1. International Aspects of China’s Tax Law
Topic: anti-tax avoidance
Dr. LI Na

2. Structure of China’s anti-avoidance rules

3. Transfer pricing
neutral concept
determination of prices
for transactions between associated parties

4. Transfer pricing
relevant to:
direct taxation (enterprise income tax),
indirect taxes (customs and VAT),
foreign exchange requirements,
accounting. etc.

5. Transfer pricing
international trade within MNCs

6. Transfer pricing
two perspectives:
international transactions:
affiliated parties
interact across borders

7. Transfer pricing
two perspectives (cont.):
domestic transactions:
affiliated parties
in one country interact
but face different tax regimes

8. Arm’s length principle
based on the concept of comparability:
compare
controlled contractions and uncontrolled transactions

9. Five comparability factors

10. China transfer pricing
source of law:
EIT Law: Articles 41 – 44
EIT Implementing Rules: Articles
Law of Tax Administration and Collection: Article 36
MOF and SAT circulars

11. China transfer pricing
affiliated enterprises:
share ownership
debt relationship
appointment of personnel
concurrent position
license of intangible

12. China transfer pricing
affiliated enterprises (cont.):
Control over purchase or sales activities
Control over receipt or provision of service
Control over production, operation and trade activities

13. China transfer pricing
arm’s length principle:
unrelated parties abide to when carrying out business transactions
in accordance with fair market prices and common business

14. China transfer pricing
Five transfer pricing methods

15. China transfer pricing
burden of proof: taxpayer
preparation of contemporaneous transfer pricing documentation

16. China transfer pricing
tax authorities’ discretion to deem the taxable income:
by reference to the profit margin of same-type or similar enterprises;
based on the enterprise’s cost plus reasonable expenditures and profit;

17. China transfer pricing
tax authorities’ discretion to deem the taxable income (cont.):
by reasonable proportion of the consolidated profit of the related party group; and
other reasonable methods.

18. China transfer pricing
location specific advantages (LSAs) principle:
location saving and market premium
China’s position in the UN Transfer Pricing Manual

19. identify if an LSA exists.
LSAs
Four-steps approach:
identify if an LSA exists.
determine whether the LSA generates additional profit.
quantify and measure the additional profits arising from the LSA.

20. four-steps approach (cont.):
LSAs
four-steps approach (cont.):
determine the transfer pricing method to allocate the profits arising from the LSA

21. LSAs - example

22. China transfer pricing
recent development
service fee paid between affiliated enterprises
Microsoft was charged $140 million by Beijing tax bureau

23. controlled foreign corporation
CFC rule
controlled foreign corporation
limit artificial tax deferral by using offshore low taxed entities
deemed distribution of dividends
concurrent taxation at the parent company or individual

24. U.K.: CFC rules (not applicable to individuals)
legislations:
U.S.: Subpart F rules
U.K.: CFC rules (not applicable to individuals)
Germany: CFC provisions in the Foreign Tax Act

25. Background of China CFC rule

26. Background of China CFC rule (cont.)
China resident-enterprises:
worldwide income
China-sourced income; and
Non-China sourced income
foreign tax credit method

27. Background of China CFC rule (cont.)
establishing subsidiaries at tax havens or low- tax jurisdictions
risk: tax deferral

28. EIT Implementing Rules: Articles 116 - 188 MOF and SAT circulars
China CFC rule
source of law
EIT Law: Article 45
EIT Implementing Rules: Articles
MOF and SAT circulars

29. CFC must be controlled by the Chinese- resident shareholder.
China’s CFC rule
two criteria
CFC must be controlled by the Chinese- resident shareholder.
CFC must be incorporated in a low tax jurisdiction

30. China’s CFC rule
control
shareholding control
effectively control

31. China’s CFC rule
shareholding control

32. shareholding control (cont.)
China’s CFC rule
shareholding control (cont.)

33. other matters of the CFC
China CFC rule
effectively control
personnel
assets
business operations
purchases
sales, and
other matters of the CFC

34. effective EIT rate of CFC jurisdiction less than 12.5%
China CFC rule
low tax rate
effective EIT rate of CFC jurisdiction
less than 12.5%

35. consequence of applying CFC rule "deemed dividend"
China CFC rule
consequence of applying CFC rule
"deemed dividend"
concurrent taxation at the parent level (i.e. Chinese resident-enterprises)

36. exception: white-listed country
China CFC rule
exception:
white-listed country
Australia, Canada, France, Germany, India, Italy, Japan, New Zealand, Norway, South Africa, U.K and U.S.

37. burden of proof is on the taxpayer De minimis operation
China CFC rule
exception (cont.):
active business
burden of proof is on the taxpayer
De minimis operation
annual profit of the CFC is less than CNY5 million

38. through a “relatively high level” of debt compared to equity
Thin capitalisation
concept:
financing situation
a company if financed
through a “relatively high level” of
debt compared to equity

39. interest payments are deductible and reduce profit
Thin capitalisation
why it is an issue?
interest payments are deductible and reduce profit
dividends payments are not deductible

40. Thin capitalisation rule
two options:
ceilings: a maximum amount of debt on which interest payments are deductible
ratios: a maximum amount of interest that may be deducted by reference to the ratio of interest to another variable

41. China thin capitalisation rule
source of law:
EIT Law: Article 46
EIT Implementing Rules: Article 119
MOF and SAT circulars
form: ratio

42. China thin capitalisation rule
‘‘debt investment’’
financing directly or indirectly
obtained by an enterprise from its related parties
requires repayment of principal and interest, or other forms of compensation with the nature of interest

43. China thin capitalisation rule
debt provided by an unrelated party:
provided by the related party through an unrelated party;
provided by an unrelated party, but is guaranteed by a related party with joint liability; or
substance of indebtedness is indirectly provided by a related party.

44. China thin capitalisation rule
‘‘equity investment’’
investment obtained by an enterprise
without the obligation of the repayment of principal or interest, and
by which the investors have the entitlement to the net assets of the enterprise.

45. China thin capitalisation rule
ratio
2:1 in general
5:1 for financial institutions

46. China thin capitalisation rule
formula
ratio =
aggregation of monthly average debt investment from related parties in 12 months
aggregation of monthly average equity investment in 12 months

47. China thin capitalisation rule
in addition
total investment – registered capital ratio requirement for FDIs
P&G case (2002) investigated by Guangzhou tax bureau for an increase of interest (CNY million) based on arm’s length principle

48. Tax resident enterprise - TRE
China resident enterprise (two types):
place of incorporation
place of actual management

49. Jiamusi case

50. China GAAR
source of law:
EIT Law: Article 47
EIT Implementing Rules: Articles 120 and 123
SAT, the Administrative Measures for GAAR (SAT Order [2014] 32)
SAT circulars

51. China GAAR
tax avoidance transaction:
where an enterprise makes any arrangement
not having reasonable business purpose, and
leading to decrease its taxable income or amount of incomes

52. China GAAR
tax avoidance transaction (cont.):
not having reasonable business purpose
the main purpose is to reduce, exempt or defer the payment of taxes.

53. China GAAR
tax authorities’ investigation:
4 specific scenarios
abuse of tax incentives
abuse of tax treaty
abuse of legal form of company
avoidance of tax by using tax havens

54. China GAAR
tax authorities’ investigation (cont.):
1 general scenario:
other arrangements without reasonable business purposes

55. form and substance of the agreement
China GAAR
6 factors:
form and substance of the agreement
conclusion time and execution period of the agreement
implementation method of the arrangement

56. relationship between each step or part of the arrangement
China GAAR
6 factors (cont.):
relationship between each step or part of the arrangement
changes in financial performance of each party involved in the arrangement, and
tax consequences of the arrangement

57. GAAR
consequence:
tax authorities following the substance over form principle
discretion to make an adjustment:
re-characterization of the whole or part of the arrangement

58. GAAR
discretion to make an adjustment (cont.):
denial of the existence of a party to the transaction for tax purposes, or treating one of the party and other parties to the transaction as one entity

59. GAAR
discretion to make an adjustment (cont.):
re-characterization of the income, deductions, tax incentives and foreign tax credits or reallocation of them between the parties to the transaction; and
any other reasonable method

60. China GAAR
penalty:
increased of 500 basis point above the benchmark lending interest rate
published by the People’s Bank of China
for the year in which tax payment occurs

61. Xinjiang case

62. retroactive effectiveness
Xinjiang case
discussion:
retroactive effectiveness
changes made to the Article 13 (Capital Gain) China - Barbados Tax Treaty
GAAR or substance over form

63. Chongqing case

64. Chinese tax authorities’ discretion remedy of the taxpayer
Chongqing case
discussion:
burden of proof
Chinese tax authorities’ discretion
remedy of the taxpayer

65. Policy implication
China’s approach to the BEPS project
counter-tax avoidance vs. keeping MNCs in China
limitation on tax authorities’ discretion