Development of the general anti-avoidance rules (“GAAR”) is never ending. It was recently reported that Microsoft had been forced to pay a record 840 million RMB (or 140 million USD) tax bill to the Chinese tax authorities in a GAAR investigation. On December 2, 2014, the State Administration of Taxation (“SAT”) officially promulgated the SAT Order [2014] No. 32 (“Circular 32”) to set up the GAAR trial rules after closing the public comments on the draft on August 1, 2014.    The trials rules will become effective on February 1, 2015.

Applicable Scope

Under Circular 32, the major characteristics of a tax avoidance arrangement are as follows:

  • Its sole or primary purpose is to obtain tax benefits, such as tax reduction, tax elimination, and tax deferral; and
  • It is technically compliant with tax laws but inconsistent with economic substance.

Unlike the draft, the trial rules apparently do not target a suspect tax structure intending to obtain tax benefits as one of multiple primary purposes. Still, the trial rules do not elaborate on technical details of various GAAR principles, such as reasonable commercial purpose, economic substance, and substance over form. The ambiguity of these principles seems to offer the tax officials greater enforcement latitude than otherwise.

Interactions with Other Rules

Circular 32 is interrelated with other rules in this area. In particular, the SAT previously issued Guoshuifa [2009] No.2 (“Circular 2”) to cover a broad range of tax avoidance circumstances and Guoshuihan [2009] No. 698 (“Circular 698) to target offshore indirect equity transfers of the Chinese resident enterprises.  Given the narrow scope, Circular 32 is considered supplemental to Circular 2, which largely focuses on transfer pricing. While the draft expressly left out indirect equity transfers, Circular 32 will likely be used to support the enforcement of Circular 698 from an anti-tax avoidance perspective. Regardless of how we view these rules separately, however, they are certainly indispensable parts of an integrated plan to tackle unfavorable tax structures and gain revenue by the Chinese tax authorities.


The stated targets of Circular 32 are cross-border transactions or payments. While it does not necessarily mean that the Chinese resident enterprises are totally exempt, foreign investors and foreign-invested companies are expected to attract specially heightened scrutiny of the Chinese tax authorities. In particular, the SAT will tightly control the entire process, from launching to closing any investigation of tax avoidance arrangements. Circular 32 allows the Chinese tax authorities to request a variety of documents in such investigation, including communications between taxpayers and tax advisors.

Our Observations

The trial rules demonstrate modest improvement of the draft based on public comments. Given the tax revenue contribution of enforcing GAAR, the SAT has strong incentive to streamline the enforcement procedure. Circular 32 is simply another milestone along the way. It is time for multinational companies to think ahead of the Chinese tax authorities in this regard.