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China: First tax case decision by Chinese Supreme Court

30 May 2017

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China's first ever tax case opens the way for an increasing body of court case guidance and makes court appeals of tax cases an increasingly relevant option for taxpayer disputes.

Khoonming Ho Lewis Lu

On April 17 2017, the first ever tax case decision by the Beijing-based Chinese Supreme People's Court (SPC) was released online. The case was brought as an appeal by Guangzhou Defa Housing Construction Co. Ltd. (Defa) against an imposition of tax and penalties by the Guangzhou Local Tax Bureau (Guangzhou LTB), following an earlier administrative review and hearings at local and provincial court levels.

In the past two years, tax cases have begun to be heard much more frequently at provincial court level. For example, a case concerning the UK-based The Children's Investment fund (TCI), heard by the Zhejiang Province People's High Court in December 2015, was the first case on the application of the general anti-avoidance rule to an indirect offshore transfer of a China investment. A further case, decided by the Shandong Province Zhifu District People's Court in December 2015, dealt with the Italian Illva Saronno Holding SPA's use of the corporate income tax (CIT) reorganisation relief provisions. A further decision, made by the Guangdong Province People's Intermediate Court in November 2015, was the first to deal with the individual income tax (IIT) treatment of dual employment arrangements, specifically under the China-US DTA.

Building on these earlier cases, the Defa case takes China court engagement in tax cases to the next level, by involving the SPC. It might be noted that all three of the above cases were decided in favour of the tax authorities. In this case, the SPC decided partly for Defa and partly for the tax authorities.

The facts of the case are that a Guangzhou-based auction house handled the sale of a portion of a residential property held by Defa in Guangzhou. The majority of the property sold by the auction house was sold to a Hong Kong company. It was observed that the legal representatives of Defa and this Hong Kong company had previously been married. The tax authorities concluded on audit that the transfer price was unduly low and that this artificially held down Defa's business tax and flood defence fee obligations on the transfer. They asserted that Article 35 (1)(6) of the Tax Collection and Administration (TCA) Law empowered them to determine the tax payable on a deemed basis, and adjust the transfer price upwards.

Support for their position was based on the facts that:

  • The other parts of the Defa residential property, sold by Defa, were transferred at much higher values,;
  • The initial value estimate prepared for Defa for the disposed estate by an accounting firm was much higher;
  • The original cost of the disposed estate audited by an accounting firm was much higher; and
  • Comparable properties in Guangzhou sold for much higher prices in the same period.

The SPC concluded that the tax authorities did have both a solid factual and legal basis for the upward adjustment to Defa's business tax and flood defence fee obligations. As has been the case with earlier lower level court cases, the SPC noted that the courts will generally not disturb the conclusions of the tax authorities, unless they abuse their powers or their actions are obviously unreasonable, in line with Article 70(1) of the Administrative Procedure Law, even if the sale is handled by an auction house.

By contrast, the late payment surcharges (LPS) impositions were considered unsupportable and the tax authorities were instructed to repay these to Defa. The relevant provisions of the TCA Law allow imposition of LPS where a taxpayer fails to pay taxes within the prescribed time limit, or underpays tax due to its own fault, or refuses tax payment. The SPC determined that the tax authorities could not prove that any of these situations ere in point. Going further, the SPC set out an interpretation of the LPS provisions that differs somewhat from the traditional understanding, in a way beneficial to taxpayers. Per the SPC, LPS is to be calculated from the date of additional tax assessment, rather than from the date of the original transfer. Further, the SPC asserted that no LPS is payable where the tax authorities are unable to prove that tax underpayment is the fault of the taxpayer – traditionally it was understood that this LPS exclusion would just apply where the tax authorities themselves were at fault.

The specifics of the decision aside, the fact that tax cases are now starting to go all the way to SPC level in China is an important development. It opens the way for an increasing body of court case guidance to emerge in the China tax space and makes court appeal of tax cases an increasingly relevant option for taxpayer disputes.

Khoonming Ho (khoonming.ho@kpmg.com) and Lewis Lu (lewis.lu@kpmg.com)
KPMG China
Tel: +86 (10) 8508 7082 and +86 (21) 2212 3421
Website: www.kpmg.com/cn






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