One last post on 698
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.
Having read through this, but not being a tax expert, I have to say that this seems to me to be very sensible, as opposed to what I have previously read about Circular 698.
My (limited) tax knowledge is also Aussie-based and I, at least, do know about Part IVA of the Australian ITAA. Put in this context, Circular 698 appears on par with world practice.
This reminds me of the time when the Chinese Ministry of Commerce issued its amended M&A provisions in Sept 2006, providing for the review of foreign investment in strategically important areas and well-known Chinese brands. There was a hue-and-cry for a bit before everyone realised that this (a) did not affect the vast majority of M&A activity in China and (b) was consistent with practice in other countries.
Just because it’s China, it seems, we tend to jump to conclusions.
Geraldine thanks for your considered comment and I similarly agree with you about the China element often inhibiting perspective – I think reaction to the government’s rejection of the Coca Cola buyout of Huaiyuan is a case in point.
The only anomaly in the Circular that I can see is the documentation requirements. However, it is likely that this same information would need to be disclosed in the Chinese company’s China transfer pricing report (I would imagine that any such structure would also include inter party transactions) so its doubtful that these requirements will create significantly more work.
In terms of the substantive issue, so long as you can document your non-tax reasons for having such a structure it is doubtful to create an issue.
In overall terms, I cant imagine why anybody would dispute China’s right to tax, what is in substance as opposed to form, the sale of a Chinese resident enterprise. If Circular 698 is used for this purpose, as the SAT have indicated it will be, I similarly dont really understand the hysteria.