On December 2, 2014, SAT released Decree No. 32 to introduce the Administrative Measures on the General Anti-Avoidance Rule (Trial) (the “Measures”) to further regulate and clarify the application of the General Anti-Avoidance Rule (“GAAR”), including the applicable scope, the characteristics of tax avoidance arrangements, the adjustment methods, the investigation procedures and the dispute resolutions.
Before issuing the Measures, China’s GAAR relied on article 47 of the Enterprise Income Tax (“EIT”) Law, article 120 of its Implementing Rules, and the Administrative Measures on Special Tax Adjustments (Trial), which provide general principles for the application of GAAR. However, because there were no detailed guidelines for applying these, GAAR left the working procedures and implementing standards to the discretion of the local tax authorities. Under this background, SAT released the Measures.
The Measures’ main highlights are as follows:
1. Applicable scope
Following the general principles provided in the EIT law and its Implementing Rules, the Measures are applicable to the special tax adjustments made to the tax avoidance arrangements that enterprises carry out without commercial purposes, with the aim of obtaining tax benefits (i.e. reducing, avoiding or deferring pay- ment of EIT).
The Measures provide the characteristics of “tax avoidance arrangements”:
- the sole purpose or main purpose is to obtain tax benefits;
- the legal form is in accordance with the tax law but not consistent with its economic substance.
However, the Measures exclude the following circumstances from the ir scope:
- illegal tax activities involving tax evasion, tax fraud, refusal to pay taxes, and issuing forged invoices, which shall be governed by the Tax Collection and Administration Law; and
- arrangements irrelevant to cross-border transactions or payments.
According to the press conference held by SAT’s in-charge tax official, GAAR is not focused on domestic transactions. The in-charge tax official also stated that if an offshore indirect share transfer involves the tax avoidance arrangement provided in GAAR, then the Measures also apply to the offshore indirect share transfer. This statement is consistent with the consideration of circular Guo Shui Han  No. 698 (which includes specific provisions on the indirect transfers of equity in Chinese entities by non-residents and their re-characterization for tax purposes as direct transfers), not as a genuine source of tax law, but as document issued by SAT to the local tax bureaus for guideline to interpret the tax laws and regulations. Therefore, also the indirect transfer of equity which does not meet the requirements for being reported to the tax authorities under article 5 of Circular 698 could be re - characterized for tax purposes as a direct transfer on the grounds of the GAAR, with the Measures being applicable. Moreover, where Circular 698 applies, the Measures could complement it, in particular concerning the formal aspects and the proceedings.
2. Adjustment methods
The Measures provide that the tax authorities shall make the special tax adjustments based on the substance-over-form principle, by referring to similar arrangements with reasonable commercial purpose and economic substance. The adjustment methods proposed in the Measures include:
- re-characterizing part or all of the arrangement;
- denying the existence of a party in the transaction, or treating all parties in the transaction as one, from a tax perspective;
- re-characterizing the incomes, deductions, preferential tax treatments or foreign tax credits, or re-allocating these among parties in the transaction;
- other reasonable methods.
The Measures also provide that if an arrangement falls under the scope of other specific special tax adjustment regulations, such as those for transfer pricing, cost sharing, controlled foreign company, and thin capitalization, then these specific regulations shall prevail over GAAR. Likewise, if an arrangement falls under the scope of the beneficiary owner clause or limitation of benefits clause in a tax treaty, these clauses shall prevail over GAAR.
3. Investigation procedures
The Measures provide the proceedings of a general tax avoidance investigation, which include three phases: selecting a case, investigating the case and closing the case.
Under the Measures, the selection and final conclusion of a case is subject to SAT’s approval. Upon receiving SAT’s approval of the selection of a case, the competent tax authority has nine months to verify and assess the information given by the taxpayer during the investigation, and to determine whether the taxpayer is subject to a tax adjustment, and if it is, report a preliminary adjustment proposal with opinion and reasons to the provincial level tax authority and then to the SAT , for approval to close the case.
The Measures will be in force on February 1, 2015, and can be applied to the pendin g investigations on tax avoidance arrangements on that date.
Date of issue: December 2, 2014. Effective date: February 1, 2015.