On 28 July 2009 the State Administration for Taxation (SAT) issued an announcement indicating its intention to strengthen and monitor cross-border related party transactions. The announcement specifically addressed the issue of the allocation of losses to Chinese enterprises stating that the profits of the enterprise shall be kept at a “reasonable level”.

This is a continuation of the aggressive posturing of the SAT regarding tax avoidance measures. Recently, we have seen strong indications from the SAT indicating that the days of gross tax avoidance in China are over. Traditionally, it has not been difficult to minimise your tax liability in China. Simple devices, such as having payments made off-shore, were usually ignored by tax officials. Such a light approach was consistent with China’s desire, at that time, to encourage foreign investment. However, recently tax officials have begun to use their now considerable armoury to stop MNCs from reducing their taxable profits. 

This announcement comes on the back of recent reports of a shortfall in China’s tax revenue as a result of the global financial crisis. These events should be taken as a warning by companies in China to ensure that their commercial arrangements (including related and third party arrangement) comply with China’s new tax laws. The 2009 tax environment is fundamentally different to that 2 years ago.