Increased tax enforcement in 2010
Posted by Matthew on February 1, 2010 under Anti-Avoidance, China Tax, Tax Controversy | 
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In 2008 China dramatically reformed its taxation system through the introduction of the Enterprise Income Tax Law. There were two substantial changes brought about by the EITL. Firstly, it removed the previous tax distinction for domestic enterprises and foreign invested enterprises (FIEs) under which FIEs had been subject to a highly concessional rate of tax. The second significant change was the introduction and strengthening of China’s international anti-avoidance rules. This included a wider definition of a tax resident company, the introduction of rules relating to thin capitalisation, extensive documentation requirements in respect of transfer pricing, the introduction of a general anti-avoidance rule and controlled foreign company rules.
Throughout 2008 and 2009 various regulations, measures and circulars were promulgated at all levels of the tax administration system for the purpose of implementing the new law. The SAT spent much of 2009 assembling an large enforcement team and hired 500 more officials. One common theme in all of this was the push to target the shifting of profits off-shore. It had been quite a common practice, up until 2008, for foreign invested enterprises to effectively generate no profit in China through an array of related party transactions. As a result of this new environment, nearly all foreign invested enterprises have had to undertake a review of their structures.
It is also important to note that, and in the usual manner of Chinese bureaucratic politics, traditionally local tax bureaus only sporadically, if at all, followed the mandate of the State Administration of Taxation (SAT). This was because the local tax bureaus were also answerable to the provincial and local level governments. Such governments were more interested in encouraging investment in their regions, then ensuring that national level policies were followed to the letter of the law. Accordingly, many legal and non-legal concessional arrangements were entered into at a local level. However, more recently there has been a growing willingness by the local tax officials to follow intructions from the national guys. This has three potential implications. Firstly, we can expect national level policies to enforced more effectively and consistently at a local level. Secondly, many non-legal concessional tax arrangements that were entered into in the past may no longer receive protection by the local officials. Thirdly, it will be less likely that such arrangements will occur in the future.
Yet, we are yet to feel the full brunt of the changes. This is because the tax authorities, whilst having undertaken internal reviews of files, have generally not put taxpayers on notice that they are being subject to an investigation in respect of the 2008 year. The authorities commenced their internal reviews in May/June 2009 and, from what we have been told, will commence sending out notices of tax adjustments in the first quarter of this year. Interesting times ahead – for us anyway.
