Demands of National Tax Conference on Anti-avoidance

Posted by on February 20, 2012 under Anti-Avoidance | Be the First to Comment

According to the 2011 state administration of taxation national working paper, China will strike more in tax avoidance. Avoidance and inspection will be executed simultaneously in order to unify the standard control and supervision system against tax avoidance. Strengthen the related transaction declaration, contemporary documents management and tracking management, conduct unilateral and bilateral advance pricing, improve the tax investigation and corporative inspection, are highlighted and emphasized.
To be more precisely, anti-avoidance requires institutional reform to improve the surveillance on all kinds of enterprises. Case studies and expert consulting and hearing team have been effective in the strengthening the internal control mechanism and reducing administrative risks in tax departments.
Secondly, the implementation of tax law must also be consolidated. Monitoring the related transaction declaration, contemporary documentation management, and tracking management are ways to detect tax avoidance in new fields of tax avoidance such as resident enterprises, service industry, associated equity, intangible assets transfer, cost allocation, and the Midwest enterprises.
Thirdly, it is important to establish economics analysis teams to conduct research on intangible assets, equity evaluation, and value chain analysis with quantitative tools. The perfection of intangible assets evaluation (taking a few insights from recent cases in auto industry, element analyses on market appreciation are applied), will therefore initiate a national improvement of rationalized analyzing standard.
The last but not the least, it will be a breakthrough if in-depth research on the collective tax avoidance activities is conducted in different professions and enterprises from a macro perspective. Subsequently, national regulation on anti-avoidance will be more effective when conditional provinces and cities can nominate one or two delegate enterprises in terms of tracking their operation features, cost control, profitability and the trend of development. Professionals and experts in anti-avoidance should also unite and establish industrial research team. For public companies, exploitation of public and internal data should be noted for industrial alarm standards in order to direct local transfer pricing.

China joined the JITSIC officially

Posted by on October 12, 2011 under Anti-Avoidance | Be the First to Comment

On 20th December 2010, China joined the JITSIC officially, sent representatives to JITSIC’s Landon office, and involved in JITSIC’s anti-avoidance work comprehensively.
JITSIC was founded in 2004, and aimed at distinguishing and containing all kinds of malicious tax planning through real-time information exchange under bilateral tax treaties. Currently, JITSIC has seven members (Australia, Canada, Japan, Britain, USA, Korea and China) and two candidates (France and German). JITSIC set offices in Washington and Landon, and all members have sent representatives to these two offices for better involvements.
In the economic globalization and tax internationalization circumstance, the tax avoidance activities that abusing tax treaties and making use of tax system divergences and tax havens became more and more complicated and concealed. Through JITSIC, representatives could research jointly all kinds of tax avoidance models and trends, make real-time tax-related information exchange, increase the transparency of international trades, trace and investigate taxpayers’ tax avoidance, share experience, jointly distinguish and contain all kinds of malicious tax planning, and provide powerful support for members to exercise tax jurisdiction and prevent tax loss.
With the joint endeavor of members and representatives, JITSIC has become an important cooperation platform in international tax collection and management, and gained high attention from all tax authorities. China SAT will make full use of JITSIC platform, take an active part in anti-avoidance work, enhance the international cooperation in tax collection and management, increase the tax compliance, maintain the sate tax benefits, and construct a more fair tax environment for taxpayers.

Anti-avoidance storm whipped up by circular 601

Posted by on July 23, 2010 under Anti-Avoidance | Be the First to Comment

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.

SAT to focus on anti-avoidance

Posted by on April 27, 2010 under Anti-Avoidance, Corporate Tax Planning | Be the First to Comment

In 2009 the State Administration of Taxation (SAT) undertook significant steps in relation to clamping down on anti-avoidance practices. Yet, recent indications suggest that the SAT considers that there is a significant way to go. Officials have been repeatedly indicating that in 2010,  China will step up efforts to counter tax evasion, with a particular focus on transfer pricing in the pharmaceutical and automotive industries, the use of intangible assets and share transfers, and cross-border related business transactions.

The SAT spent considerable recourses in 2009 developing a sound system for its anti-avoidance investigation practices and it is expected that in 3020 this will continue to be fine-tuned. An official from the SAT’s International Tax Department recently commented that up until “present investigations focused more on anti-avoidance in respect of the purchase and sale of tangible assets, cost sharing by controlled foreign companies and thin capitalization”. However, from this year, the SAT will look beyond these more simplistic anti-avoidance practices and will examine the issues on a more complex level, including exploring rational pricing of intangible assets and equity. In addition, outbound investment will receive special attention, particularly the transfer pricing practices employed by Chinese companies investing abroad and controlled foreign company management.

The SATs efforts to combat anti-avoidance in 2009 garnered significant results – the work of the national anti-avoidance team resulted in adjustments to taxable income totally 16.09 billion yuan and 2.09 billion yuan in back taxes.

Promisingly, the SAT official also indicated that the SAT will seek to encourage bilateral Advance Pricing Agreements (APAs). Bilateral APAs allow multinational companies to achieve greater certainty in terms of their transfer pricing practices. There has been some doubt in the past about the difficulties in obtaining bilateral APAs and accordingly it is encouraging to see commitment to them by the SAT. Since 2005 China has entered into 12 bilateral APAs and it is expected that this number will rise as multinationals become more familiar with China’s approach and the attitude of tax officials to them.

China’s General Anti-Avoidance Rule

Posted by on January 6, 2010 under Anti-Avoidance, Corporate Tax Planning | Be the First to Comment

The General Anti Avoidance Rule

Contrary to some claims, China’s GAAR is not “one sentence in a quasi-civil law statute“. The GAAR is actually conained in three legal documents - the EITL (promulgated by the NPC), the EITL Implementing Regulations (promulgated by the State Council) and the Notice of the State Administration of Taxation on Issuing the Measures for the Implementation of Special Tax Adjustments (for Trial Implementation) (“Measures No 2“) (promulgated by the SAT but authorised by the Implementing Regulations).

As mentioned in an earlier post on 698, Article 47 of the EITL basically empowers the SAT to make a tax adjustment where a transaction has been entered into:

  1. that results in a reduction in taxable income; and
  2. has no reasonable business purpose.

Article 120 of the Implementing Regulations of the Enterprise Income Tax Law then defines “reasonable business purpose” as:

The expression “not have a reasonable business purpose” as used in Article 47 of the EIT Law means that the main purpose is to reduce, exempt or defer the payment of taxes.

Article 92 of Measures No. 2 then provides that anti-avoidance investigations should target the following arrangements:

  1. Abusing tax preferences;
  2. Abusing a tax agreement;
  3. Abusing the corporate organizational form;
  4. Avoiding tax through a tax haven; and
  5. Any other arrangement without a reasonable business purpose.

Article 93 of Measures No 2 indicates  the principle of “substance prevails over form” should be followed and that the following matters should be considered:

  1. The form and substance of an arrangement;
  2. The time of conclusion and the period of execution of an arrangement;
  3. The manners for realizing an arrangement;
  4. The connections between different steps or components of an arrangement;
  5. The changes of financial status of each party involved in an arrangement; and
  6. The tax results of an arrangement.

Articles 94, 95, 96 and 97 then provide further detail on how investigations should be conducted, matters to be considered, the method of canceling tax benefits and what can be expected from the taxpayers (and its professional advisers).

That seems fairly detailed and rather precise to me. Compare this with Australia’s first GAAR (that has now been repealed and replaced). The former section 260 of the Income Tax Assessment Act 1936 held any contract

  1. altering the incidence of any income tax;
  2. relieving any person from liability to pay any income tax or make any return;
  3. defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or
  4. preventing the operation of this Act in any respect;
to be void as against the Commissioner.

That was it  – pure and simple.

Do vague tax laws always favour the tax officials?

This leads me to a point I made above. In developed tax jurisdictions vague, broad laws can be counter-productive – section 260 is a case in point. From 1936 to 1981 (apart from some early positive cases) this section was over time gradually read down by the courts so that it was effectively neutered. Initially this was done on the basis that the section:

“The section, if construed literally, would extend to every transaction whether voluntary or for value which had the effect of reducing the income of any taxpayer” (Deputy Federal Commissioner of Taxation v Purcell (1921) per Knox CJ) (this was with respect to earlier legislation drafted in similar terms)

However, the courts in the 1950′s provided that section 260 had no application where the taxpayer made a choice between two alternatives explicitly permitted by Act. This may seem a common sense approach. However, in the 1970′s, this “choice principle” was subsequently used to allow taxpayers to flagrantly construct circumstances permitted by the Act to avoid the operation of section 260.

This could not occur in China. All decisions in cases that I have seen which involve disputed interpretations of vague tax provisions have been interpreted to provide the widest possible meaning. I am also not aware of any case where a SAT Circular (or other Regulation) has been invalidated by the courts because of an inconsistency with a Basic Law. A colleague has mentioned (Im not sure if this was a tax case) that there was a case where the judge held a regulation to be inconsistent and refused to enforce it. However, this judge was, apparently, subsequently suspended. Caution should be used in relying on this story as may be the legal equivalent of an urban myth.