The SAT published the draft administrative measures on GAAR (draft) set out in Article 47 of the corporate income tax law of the People’s Republic of China and its Detailed Implementation Regulations (DIR), last month for public comment. One of the draft’s objectives is to give clarity to taxpayers on how the SAT determines tax avoidance, the policies and procedures of GAAR cases, the documents that may be requested, and the types of tax adjustments that could be made to deny tax benefits for transactions without reasonable economic purpose.
“The draft measures are a welcome addition to the Chinese domestic law GAAR as they provide guidance to in-charge authorities that is absent in the existing law,” said TEI president, Terilea Wielenga. “We are concerned, however, that the draft measures expand the GAAR to reach transactions outside the scope established in the DIR, unfairly subject taxpayers to two independent substance-based inquiries when special tax adjustment rules also apply to a transaction, and contain overly expansive document production requirements.”
Article 4(1) of the draft defines a practice as a tax avoidance scheme if:
(i) the sole or main purpose, or one of the main purposes is to obtain a tax benefit; and
(ii) the form of scheme is permitted in accordance with the tax rules, but the form is not consistent with its economic substance.
TEI argues this definition is inconsistent with Article 120 of the DIR, in which the “main purpose is reduction, exemption or deferral of tax payments”. This new definition for tax avoidance, proposed in the draft, would broaden the scope of existing GAAR rules. TEI has recommended the SAT to avoid the increased costs and uncertainties associated with the “one of the main purposes” standard in the draft and to keep the “main purpose” standard set out in Article 120 of the DIR.
Another area of contention for TEI is Article 5 of the draft, which is meant to clarify the types of adjustments that can be made to disallow tax benefits arising from arrangements that lack a reasonable commercial purpose. But in their opinion, the fact that Article 5(4) permits in-charge authorities to make adjustments using “any other reasonable method” is overly broad and could encourage abuse by authorities.
“Undoubtedly, the corresponding impacts to tax planning practices would be higher level of uncertainty,” said Andrew Choy of EY. “Unfortunately, unlike some countries (e.g. Australia) where application of GAAR is subject to more objective examination (e.g. the taxpayers can prove the planning scheme is not tax driven by measuring and quantifying the non-tax savings against the tax savings), MNCs would likely have to adopt higher standards when evaluating the feasibility of tax planning, whether or not, the commercial considerations can obviously outweigh all tax benefits.”
Jinghua Liu of Baker McKenzie agrees with TEI that the draft measures, as they exist now: (i) wrongly expand the scope of GAAR; and (ii) contain overly expansive documentation requirements. However, she does not think the draft unfairly subjects taxpayers to two independent substance-based inquiries when special anti-avoidance rules (SAARs) apply.
“Article 6 of the draft measures stated that the SAARs (for example beneficial ownership requirements, controlled foreign corporation rules and transfer pricing rules) should prevail over GAAR,” said Liu. “MNCs may also need to put more effort into defending their holding structures and business models. With increasing numbers of anti-avoidance cases against them, MNCs can no longer afford to simply accept all adjustments by tax bureaus.”
“Carefully preparing defence strategies, standing firm in negotiations with tax bureaus, being prepared to go to formal proceedings such as administrative review, litigation or competent authority when necessary would help MNCs to safeguard their tax interests in China,” added Liu.
Article 11 of the draft requires businesses that are under investigation by the SAT to submit a wide array of documentation, including communications between taxpayers and their advisers. This would erode client confidentiality and, if not amended, may have implications for tax planning practices.
From the perspective of the SAT, Abe Zhao of KPMG recommends that the draft be amended to contain a provision that allows for the burden of proof to be transferred between the tax authority and the taxpayer. He suggests that, initially, when the SAT issues an information request on the suspicion of tax avoidance, the burden of proof be placed on the taxpayer, but once the request is fulfilled it be transferred to the tax authority, which must produce fresh evidence of tax avoidance to make further documentation requests.
“This can offer some protection to the taxpayers who otherwise may have to comply with never-ending information requests from the tax authorities,” said Zhao. “For MNCs, in the GAAR environment, tax planning can no longer be accomplished between tax professionals alone behind closed doors.”
“Close collaboration between the tax department and the other business functions, as well as the central coordination of senior management, are needed to provide the necessary business purpose and substance to a contemplated tax planning arrangement,” added Zhao.
