Preserving taxpayers’ rights in China
Kevin Ng, Ron Cheng Ma and Kerry Yanbin Kuang of Deloitte explore how China has strategically developed its legal framework to provide a higher level of protection for taxpayers.
If you ask a tax director what keeps them awake at night, uncertainty arising from the unprecedented changes in global tax regimes may well be the most popular answer.
As the second largest economy globally, China has been striving to improve its tax regime by including a higher level of protection of taxpayers' rights – the journey is, however, long and winding.
The highly centralised tax administration system in China comprises succinct laws and regulations, which inevitably lead to dispersive and divergent interpretation by the local tax authorities, especially if the matter is abstruse and complicated.
This article explores the potential alternatives for taxpayers to preserve their rights in China.
China tax administration reform
The China tax administration reform, which debuted in 2015, has greatly enhanced the rights of taxpayers in China, and has overseen an acceleration in tax reform in China, including, but not limited to: delegation of power and improvement of services to taxpayers; large scale abatement of tax and a reduction in fees and levies; continuous advancement in legislation; and optimisation of the tax-related business environment.
To identify possible tax implications, taxpayers used to discuss their proposed activities with the tax authority, with a view to securing verbal commitment from the official in charge. Needless to say, the discussion could be time consuming and painstaking, with a highly unpredictable outcome. However, the process was streamlined following the abovementioned reform, which has removed the necessity to seek prior approval from the competent tax authorities (with the exception of six items) and, therefore, allows taxpayers to choose the applicable tax treatment based on their own assessments. The Chinese tax authorities, however, still review the choice made by the taxpayers and may challenge it, leading to a potential reversal of the tax treatment chosen, and an imposition of incidental interest or penalty, depending on the merits of each case.
One important point to note is the Chinese tax authorities’ increasing deployment of digital means, making use of data analytics tools to assess the tax risks of taxpayers (especially the large scale enterprises or key revenue taxpayers) with a view to identifying suspicious transactions or irregular or unusual tax statistics, which are then cascaded to the local level authorities to follow up. Taxpayers are given the opportunity to review and explain the situation. It therefore becomes critical for taxpayers to be cautious in conducting their tax compliance in China.
Possible alternatives to preserve taxpayers' rights
After decades of ‘tug of war’ with the Chinese tax authorities, taxpayers have three opportunities to address their tax matters: pre-, mid-, or post-event, depending on their own merits.
Advanced pricing agreements
Advanced pricing agreements (APAs) have gained popularity among multinational companies (MNCs), especially when there are related-parties transactions involving China, as APAs serve as an effective ex-ante mechanism to provide higher certainty to taxpayers, to enhance the efficiency of tax administration, and to mitigate avoidable disputes between parties.
With a clear regulatory framework and standardised application procedure the State Taxation Administration (STA) has received hundreds of APA applications which are handled by a specialised team comprising officials from the STA and lower level tax bureaus with expertise, experience and language proficiency. Despite the unprecedented impacts attributable to the COVID-19 pandemic, the Chinese tax authorities continue to accept new APA applications, including bilateral and unilateral, and to expedite the settlement of existing APA cases through an unconventional approach. For example, competent authorities’ negotiation under the bilateral APA application can now be conducted online, which is proven particularly successful for Sino-Japan and Sino-Korea bilateral APA cases. Meanwhile, a couple of provinces and municipalities, including Beijing, Shenzhen, and Guangzhou, have concluded unilateral APA cases through a combination of online and offline communications with taxpayers. This demonstrates that the APA is one of the most feasible solutions for MNCs to ascertain and secure their rights.
Pilot advanced ruling system
Other than the APA mechanism, taxpayers have been longing for an advance ruling system in China, with proven results beginning to emerge. There was a reported pilot case in Wuxi, Jiangsu Province where the local tax authority granted prior consent regarding a deferral of tax liability arising from a contemplated merger of Chinese entities owned by two non-resident companies. Earlier in 2020, the tax bureau of Nansha District, Guangzhou, issued a local tentative regulation stating that they would accept advanced ruling applications from taxpayers on ‘complicated’ tax issues. Hence, a ripple effect is anticipated such that an advanced ruling mechanism will be officially considered and introduced into the next round of the Tax Administration and Management Law Review.
Taxpayers should, however, bear in mind that an advanced ruling is not a substitute for prior approval, as it is not legally binding on the Chinese tax authorities, but merely a right of taxpayers in most of the tax regimes. Therefore, its effects are yet to be seen, even if it is formally introduced into the Chinese tax legislation.
Taxpayers may inadvertently make mistakes – due to human error, or unpredictable changes in circumstances – which may trigger a penalty, and in some instances, adversely affect their creditability standing, eligibility for tax incentives, or even their public listing status or fund raising ability. Taxpayers have a number of recourses in order to avoid unfavourable consequences:
Taxpayers are encouraged to correct their non-compliant behaviour voluntarily in order to avoid or mitigate an administrative penalty, which is imposed by the Law of Administrative Punishments of China. For example, the Chinese customs rules stipulate that the administrative penalty could be waived for import/export enterprises if they disclose the violations voluntarily and correct them within three months of the violation. Although the Chinese tax authorities have not yet promulgated similar rules, in practice, they do encourage voluntary correction by taxpayers without triggering any administrative penalty. It is anticipated that the next round of Tax Administration and Management Law Review will take this into consideration.
No subjective fault, no administrative penalty
This principle is notably added into the proposed revision of the Law on Administrative Punishments, published in July 2020 for public consultation. The draft suggests that administrative punishments would be imposed on a party who has made errors wilfully.
Once this rule is legislated, the onus of proof will be on the Chinese tax authorities before they can impose any penalty. This should provide relief to taxpayers, in cases where they have accidentally made incorrect filings or treatment with respect to their tax matters.
Complaint about services of tax officials
The STA published the Administrative Measures for Complaint about Services of Tax Officials in 2019, which regulates and optimises the treatment of complaints about the services of tax officials in order to improve the quality and efficiency of the services, and most importantly, to protect the legitimate rights and interests of taxpayers better.
The scope of complaints covers not only the improper choice of words or inappropriate attitude of the tax officials, but also the circumstances when the taxpayers fail to enjoy the legitimate tax benefits or incentives due to the misinterpretation of the relevant rules or regulations by the tax officials. Obviously, this will greatly enhance the equality between tax officials and taxpayers.
Rights of stating, defense and hearing
Despite the above, if taxpayers disagree with the tax authorities about the treatment of their tax matters, there are several alternatives available to resolve the situations.
The Law of Administrative Punishments was promulgated in 1996 and has been widely applied by the Chinese Administrative authorities. It has, however, drawn increasing attention of taxpayers in recent years, as the punishments imposed therefrom may create far-reaching effects. Depending on the merits of each case, it is not uncommon for tax authorities to impose administrative actions such as a penalty, or withdrawal of the right to issue value added tax invoices against the delinquent taxpayers.
Such actions will affect the operations of the taxpayers and may jeopardise their listing status or creditability in the market place. Should this be the case, the taxpayers are, however, entitled by law to plead their case. Taxpayers are entitled to receive a notification from the tax authority, clearly summarising the facts and findings of the matter, the legal basis of the tax authority's decision, and the rights of the taxpayers to state and defend their case. The taxpayers can respond in writing or verbally, or even call for a hearing with the competent tax authority if they do not accept the decision. The taxpayers must clearly state their case with supporting evidence, for the competent tax authority to re-evaluate its prior decision. Regardless of the outcome, the expenses pertaining to the hearing are to be borne by the Chinese tax authorities and, more importantly, no additional penalty or actions are to be imposed on the taxpayers for this recourse.
One point to note is that the law is under review by the Chinese government. While the draft amendments are still to be finalised, it can be understood that the review mainly aims at refining the definition of administrative punishments, widening the types of punishments, delegating the legislative powers to lower levels, and intensifying the key administrative punishments, in order to improve the system and procedures of the law.
Taxpayers are reminded that the call for a hearing must be submitted in writing within three days of receipt of the Notification of Administrative Punishments and that the tax authorities must respond to the hearing application no later than 15 days from receipt of the application. If the hearing application is accepted, the tax authorities must give at least seven days’ notice to the taxpayers before the hearing.
If the taxpayers cannot resolve the matter, they can consider to resort to the administrative appeal or litigation in accordance with the relevant Chinese laws.
Administrative appeals and litigations
Legal action is generally regarded as natural means available for taxpayers when they disagree with the decision of the tax authorities. However, there has not been many appeal or litigation cases in China as, traditionally, taxpayers seldom resort to these alternatives when they have disagreement with the tax authorities. This may be attributable to the rule of ‘pay before appeal’ stipulated by the Tax Administration and Management Law. This rule requires taxpayers to settle the disputed tax amount first, or provide a guarantee to the tax authority, before submitting an appeal to the higher level tax authority.
However, in the past decade, the number of tax administrative appeals and litigations reported has quadrupled, and among the cases, it is very encouraging to see more verdicts are in favour of taxpayers. In 2018 and 2019, the Supreme People’s Court of China published a set of ‘exemplary’ tax cases, where some rules or common practices adopted by tax bureaus for decades were re-interpreted and overruled by the judges. Although China is not a case law jurisdiction, local courts usually prefer to follow the Supreme Court's precedents, so there is optimism that legal remedies can be an effective alternative to preserve the rights of taxpayers in China in the near future.
Meanwhile, the government has been receiving some opinions from academia and industry practitioners to relax the requirement of ‘pay before appeal’ in the next revision of the Tax Administration and Management Law, and if that change is written into law, it should provide further impetus to taxpayers to consider the appeal alternative.
In recent years, the Chinese government has emphasised the importance of creating an open and level business operating environment in China, and indeed formulated many strategies and policies, including the increasing promotion and protection of taxpayers' rights. Coupled with the various reductions in taxes and levies in the past two years, taxpayers in China should experience some sunshine despite the global political instability and economic downturn.
However, in the midst of the global pandemic, there will be mounting pressure on governments to address the challenge of economic recovery, and it is highly likely that some tightening-up measures will be implemented in the tax administration, not just in China, but also overseas jurisdictions, especially towards suspicious transactions or irregular business activities. Therefore, taxpayers should thoroughly be aware of their legitimate rights under the relevant rules and regulations, and take the appropriate course of action to preserve their rights.
T: +86 10 85207501
Kevin Ng is the national leader of tax controversy services in China. He has more than 30 years of professional experience in China and Hong Kong SAR focusing on tax and business advisory services.
Kevin’s areas of expertise focus on corporate tax matters such as transfer pricing, tax compliance and advisory, initial public offerings, and in-bound and out-bound investment advisory. He also represents clients in communicating and negotiating with the tax authorities in the mainland and Hong Kong SAR with respect to tax disputes, tax incentives or advance rulings, and the like.
Ron Cheng Ma
T: +86 10 85125659
Ron Cheng Ma is a tax and legal partner of Deloitte Legal based in Beijing. He leads the tax-related dispute resolution team in China and represents clients in dispute resolution proceedings concerning company law, investment, and intellectual property (IP).
Ron provides tax consulting and advisory services for foreign and Chinese domestic clients from various industries and has extensive practical experiences in establishing various foreign invested vehicles, enterprise restructuring, initial public offerings (IPOs), merger and acquisition (M&A), and cross-border transactions.
Kerry Yanbin Kuang
T: +86 10 85207535
Kerry Yanbin Kuang is a senior counsel with over 20 years of experience in commercial dispute resolution and resolving complex disputes for both large multinational and domestic companies.
Kerry represented clients in several influential unfair competition litigation cases in China, and in recent years has successfully handled a number of litigation and arbitration cases involving disputes on investments, shareholders' rights, bond defaults and construction contracts. She has also provided multiple legal services for clients on compliance and human resources (HR) related issues.