China’s Anti-tax Avoidance Rules

By China Briefing, Dezan Shira & Associates

Posted: 28th February 2018 09:04

The general anti-avoidance rule was first introduced in China under the 2008 CIT Law. It empowers Chinese tax authorities to make reasonable adjustments where an enterprise implements an arrangement without reasonable business purposes in order to reduce its taxable income or profit. According to the CIT Law’s Implementation Guidelines, “an arrangement without reasonable business purpose” refers to an arrangement which has the main purpose of obtaining tax benefits such as the reduction, elimination, or deferral of tax payments.

Prior to 2008, a special purpose vehicle (SPV) was the most common structure used by foreign companies to hold investments in China. A SPV refers to a holding company set up outside of China – usually in Hong Kong or other locations that boast notable tax advantages and favorable tax treaties with China – for the special purpose of holding equity interest in an onshore FIE.

When the foreign investor disposes of its investment in China by transferring equity in the SPV instead of directly selling the Chinese company’s shares, the transfer is technically exempt from capital gains tax in China since both the seller and subject entity are located offshore. The shares of the Chinese company didn’t change owners – it continues to be owned by the holding company – so the investor would not have to pay Chinese capital gains tax. The offshore company in such a transaction would often be in a country that imposes a low, or even zero, capital gains tax on income from equity transfers, which enables further tax benefits for the investors.

However, in recent years, offshore equity transactions have been increasingly subject to heightened scrutiny by the Chinese tax authorities as the country strives to protect its tax revenue.

On January 9, 2009, the SAT issued the Implementation Measures for Special Tax Adjustments (for Trial Implementation) (Guo Shui Fa [2009] No.2), among other measures, provided a stronger regulatory basis for disregarding an SPV that lacks economic substance. The areas specified for anti-avoidance investigation include:
Guo Shui Fa [2009] No.2 empowers the tax authorities to disregard the existence of an enterprise that has no economic substance and to annul the tax benefits obtained by such an enterprise – specifically, enterprises established in tax havens that allow their related parties or non-related parties to avoid taxes.

At the end of 2009, China’s tax authorities further emphasized their intention to scrutinize offshore indirect transfers of Chinese equity interests by non-resident enterprises via the promulgation of Guo Shui Han [2009] No.698. It was further amended by SAT Announcement [2015] No.7 in 2015.

Accordingly, where an offshore controlling shareholder indirectly transfers equity in a Chinese resident enterprise, the parties to the transaction and the Chinese resident enterprise whose equity is transferred indirectly should subject relevant materials to the tax authorities voluntarily or upon request. By submitting relevant materials voluntarily within 30 days from execution of the equity transfer contract or agreement, the future tax penalty may be reduced or waived if they are not qualified for the tax breaks.

Guo Shui Han [2009] No.698 and SAT Announcement [2015] No.7 also clarify the tax policies for the indirect transfer of Chinese assets/equity. Where an offshore equity transfer has no reasonable commercial purpose, the indirect transfer shall be redefined as direct transfer of equity of Chinese resident enterprises and Chinese tax shall be imposed on the transfer.

Importantly, SAT Announcement [2015] No.7 clarifies what is considered a reasonable commercial purpose. Instead of having a single defining factor, SAT Announcement [2015] No.7 lists a number of elements that may contribute to the transaction having a reasonable commercial purpose. The official explanation emphasizes that more than one factor needs to have been met. Single or partial factors will not suffice. These factors are:
Certain transactions are automatically deemed to not have a reasonable commercial purpose if:
However, an indirect transfer shall not be flagged in following circumstances:

This article was first published on China Briefing.

Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll, and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India, and ASEAN, we are your reliable partner for business expansion in this region and beyond.

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