Comments (2)

By Matthew, March 10, 2010 2:09 pm

I have just been sent a link to a series of tax blog entries posted by US law firm, Sheppard Mullin, which heavily relies on or copies from materials I have written for this site.

Compare (from Instalment 1 of the Sheppard series) the following with a blog entry I wrote here on the general anti-avoidance rule (see the middle from where it says “The General Anti-Avoidance Rule”):

The introduction of the GAAR is contained in three documents: the Enterprise Income Tax Law (“EITL”), the EITL Implementing Regulations, and the Notice of the State Administration of Taxation on Issuing the Measures for the Implementation of Special Tax Adjustments (for Trial Implementation) (“Measures No. 2”). The SAT has also indicated that it will aggressively use the GAAR to target offshore transactions.

Article 47 of the EITL empowers the SAT to make a tax adjustment where a transaction results in a reduction in taxable income or has no reasonable business purpose. There is “no reasonable business purpose” as defined by Article 120 of the Implementing Regulations of the EITL where the main purpose of a transaction is to reduce, be exempt from, or defer the payment of taxes.

Anti-avoidance investigations, according to Article 92 of Measures No. 2, will target the following offenses:

1. Abusing tax preferences;
2. Abusing a tax agreement;
3. Abusing the corporate organizational form;
4. Avoiding tax through a tax haven; and
5. Any other arrangement without a reasonable business purpose.

Investigations will follow the principle of “substance prevails over form,” which is outlined in Article 93 of Measures No. 2 and requires that the following issues be considered:

1. The form and substance of an arrangement;
2. The time of conclusion and the period of execution of an arrangement;
3. The manners for realizing an arrangement;
4. The connections between different steps or components of an arrangement;
5. The changes of financial status of each party involved in an arrangement; and
6. The tax results of an arrangement.

Articles 94, 95, 96 and 97 elaborate on the methods through which investigations are conducted and tax benefits are canceled, and on other detailed issues.

The sentence I have highlighted in bold actually comes from a M&A tax article that I wrote.

Now compare that article on M&A Tax in China with Instalment 2 and Instalment 3 of the series. What you will notice is that, whilst the language has changed slightly, the exact same structure has been adopted, including names for headings and sub-headings. Despite the change in wording (which isnt great) a few things give the game away:

1. Firstly, Sheppards refer to the fact there are two types of mergers in China. This type of detail wasnt necessary and I only added it in my original article because I wanted to better illustrate the difference between a merger and asset acquisition. It really makes no sense to point this out otherwise and I highly doubt another person would have had the same thought.
2. Secondly, compare this sentence (from my article):

Recent DTA interpretations by the State Administration of Taxation placing considerable doubt upon previously conceived tax benefits obtained from incorporating special purpose vehicles in particular low tax jurisdictions.

with this sentence from Sheppard’s blog:

the new tax law also outlines specifics M&A and liquidation tax rules and places doubt on previously conceived tax benefits from incorporating SPVs in some low-tax jurisdictions

3. Thirdly, the Sheppard series doesnt mention demergers, a critical issue for M&A in China, and something that should be considered in any comprehensive analysis. So why doesnt Sheppard mention this? Because I didnt. I got a bit lazy and left this out of my article as I wanted to get it published asap.

Am I being paranoid with all this?

I dont think so. It seems fairly obvious that my work has been the source of, and copied, by Sheppard. This annoys me, particularly as Sheppard is a relatively large firm that is, presumably, generating significant revenues. By contrast, I work for a small firm with a marketing budget around 1/1000th of Sheppard’s marketing budget (probably even lower). I work hard (mainly on my own time) to make this site what it is and this kind of stuff makes me question if it is worthwhile.  So I can definitely say that I dont take this kind of thing as a compliment. Whether the changes are enough to get around my copyright is irrelevant – it is extremely bad form.

I have pointed out this similarity to the writer. I hope the firm has the good grace to take down these posts and to cease from copying my writing in the future. I accept that this is probably just a case of a young associate facing billable hours pressure trying to get their job done and that senior people within the firm had no knowledge of this.

Comments (3)

By Matthew, March 5, 2010 5:46 pm

During my time in China, I have always been amazed at the types of China tax news that the mainstream Western media reports on. The past few months have seen further examples – we have seen reports on the lifting of the exemption for restricted share, the tax on cars over 1.6 litres and the proposed annual property tax.

I guess these are all newsworthy in their own right but when you consider that the general demographic of the readership of those newspapers would be foreigners and foreign businesses, I am amazed at how much these news items are non-issues in respect of their interests. Yet, we saw little or no reports on Circular 698 and other significant tax developments. I also have not seen any reports on the tax changes for representative offices which is clearly quite significant.

Does anyone have ideas on why the mainstream focuses on these non-issues and not real, substantive tax issues? Any journalists out there want to explain this one to me?

Comments (4)

By Matthew,

Okay as I mentioned, here is my analysis of Guoshuifa [2010] 18. This actually represents my second nostradamus moment during the existence of China Tax Insights. Once again, for those who had paid attention to the tax landscape in China it was not completely surprising. For the last few months I have, on several occasions, indicated that the taxation of ROs was about to change and that people should expect a change for the worse. In fact one of these posts was part of series I did on predicting big tax events for 2010 (a series I havent finished yet and probably wont before 2011 by the way Im going). Its great to already see one of my predictions – well for the ego anywhere – and in fact one of my more adventurous predictions, has come to fruition. The previous posts on this issue can be found here:

1. The Beginning of the End for Representative Offices
2. Are we there yet – Part 1

I should note that another circular issued by the SAT in February (Guoshuifa [2010] 19 is also relevant to my predictions in Are We There Yet – Part 1 and should be read in conjunction with the Circular. I will post about that other circular over the next few days.

___________________________________________________________________________________________

On 20 February 2010 the State Administration of Taxation (SAT) issued Guoshuifa [2010] 18 (the “Circular”), a circular outlining a new tax treatment for representative offices (ROs) of foreign enterprises in China. The Circular replaces several older circulars related the taxation of ROs and the changes are quite significant.

End of Tax Exemption for ROs

In the past, a large number of ROs were exempt from tax in China. The Circular now indicates that the exemption for ROs is to end – both for ROs established in the future and currently existing ROs that are tax exempt. This means a radical shift in profitability for foreign enterprises that had operated in China with such an exemption.

The Taxable Income of the RO

The Circular provides three bases on which the taxable income of a RO is determined; the actual method and two deemed methods. The actual method will apply where the RO can adequately prove gross income and expenses. A similar actual method applied in the past, but in practice it was only used with respect to professional services firms. It is not clear whether the actual method under the Circular will be similarly limited.

The two deemed methods apply where the income of the RO or the expenditure of the RO cannot be adequately established. In such, circumstances the Circular deems the taxable income of the RO to be a minimum of 15% of expenditure or gross income (whichever applies). Under the previous system, the deemed taxable income was 10% so the new Circular will lead to a higher level of taxable income for ROs using the deemed method. The fact that the deemed profit rate is a minimum amount means that local tax officials will have the discretion to impose a higher rate. Once the deemed taxable income is determined, it will then be taxed at the applicable EITL tax rate, which as indicated above will likely be 25%. As a result of all this, where minimal profit is being made by the RO, the Circular provides a strong impetus to keep accurate and sound accounting records so that the actual method can be applied.

Repeal of Guoshuifa (1996) 165

One of the more significant aspects of the Circular is that it repeals Guoshuifa (1996) 165 (“Circular 165”) without addressing matters covered in that circular. Circular 165 indicated what activities of a RO would be taxable and what activities would not be taxable. Non-taxable activities included work carried in relation to the production, manufacturing and sale of the head office’s products, market research, and liaison work. As Circular 165 has been repealed and no mention of non-taxable activities has been made in the Circular, we must assume, unless and until a further circular is issued, that all activities of ROs will be taxable in the future. We understand that tax officials have had long-held concerns about the practice ROs falsely characterising activities to fall within the exception and this may explain why these non-taxable activities are not continued in the Circular.

The Circular possibly represents a fundamental shift in tax liability for ROs in China and, as such, all ROs need to determine how it affects them and impacts upon their profitability.