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China’s GAAR

Tuesday, 17 March 2015   (0 Comments)
Posted by: Authors: Paul Barnicke and Melanie Huynh
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Authors: Paul Barnicke and Melanie Huynh (PricewaterhouseCoopers LLP, Toronto)

The concept of a general anti-avoidance rule is still relatively new in China. The Chinese GAAR was first introduced (and was effective) on January 1, 2008; since then, the rule has been used mainly to combat (1) avoidance by a non-resident of capital gains tax on a Chinese company’s shares by selling an interposed offshore holding company and (2) treaty shopping to reduce capital gains tax or withholding tax on cross-border payments. New guidelines may signal the Chinese tax authorities’ greater willingness to proceed more aggressively against international tax avoidance.

A July 4, 2014 discussion draft scheduled a public consultation on proposed GAAR guidelines for December 12, 2014. China’s State Administration of Taxation (SAT) then issued final Administrative Measures on the General Anti-Avoidance Rule (Order no. 32), which contain comprehensive guidelines on GAAR’s implementation with a focus on cross-border arrangements. The measures are effective February 1, 2015 but are expected to apply retrospectively back to January 1, 2008 to files that have not been assessed and closed.

Under the measures, a GAAR adjustment applies to a cross-border tax-avoidance arrangement that is carried out to obtain a tax benefit and that has no reasonable commercial purpose. The measures mention "purpose” and "substance” as the two key features of a tax-avoidance arrangement: that is, (1) the arrangement’s main purpose is to obtain a tax benefit, and (2) the arrangement legally complies with the tax rules but its form is inconsistent with its economic substance.

If GAAR applies, the benchmark for tax adjustments by tax authorities is established in similar arrangements that have a reasonable business purpose and economic substance. The different adjustment methods include recasting part or all of an arrangement; disregarding the existence of a party to a transaction or treating all parties to the transaction as one entity; recasting the nature of the income or deduction or reallocating those items among the parties to the transaction; and using any other methods that the tax authorities deem reasonable.

Selection of a file for a GAAR audit and the audit’s final outcome are subject to SAT approval. In order for an audit to be authorized, the local tax authorities first identify a potential GAAR case; notice of the intention to initiate an audit must be submitted to and approved by the provincial tax authorities and then by the SAT. The local tax authorities begin the audit by issuing a formal notice to the taxpayer being investigated. Within 60 days of the notice’s receipt (a 30-day extension may be available on request), the taxpayer must provide extensive documentation and evidence. All documents submitted to the tax authorities must be in Chinese.

The local tax authorities have up to nine months to complete their audit and report their finding and recommendation, which must be submitted to and approved first by the provincial tax authorities and then by the SAT. No time limit is specified in the measures for the review by the provincial tax authorities or the SAT.

If the SAT gives final approval to a GAAR assessment, the local tax authorities issue a draft assessment with the proposed tax adjustment. The taxpayer has seven days from the assessment’s receipt to file an objection (in Chinese); if no timely objection is filed, a final assessment is issued. The objection is reviewed by the three different levels of tax authorities, and is subject to final rejection or acceptance by the SAT. The seven-day deadline for an objection seems to be impractically short.

It is unclear whether the new measures signal that China will use GAAR more aggressively to attack cross-border structures in order to protect its tax base now that BEPS changes may be on the horizon. The Chinese GAAR is still in its infancy, and it is too early to tell how it will be applied and whether Chinese tax officials are prepared to assess a GAAR challenge in respect of complex business arrangements. It is clear, however, that multinationals must maintain the business substance of their international structures in order to withstand GAAR scrutiny in China.

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