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On 16 November 2014 when discussing on the topic of strengthening the world economy’s anti-risk capacity at the Second Phase of 9th G20 Leaders?Summit held in Brisbane, Australia, China’s President Xi Jinping pointed out that "efforts should be made to reinforce the international collaboration on tax matters, to crack down on cross-border tax avoidance and evasion, and to help developing countries and low-income countries improve their capabilities of tax collection and administration." It is the first time that tax matters were noted in an important statement by China’s paramount leader in such a high-profile international political context. To act upon President Xi’s direction to “crack down on international tax avoidance and evasion", China’s State Administration of Taxation ("SAT") has responded immediately, and has released the Administrative Measures on the General Anti-Avoidance Rule (Trial) (the "Measures") to further regulate and clarify various matters relating to application of the general anti-avoidance rule (“GAAR?, such as the applicable scope, judging criteria, adjustment methods, working procedures, dispute resolutions when employing GAAR measures. The in-charge SAT officials recently replied to regulation-related questions from the press on the Measures.
Question 1("Q1"): What motivates the release of the Administrative Measures on the General Anti-Avoidance Rule (Trial) ("the Measures")?
Answer 1 ("A1"): While GAAR was first introduced into China’s Corporate Income Tax (CIT) Law in 2008, it is still a relatively new concept in China. Although the CIT Law and its Detailed Implementation Rules ("DIRs"), together with the Implementation Measures on Special Tax Adjustments (Trial), provide the principles for GAAR application, a set of comprehensive administrative measures has long been absent to regulate local tax authorities?operation procedures and enforcement standards across the country until the release of the Measures. During the last six years or so, the Chinese tax authorities have gathered some practical experience in administering GAAR in examination, and have found an increasingly pressing need to introduce a set of coordinated administrative measures. The Measures are intended to provide a detailed set of guidelines for GAAR application, in order to build up a more transparent, consistent and fair GAAR framework.
Q2: What are the key elements in the Measures?
A2: The Measures further clarify the applicable scope and judgment criteria of GAAR. They also clarify some critical definitions and issues, such as the definition of "tax benefit" and the major features of a "tax avoidance arrangement". These should provide clear guidance to the tax authorities on when GAAR should be invoked in practice.
The Measures provide a set of sound procedures, covering all phases of GAAR administration, from case selection, examination, to conclusion. They also provide sound procedural rules setting out the roles and responsibilities of tax authorities at different levels in each phase to ensure transparent and fair implementation of GAAR. In addition, they provide taxpayers with the right to raise evidence, file objections, and apply for relieves as well as dispute resolutions so as to protect their legitimate rights.
Q3: What kind of tax avoidance arrangements should be subject to GAAR?
A3: According to Article 47 of the CIT Law and Article 120 of its DIRs, any tax avoidance arrangement intended to obtain a tax benefit without reasonable commercial purpose should be subject to GAAR. There are two key elements involved here: one being "without reasonable commercial purpose", which calls for a comprehensive consideration based on the specific facts of each individual case with a key focus on evaluating the economic substance of such an arrangement; the other being "to obtain a tax benefit", which means to obtain any reduction, exemption or deferral of CIT payable. The fact that a tax advantage has been obtained does not necessarily make an arrangement subject to GAAR. This is because the CIT Law itself offers legitimate tax incentives to enterprises. If the economic substance of an enterprise satisfies the relevant conditions for a preferential tax policy under the CIT Law and it enjoys that tax benefit as a result, it should not be subject to GAAR.
In addition, to facilitate the assessment by local tax authorities and self-assessment by taxpayers, the Measures also specify the following two major features of a "tax avoidance arrangement":
1) obtaining a tax benefit is the sole purpose, or the main purpose; and
2) the tax benefit is obtained by using a scheme which is not consistent with its economic substance even though its form may be permissible in accordance with the tax laws.
Q4: Are the Measures applicable to all types of domestic and cross-border transactions?
A4: The Measures are not applicable to the following two scenarios:
1) Arrangements not involving cross-border transaction or payment. Cross-border tax avoidance arrangements may lead to the loss of China’s tax revenue, while the tax adjustments to solely domestic transactions may result in domestic double taxation for the two locations concerned in China. Thus, domestic transactions are not our key focus. The Measures only target cross-border transactions or payments at the moment.
2) Illegal tax behaviors potentially related to avoiding tax payments, avoiding paying taxes due for recovery claim from tax authorities, cheating on taxes payable, refusing to pay taxes and provide forged tax invoices. These violations should be dealt with by the relevant provisions in the Tax Collection and Administration Law.
Q5: Article 92 of the Implementation Measures on Special Tax Adjustments (Trial) also sets out the scope of tax avoidance schemes subject to GAAR. What is the connection between Article 92 and the relevant provisions in the Measures?
A5: The Measures and the existing policies are complementary to each other, and they together form a comprehensive GAAR framework. The CIT Law and its DIRs together with the Implementation Measures on Special Tax Adjustments (Trial) provide the principles for the application of GAAR, while the Measures are to elaborate and explain the relevant provisions of existing policies and to provide detailed assessment criteria for invoking GAAR procedures in practice. Tax authorities and taxpayers should consider the principles under the entire GAAR framework in totality.
Q6: Under what circumstances should GAAR be evoked? How do you see its interactions with other anti-tax avoidance provisions?
A6: Chapter 6 of the CIT Law sets forth a series of anti-tax avoidance measures, including transfer pricing, thin capitalization, cost sharing, controlled foreign corporations, etc. These measures are formulated to target specific tax avoidance schemes respectively and should be applied first in the event that the scheme falls into one of these categories respectively. GAAR should only be evoked if a tax avoidance arrangement is properly dealt with by any of the other specific anti-tax avoidance measures. In other words, GAAR should be the last resort to counter tax avoidance schemes when all other anti-avoidance tools are exhausted.
Q7: How to make special tax adjustment once GAAR is invoked?
A7: Once GAAR is invoked, tax authorities are empowered to make special tax adjustments in accordance with the principle of "substance over form" by referring to similar arrangements with a reasonable commercial purpose and economic substance as the benchmark. The adjustment methods include re-characterizing the arrangement in part or entirely; disregarding the existence of a party to the transaction for tax purposes, or deem this party and the other party to the transaction as the same, one entity; relevant income, deduction, tax incentives and foreign tax credits etc. will be re-characterized or re-allocated among parties to the transaction; or any other reasonable methods.
Q8: Which level of tax authority is authorized to establish and conclude a GAAR case?
A8: Considering the complexity of GAAR cases, both the selection and final conclusion of cases are subject to the SAT’s approval. In-charge tax authority’s application to initiate a GAAR case, the proposal of making no adjustment, along with the preliminary opinion and final opinion for any adjustments should all be reported upwards, step by step, to the provincial-level tax authorities for their review and consensus, which then in turn are further submitted to the SAT for final assessment and determination. This is in line with the current regulations.
Q9: What are the roles and responsibilities of the different levels of tax authorities throughout the GAAR procedures?
A9: Local-level tax authorities should timely identify potential cases for GAAR examination when dealing with corporate income tax filing, tax assessment, contemporaneous documentation review, tax clearance for outbound payments, tax administration of equity transfer transactions and implementation of tax treaties etc.
Where the in-charge tax authority discovers that an enterprise is suspicious of tax avoidance, it shall report the case upwards through different levels to the provincial-level tax authorities for their review and consensus, who in turn further submit it to the SAT for approval to initiate the case for GAAR examination.
In reviewing the information provided by the enterprise, planning advisor, related parties and any other parties involved in a related party transaction examination, the in-charge tax authority may validate the information via field examination, requesting for joint examination with other in-charge tax authorities with formal written requests, or utilize publicly available information etc. Within nine months after SAT’s approval to initiate the case, the in-charge tax authority should, based on the information obtained from the examination, evaluate and assess the case, determine in totality whether the enterprise is involved in a tax avoidance scheme, whether the case should be subject to no adjustment or with an adjustment, the preliminary or final proposal together with the underlying reasons for the adjustment, and report gradually upwards to the SAT to conclude the case.
Q10: Throughout the process of case selection, examination and conclusion of a GAAR case, is it possible for the enterprise under examination to propose a different idea to safeguard its due rights and interests?
A10: Once a GAAR case is initiated, the enterprise being examined receives a "Tax Examination Notice". The enterprise can provide information to the in-charge tax authority, within 60 days upon receiving the Notice (applicable to application for submission extension), explaining the commercial purpose of the scheme and demonstrating that it is not a tax avoidance scheme. Before the case is concluded, the enterprise being examined can respond in writing within seven days upon receiving the Preliminary Adjustment Notice for Special Tax Adjustment Examination ("Preliminary adjustment") if it disagrees with the preliminary adjustment. The above timeline requirements are intended, on one hand, to ensure the efficient application of the GAAR procedures to the case and, on the other hand, to promote a better tax internal control and compliance within taxpayers.
Where the enterprise being examined disagrees with the GAAR assessment made by the in-charge tax authorities, it can apply for legal relief in accordance with the relevant laws and regulations.
Q11: Will the Measures also be applicable to indirect offshore equity transfer?
A11: If an indirect offshore equity transfer involves tax avoidance arrangements subject to GAAR, the Measures are also applicable.
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