying dividends can enjoy a preferential 5% tax rate. But this requires meeting conditions like the “beneficial owner” test-so shell companies created purely for tax avoidance won’t qualify.

Third, consider restructuring. With growing support from domestic capital markets for red-chip companies returning home-such as the STAR Market allowing VIE + CDR models-some firms are now exploring dismantling their VIEs and relisting on mainland exchanges. This not only improves valuation transparency but also simplifies tax relationships. Of course, unwinding a VIE comes with substantial tax costs and should be carefully weighed.

Finally, remember tax planning must be built on legality. In the past, some companies funneled profits offshore by fabricating service fees or royalty payments. Today, under tighter scrutiny, such practices are easily flagged as tax evasion. Getting caught could mean back taxes, penalties, reputational damage, and even derailment of IPO plans.

At the end of the day, the VIE structure is a double-edged sword. It helped countless Chinese companies go global, but it also planted seeds of governance and tax risk. Now, as the external environment shifts and regulation tightens, the space for operating in legal gray zones is shrinking fast. The winners moving forward will be entrepreneurs who understand both capital markets and compliance fundamentals. They won’t wait for a crisis to act-they’ll factor tax responsibility into their strategy from day one.

After all, walking in the sunlight may feel exposed, but it’s the safest and farthest way to go.