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:
- that results in a reduction in taxable income; and
- 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:
- Abusing tax preferences;
- Abusing a tax agreement;
- Abusing the corporate organizational form;
- Avoiding tax through a tax haven; and
- 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:
- The form and substance of an arrangement;
- The time of conclusion and the period of execution of an arrangement;
- The manners for realizing an arrangement;
- The connections between different steps or components of an arrangement;
- The changes of financial status of each party involved in an arrangement; and
- 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 Compare this with Australia’s first GAAR (that has now been repealed and replaced).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
- altering the incidence of any income tax;
- relieving any person from liability to pay any income tax or make any return;
- defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or
- 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.