Sorry I just have a problem with some of the supposed “legal” analysis going on out there about 698. Deloitte made the following comment in their summary of the Circular.
Circular 698 creates some legal questions as to whether the Chinese government has the right to tax foreign companies
Now perhaps I have misinterpreted this but this is just plain wrong. China has a right to tax foreign companies in respect of income sourced from China. Every single one of China’s double tax treaties recognises such a right, subject to some limitations. Standard theories of international taxation support such a right. China’s Enterprise Income Tax Law supports such a right. Perhaps this is just a loose statement by Deloitte but I expect better.
The difficult issue in respect of Circular 698 is that income from the sale of an off-shore entity is not strictly China sourced income (in the usual sense that the term is understood). Accordingly, the more pertinent question is whether the SAT can use Article 47 (the general anti avoidance rule) of the EITL to reconstruct the arrangement to deem the income to be Chinese sourced (that is, a sale of the Chinese resident enterprise). Personally I cant see why not. Perhaps this is because I am accustomed to the Australian Taxation Office’s use of Part IVA of the Income Tax Assessment Act (which contains Australia’s general anti-avoidance rule). However, Article 47 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.
Interposing an off-shore company and the sale of it would seem to be a transaction that results in a reduction of taxable income. The real question will be whether there is a reasonable business purpose and that will be subject to the particular circumstances.
Those people over at PWC provide a more reasoned argument when they raise the issue of the interaction between Chinese taxation and taxation in the home jurisdiction (not the off-shore jurisdiction). For example, if an Australian company transfers an off-shore company, the income would be taxable under Australia’s capital gains regime. However, if tax has been paid to China (under Circular 698) then the Australian company would be entitled to a tax off-set in Australia and the ATO would be worse off. However, it does seem that the ATO wants to do the same thing as the SAT so there may be the prospect of agreement on this issue.
Good little post by one of my Hwuason colleagues over at China Tax Blog on the operation of the myriad of Chinese tax laws and regulations. It can be rather confusing at times. That post should give you some idea of where Guoshuihan 698 came from and where it sits within the Chinese tax framework. It is basically an internal policy document – an interpretative document in respect of GAAR (Article 47) in respect of off-shore companies. Strictly speaking it cannot be binding on taxpayers. The source of the legal basis for the requirements of the circular must be found elsewhere – in this case the SAT would argue Article 47 of the Enterprise Income Tax Law and Article 120 of the Implementing Regulations would provide such a legal basis. Whilst this may fine for the substantive part of Circular 698 (that avoiding tax through interposing an off-shore company may be subject to tax adjustment), it is not clear what is the legal source of the documentation requirements.
However, this is pure legal analysis. Such legal niceties are not always relevant in tax administration in China and, as Zhiqun points out, in practice circulars like 698 effectively have the force of law.
A fascinating little case was decided by the Indian High Court a few weeks ago in relation to foreign law firms establishing offices in India. The issue at the centre of the case was whether a particular clause of the Advocates Act, the relevant legislation regulating the Indian legal profession, requiring persons “practising the profession of law” to be enrolled with a State Bar council, applied to non-litigous legal work. Accordingly, the criticial issue was whether person’s engaged in non-litigous work practice the profession of law. The foreign firms that were the respondents to the writ argued that they were not. How often do you get lawyers to say they are practising law? Did the law firms fees reflect the fact that they werent “practising law”? I very much doubt it.
I should note that the argument by the respondents in the case was a techical argument based on the terms of the Act so its not really as incredible as it may seem at first glance. However, I still enjoy the image of these lawyers then explaining to their clients that they do not practise law in India – very much doubt that would ever happen.
I would think that the argument would give a lot of joy to the litigation lawyers out there who generally do not regard corporate and tax lawyers as true lawyers 
Interestingly, there does not appear to have been the usual consideration in respect of whether foreign law firms are able to practice foreign law in India. This is the basis on which foreign law firms practice in China – strictly speaking they are not permitted to practice Chinese law. I am not sure why this was not mentioned. I assume if this submission had been made by the respondents it would have been dealt with in the judgment. I also assume that if the submission was not made it was for good reason.
I have uploaded a copy of the judgment here:
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