Anti-avoidance storm whipped up by circular 601
Posted by Jiang Diwei on July 23, 2010 under Laws and Regulations | 
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Recently, Company A, which registered in Barbados, transferred its holding equity, of which certain real estate company in Xuzhou, to Company B which registered in China at a premium. According to bilateral tax treaty between China and Barbados, income of the transfer should be levied by resident country. As a result, company A filed its applications to National Tax Bureau in Xuzhou on the purpose of enjoying the treatment of tax treaty. National Tax Bureau in Xuzhou considered company A was a conduit company through inspection, which was inconformity to the conditions of tax exemption by tax treaty. The tax bureau required company A to prove itself beneficial owner and having effective management according to circular 601 and Chinese new enterprise income tax law respectively. After rounds of negotiation, company A could not offer valid proof throughout, as a result, company B withheld non-resident enterprise income tax on the equity transfer for company A.
Xuzhou case is another sample which shows the tax authority’s determination in anti-avoidance since the issuing of circular 601. Regardless of the rationality of the circular, it is arguable that whether tax authority properly dealt with the case.
First of all, there was defective on application of law. According to the rules of validity of laws, when applying laws concerned tax, the validity of international treaty is usually ranked higher than the domestic regulation. Therefore, it should be followed bilateral tax treaty to decide that whether Company A can enjoy the tax treatment, rather than Chinese enterprise income tax law or any provisions in circular. In this case, tax authority applied general anti-avoidance standards according to domestic law in order to make judgment that company A could not be classified into the privileges beneficiary, which should be deemed as breaching rules of law application.
Secondly, whether company A can be defined as a resident enterprise in Barbados should be determined by bilateral treaty or domestic law in Barbados, rather than Chinese law. While the bilateral treaty stipulates that, residence of the contracting country means that according to the domestic laws of contracting country, someone who has the obligation for tax to contracting country, in consideration of the place of residence, dwelling, head office, effective management or other similar standards. Company A has already provided the proof for resident tax payer in Barbados, which has satisfied the conditions of being a tax privilege at least in formality. On some degree, it is with doubt that tax authority identifies company A as a non-residence enterprise in Barbados based on Chinese law is legal and rational.
After all, there are two issues needed to be paid attention to when observing Xuzhou case.
As first, when should the taxpayer identify as a beneficial owner? Circular 601 requires it at the time when residence enterprise of contracting country applies for enjoying the treatment in aspects of dividends, interests, loyalties and etc. While how to understand the word etc, and whether it should include property entitlements, both of which have not yet been final concluded. More or less, observing from the attitudes when tax authority deals with relative issues, circular 601 should apply to property entitlements and other incomes.
In additional, circular 601 objectively exempts the tax authority’s proving obligation, which is equivalent to conversion of burden of proof. As stipulated in circular 601, when tax payers apply to enjoy the treatment of tax treaty, they should prove themselves beneficial owners. On these grounds, tax authorities actually shift their proving obligations to taxpayers, and make it harder for taxpayers to apply for the privileges.
