China’s General Anti-Avoidance Rule

Posted by Matthew 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 Compare this with Australia’s first GAAR (that has now been repealed and replaced).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.

China tax regulations aim to confuse.

Posted by Shi Zhiqun on December 31, 2009 under China Tax | Be the First to Comment

Many readers may have come across the many different types of tax regulations and policies in China – such as Caishui, Guoshuifa, Guoshuian etc. This can all be quite confusing at times so we thought that we would attempt to clarify how the laws, regulations etc interact. We will use the Enterprise Income Tax system as an example.

Basic Law

The taxation of enterprises is governed principally by the Enterprise Income Tax Law which was promulgated by the National People’s Congress (China’s governing parliament). The EITL is what is referred to as a Basic Law. This is the fundamental law underpinning a certain legal area (in this case the income taxation of enterprises). The NPC only meets once a year so Basic Laws can be very difficult to change. It can take up to ten years from an initial draft stage to the promulgation stage. Also, as with any political system, the more decision makes involved in a process the more highly politicised an issue will be. As such, Basic Laws are usually very … basic. They tend to be quite short and vaguely drafted in order to accomodate change at the level of regulations and to obtain a broad consensus.

Implementing Regulations

The next document in respect of enterprise income taxation is the Implementing Regulations of  Enterprise Income Tax Law which is issued by the State Council. Now we start to get a bit more substantive.  The State Council meets on a regular basis and is a relatively small group (in contrast to the NPC). The Implementing Regulations puts the meat on the bone of the EITL. However, once again the Implementing Regulations are not overly detailed and leave a lot to the imagination (or the tax authorities). Implementing Regulations are basically drafted by the SAT and signed off by the State Council.

Circulars and Measures

There are a number of different circulars and measures that are issued at different levels of the tax administration including the following:

1. Guofa -  these are circulars issued by the State Council. These are usually very short and confined to a single issue or topic area;
2. Caishui – these are notices jointly issued by the SAT and the Ministry of Commerce;
3. Guoshuifa (or Measures) – these are issued by the State Administration of Taxation and can be quite detailed. In 2009 the SAT issued Guoshuifa (No 2) a very detailed range of measures on anti-avoidance practices.
4. Guoshuihan – these are internal circulars issued by the SAT to the various provincial and local level SATs and local taxation bureaus outlining policy practice in respect of a certain area. In early December 2009 the SAT issued Guoshuihan [698] 2009 which outlined a new practice in respect of the taxation of off-shore equity transactions.

From a theoretical legal perpsective, the regulations higher up the end of the chain will have more force. For example, if a Guoshuihan circular contradicts a Caishui circular, the latter will prevail. However, in practice they are all fairly equal in terms of the need to be obeyed. Whilst Guoshuihan circulars are only internal policies, they effectively reflect the terms of the superior Laws and Regulations themselves, or at least the SAT’s interpretation of those Laws and Regulations.

To make things more confusing, these are just the regulations issued at a national level. Each provincial level SAT and, in fact, each provincial taxation bureau have their own set of regulations and policies.