On July 3, 2014, the State Administration of Taxation (the "SAT") released a discussion draft on the Administrative Measures on the General Anti-Avoidance Rule (the "Draft Measures). The General Anti-Avoidance Rule ("GAAR") was introduced in China Corporate Income Tax Law effective on January 1, 2008. However, the provision of law and subsequent interpretation tax circulars provide only some basic principles. The Draft Measures provide comprehensive guidance on the implementation of GAAR.
According the Draft Measures, GAAR applies to a tax avoidance scheme where the sole or main purpose or one of the main purposes is to obtain a tax benefit, and the form of scheme is permitted in accordance with the tax rules, but the form is not consistent with its commercial substance. The tax authorities may make special adjustments based on the principle of substance over form.
The adjustment methods include:
- Recharacterize the whole or part of a transaction;
- Disregard a party to the transaction or treat the parties to the transaction as the same entity, for tax purposes;
- Redefine relevant income, deduction, tax incentives, foreign tax credit, etc. and reallocate them among the parties to the transaction; and
- Other reasonable methods.
The Draft Measures also provide investigation procedures and documentation requirements.
Once the tax authority commences a GAAR investigation on an enterprise, the enterprise should provide, within 60 days of the investigation notice, the documents to prove its arrangement is not a tax-avoidance scheme, including:
- The background of arrangement;
- Explanation of reasonable commercial purpose;
- Internal decision-making and administrative documents concerning the arrangement such as board resolution, memorandum, and emails;
- The details of transaction information of the arrangement such as contracts, supplemental agreements, and the evidence of payment or receipt of consideration;
- Communications with tax advisors;
- Communications with other parties to the transaction;
- Other information evidencing that the transaction is not a tax-avoidance scheme; and
- Other information that the tax authority believes necessary.
The tax bureau at local level may initiate a GAAR investigation. However, both the formal commencement of such investigation and the conclusion of the case must be reported to and approved by the SAT.
Although the Draft Measures provide helpful guidance on the implementation of GAAR, the tax circular, if finalized and issued in current form, can give tax authorities broad authority to invoke as long as one of the main purposes is to obtain a tax benefit.