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By Matthew, September 3, 2010 5:57 pm

On January 2010, a multinational investment group disposed of its shares (100%) in a Hong Kong holding company which held a 49% interest in a Chinese joint venture. The transaction was subsequently investigated by the Jiangdu National Tax Bureau in Jiangsu Province. As a result of this investigation, the Jiangdu National Tax Bureau concluded that the Hong Kong company was simply a special purpose vehicle without any employees, assets, liabilities, other investments or transactional business. On this basis the Jiangdu National Bureau indicated to the group that it would impose tax on the transfer on the basis of Circular 698, in particular that there was no reasonable business purpose for the interposed holding company. The group ultimately accepted this position and agreed to pay tax on the transfer amount.

As previously noted on this blog, Circular 698 provides that under certain conditions, overseas investors who indirectly transfer equity in a domestic resident company shall submit materials to the Chinese tax authorities as an obligation. Under the examining and verifying by SAT, indirect transfer can be re-determined according to economic substance, and the overseas intermediate company can be denied as an existence for tax arrangement. This shows the China tax authority’s determination in preventing overseas enterprise avoiding tax obligation in China by indirect equity transfer. The Circular provides the policy basis for taxing indirect equity transfers that was first established in the Chongqing case which was before the release of Circular 698.

Good time to start reviewing some of those ‘tried and true’ structures.

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By Matthew, April 22, 2010 5:04 pm

In 2009 the State Administration of Taxation (SAT) undertook significant steps in relation to clamping down on anti-avoidance practices. However, taxpayers certainly should expect any lessening of the resolve of China’s tax authorities. I just came across an article published (in Chinese) on the SAT website that indicates (and confirms what Hwuason has been hearing) that the SAT considers that there is a significant way to go in relation to anti-avoidance practices – unsurprising really but it reinforces to extent to which the SAT considers this to be an issue.

The article quotes officials as stating that in 2010  China will step up efforts to counter tax evasion, with a particular focus on transfer pricing in the pharmaceutical and automotive industries, the use of intangible assets and share transfers, and cross-border related business transactions.

The SAT spent considerable resources in 2009 developing a sound system for its anti-avoidance investigation practices and it is expected that in 3020 this will continue to be fine-tuned. An official from the SAT’s International Tax Department recently commented that up until “present investigations focused more on anti-avoidance in respect of the purchase and sale of tangible assets, cost sharing by controlled foreign companies and thin capitalization”.

However, from this year, the SAT will look beyond these more simplistic anti-avoidance practices and will examine the issues on a more complex level, including exploring rational pricing of intangible assets and equity. In addition, outbound investment will receive special attention, particularly the transfer pricing practices employed by Chinese companies investing abroad and controlled foreign company management.

The SATs efforts to combat anti-avoidance in 2009 garnered significant results – the work of the national anti-avoidance team resulted in adjustments to taxable income totally 16.09 billion yuan and 2.09 billion yuan in back taxes.

Promisingly, the SAT official also indicated that the SAT will greater encourage bilateral Advance Pricing Agreements (APAs). Bilateral APAs allow multinational companies to achieve greater certainty in terms of their transfer pricing practices. There has been some doubt in the past about the difficulties in obtaining bilateral APAs and accordingly it is encouraging to see commitment to them by the SAT. Since 2005 China has entered into 12 bilateral APAs and it is expected that this number will rise as multinationals become more familiar with China’s approach and the attitude of officials towards them.

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By Matthew, April 7, 2010 2:55 pm

I recently came across a PWC article on the new protocol to the China-Barbados DTA that indicated DTAs can restrict and preclude the GAAR in China. I have extracted the relevant information below (I reducted information not relevant to the point I am making)

This is a rather interesting topic. Many countries take different approaches to the issue. For example, Australia incorporates the terms of DTAs and provides that they will override Australia’s domestic laws except for Part IVA (Australia’s GAAR) – see Section 4(2) of the International Tax Agreements Act 1953 (Cth). Accordingly, Australian law unilaterally determined that its GAAR could not be overruled by a DTA.

Based on the article from PWC above, it seems that China has taken the view that its DTAs must explicitly provide a right to use the GAAR. I am surprised that China did not simply revise Article 58 of the Enterprise Income Tax Law which relevantly provides as follows:

Article 58 Where any provision in a tax treaty concluded between the government of the People’s Republic of China and a foreign government is different from the provisions in this Law, the provision in the treaty shall prevail.

Further, does the new Barbados-China protocol provide a basis for taxpayers to assert that pursuant to the Enterprise Income Tax Law, a DTA will always override the GAAR unless the relevant DTA permits China to apply its GAAR provisions? Not many of China’s DTAs explicitly address the China’s GAAR. Primarily because they predate the GAAR itself.

One thing to note is that the terms of the new protocal may merely be a  clarification that the GAAR will not be restricted by a DTA. PWC’s analysis suggest that it is more than this, hence their contrast between the pre and post protocol position. However, I am not sure that I totally agree. In fact, the local taxation officials (地税）in Xingjiang have already used the GAAR in relation to a Barbados company. The use of the GAAR in this context was endorsed by the SAT. Accordingly, it is not clear that China’s tax authorities accept that a DTA will restrict the GAAR.