The Measures for Administration of Individual Income Tax on Income Derived from Equity Transfer (for Trial Implementation)

On December 7, 2014, the State Administration of Taxation has issued the Measures for Administration of Individual Income Tax on Income Derived from Equity Transfer (for Trial Implementation) (the "Measures"). The Measures, once taking into effect on January 1, 2015, will abolish the Notice of the State Administration of Taxation on Strengthening Administration of the Collection of Individual Income Tax on Income Derived from Equity Transfer (Guo Shui Han [2009] No. 285), and the Announcement of the State Administration of Taxation on Issues Relating to Determining Verifying the Taxation Basis for Individual Income Tax on Income Derived from Equity Transfer (Announcement of the State Administration of Taxation [2010] No. 27) (the “Announcement”).

The Measures have specified considerable rules regarding individual income tax on income derived from equity transfer which are listed as follows, among others:

1. Overview

1.1 Proper Taxpayer

Pursuant to Article 2 and Article 5 of the Measures, individual shareholders who invest equities or shares into enterprises or organizations established within the territory of China, excluding sole proprietorships and partnerships, shall be regarded as the proper taxpayer. During transfer transactions, the equity transferor is regarded as the tax payer and the transferee is deemed as the withholding agent.

1.2 Competent Tax Authorities

Pursuant to Article 19 of the Measures, competent tax authorities for the individual income tax (“IIT”) on the income derived from equity transfer by individuals are local tax authorities where the invested enterprise is located.

1.3 Circumstances of Equity Transfer (Scope of Tax Collection)

Pursuant to Article 3 of the Measures, the equity transfer means the individual transfers his/her equity to other individuals or legal entities, specifically includes:

a. The sale of equity;
b. The repurchase of equity by enterprises;
c. When the issuer initiates the public offering of shares, shareholders of the invested enterprise also sell their shares to the investors by way of the public offering;
d. The equity is compulsorily transferred by judicial or administrative authorities;
e. Equity investment or any non-monetary transactions;
f. The equity is used for clearing off debts;
g. Other equity transfer conducts.

1.4 Calculation of Taxable Income of Equity Transfer

Pursuant to Article 4 of the Measures, the IIT shall be calculated and paid in the name of "asset transfer income" based on the taxable income during the equity transfer. The taxable income refers to the balance of "equity transfer income" minus "original value of equity and reasonable cost". "Reasonable cost" refers to relevant taxes paid to competent tax authorities for the equity transfer.

2. Identification of Original Value and Equity Transfer Income

2.1 Original Value

Pursuant to Article 15 of the Measures, the original value of the transferred equity shall be identified through the following methods:

2.2 Equity Transfer Income

Pursuant to Article 7, Article 8 and Article 9 of the Measures, the "equity transfer income" refers to the economic income acquired in such forms as cash, physicals and securities for equity transfers, which also includes liquidated damages, compensation, as well as other payments, assets, and interests under other items. Moreover, the subsequent income acquired by a tax payer under a contract after meeting the agreed terms shall also be regarded as the equity transfer income.

3. Income Determined by Competent Tax Authorities

3.1 Pursuant to Article 11 of the Measures, competent tax authorities may determine the equity transfer income under any of the following circumstances:

a. The declared equity transfer income is obviously low and unjustified;
b. Relevant taxes have not been declared before the deadline and such taxes are still not declared after tax authorities have ordered to declare taxes within a limited period;
c. The transferor fails to or refuses to provide information of the equity transfer income;
d. Other circumstances under which the equity transfer income shall be determined.

3.2 Pursuant to Article 14 of the Measures, competent tax authorities shall adopt the following methods in turn to determine the equity transfer income:

a. Confirmation by Net Asset
b. The method of analogue
c. Other reasonable methods

3.3 Pursuant to Article 12 and Article 13 of the Measures, the circumstance that “the equity transfer income is obviously low” is defined in order to prevent the tax avoidance during the equity transfer, which is clarified as follows:.

a. Equity Transfer Income is Obviously Low Without Reasonable Causes (Article 12)

i. The declared equity transfer income is lower than the net asset share corresponding to the equity, amongst which, if the invested enterprise has land use rights, buildings, unsold real properties of real estate companies, intellectual property, right of prospecting, mining rights, equity and other assets, the declared equity transfer income is lower than the fair value of the net asset fair value share corresponding to the equity;
ii. The declared equity transfer income is lower than the initial investment cost or lower than the price and related taxes paid for the acquisition of the shares;
iii. The declared equity transfer income is lower than the equity transfer income of the same shareholders or other shareholders of the same company under the same or similar conditions;
iv. The declared equity transfer income is lower than the equity transfer income of enterprises in the similar industry under the same or similar conditions;
v. Unjustified transfer of equity or shares without consideration;
vi. Other circumstances determined by competent tax authorities.

b. Equity Transfer Income is Obviously Low With Reasonable Causes (Article 13)

i. Valid documents can be provided to prove that invested enterprises transfers the equity at a low price because the corporate production and operation are significantly affected due to national policy adjustments;
ii. Inheritance, or equity transfer to spouse, parents, children, grandparents, grandchildren, brothers and sisters who can provide valid legal proof of the identity and relationship, or equity transfer to financial supporters of the transferors who undertake direct duties of the financial support;
iii. Internal transfer of equity held by enterprises' employees, which cannot be transferred externally and have relevant documents that can fully prove the reasonability and the authenticity of the transfer price;
iv. Any other reasonable circumstances where the transferors and transferees can provide valid certificates to prove the reasonability.

4 Timeline of IIT Payment and Submission of Documents

4.1 Timeline of Tax Payment

Pursuant to Article 6 of the Measures, the withholding agent/transferee shall report the relevant information to competent tax authorities within five working days after the relevant equity transfer agreement is signed.

4.2 Submission of Documents

Pursuant to Article 21 of the Measures, the following documents shall be submitted competent tax authorities for the tax payment (withholding) declaration:

a. The equity transfer contract (agreement);
b. The identification certificates of transferors and transferees of the equity transfer;
c. Asset value appraisal reports on net assets or land/real properties issued by qualified agencies if required according to relevant provisions;
d. Documents proving that the tax calculation basis is obviously low for certain reasonable causes;
e. Other documents required by competent tax authorities.

Comments

In general, compared to the Announcement, the Measures provide a more comprehensive guideline for the Chinese tax authority to supervise the payment of IIT during the equity transfer cases in respect of the following critical elements:

1) Clarify the scope of equity share, equity share income and tax payment;
2) Identify the equity transfer income and incorporate the subsequent income acquired by a tax payer under a contract after meeting the agreed terms as the equity transfer income;
3) Specify the circumstance “the equity transfer income is obviously low” and the exception;
4) Establish methods for competent tax authorities to determine the equity transfer income;

Detailed and clear rules regulated in the Measures, especially the elements mentioned above, will definitely facilitate the supervision of IIT payment by the Chinese tax authority in order to prevent the tax avoidance of individuals during the equity transfer transactions.

However, the Measures still have certain unclear sectors which need to be improved regarding the IIT derived from the equity transfer as follows:

1) During non-monetary transactions such as the investment with equity as one of circumstances of equity transfer, in general, there is no cash income incurred. As a result, it will be difficult to determine the income since the anticipated revenue will normally be different from the actual income. In practice, under certain circumstances, there still exist difficulties to determine the income.

2) With regard to the value adjustment mechanism (“VAM”), although the Measures regulates the subsequent income acquired by a tax payer under a contract after meeting the agreed terms as the equity transfer income in Article 9, which is one type of VAM, other types of VAM is still not taken into account. Therefore, the IIT involving other types of VAM needs to be further clarified.

3) With regard to “reasonability” in the item 4 of Article 13, it is still unclear what situations the “reasonability” shall prevail.

Therefore, no matter the transferor, the transferee or the invested enterprises shall keep a close eye on the Measures and the following improvements or adjustments.

by UBILLA & CIA

Key Issues Regarding the Administrative Measures on the General Anti-Avoidance Rule (for Trial Implementation)

On December 2, 2014, the State Administration of Taxation (“SAT”) issued the Administrative Measures on the General Anti-Avoidance Rule (for Trial Implementation) (the “Measures”), which will be effective on February 1, 2015.

Although principles on the application of general anti-avoidance rules (“GAAR”) were included in Corporate Income Tax Law of People’s Republic of China (“CIT Law”), Detailed Implementation Rules of CIT Law and the Implementation Measures on Special Tax Adjustments (for Trial Implementation), specific administrative measures regarding GAAR application such as the operation procedures and enforcement standards were absent for a long time until the release of the Measures.

In general, the Measures further regulate and clarify various issues regarding GAAR application such as the applicable scope, features of tax avoidance arrangements, adjustment methods, working procedures, dispute resolutions when applying GAAR, etc.

The main contents in detail are clarified as follows:

1. Applicable Scope (Article 2 and Article 3)

The Measures shall be applicable when Chinese tax authorities implement special tax adjustments towards the corporate tax avoidance arrangements conducted by companies in order to obtaining Tax Benefits (defined below) without reasonable commercial purposes.

Tax Benefits refer to the reduction, exemption or delay of corporate income tax payments.

According to Article 120 of CIT Law Detailed Implementation Rules, “without reasonable commercial purposes” refer to the key purposes of obtaining the aforementioned Tax Benefits.

On the other hand, the Measures shall not apply to the following circumstances:

a. Arrangement irrelevant to cross-border transactions or payments.
b. Illegal tax behaviors such as avoidance of paying taxes, avoidance of paying unpaid taxes, tax fraud, refusal of paying tax, and issuance of forged invoices.

2. Exception of Application of the Measures (Article 6)

The corporate tax avoidance arrangements which are within the range of other special tax adjustments including transfer pricing, cost sharing, controlled foreign corporations, thin capitalization shall first apply to relevant laws regulating special tax adjustments, such as Section 6 of CIT Law.

On the other hand, the corporate tax arrangements which are within the range of execution of taxation agreements such as beneficial owner and interest restriction shall first apply to relevant rules of execution of taxation agreements.

Note: The Measures should only be applicable if a tax arrangement cannot be regulated by any of aforementioned special tax adjustments. In other words, the Measures shall be the last resort to counter tax avoidance when all other anti-avoidance tools are exhausted.

3. Features of Tax Avoidance Arrangements (Article 4)

In order to facilitate the assessment of Chinese tax authorities and the self-assessment of involved companies, the Measures specify the following major features of “tax avoidance arrangements”:

a. The sole purpose or primary purpose is to obtain Tax Benefits;
b. Obtaining Tax Benefits by certain means, the form of which is compliant with the tax laws but inconsistent with the economic substance.

4. Tax Adjustment Methods (Article 5)

Chinese tax authorities shall implement special tax adjustments on the basis of “ similar arrangements with reasonable commercial purposes and economic substance” and in accordance with the principle that "the substance is superior to the form". Special adjustment methods shall include:

a. Re-characterizing the entire or part of transactions of the tax arrangements;
b. In terms of tax, denying the existence of a transaction party for tax purposes, or deeming the transaction party and other transaction parties as the same entity;
c. Re-characterizing the related income, deductions, tax incentives and overseas tax discount or exemption, or reallocating them among transaction parties;
d. Any other reasonable methods.

5. Information Provided for Investigation of Tax Avoidance Arrangements (Article 11)

Companies being investigated for the tax avoidance arrangements shall provide the following documents within 60 days after receiving inspection notice from Chinese tax authority if they consider that their arrangements shall not be regarded as tax avoidance arrangements:

a. Background documents for the arrangements;
b. Documents for the commercial purposes of the arrangements;
c. Information on the internal decision-making and management of the arrangements, such as board resolutions, memorandums and emails;
d. Detailed transaction information relating to the arrangements, such as contracts, supplemental agreements, and payment receipts or payment collection;
e. Communication information with other transaction parties;
f. Other documents which may prove that their arrangements shall not be regarded as tax avoidance arrangements;
g. Other documents considered necessary by Chinese tax authorities.

Companies that cannot submit such documents on time due to special circumstances may apply to the Chinese tax authorities for an extension of submission timeline in written form. However, even if the application is approved, the extended period for submission shall not exceed 30 days.

Note: The purpose of timeline requirements mentioned above is, on one hand, to ensure Chinese tax authorities to handle GAAR related cases efficiently and, on the other hand, to improve tax related risk control measures and internal tax related rules compliance of relevant companies.

6. Working Procedures (Article 8, Article 15 and Article 16)

Besides the substantial regulations mentioned above, the Measures also specify relevant working procedures which cover all phases of GAAR administration, including admission, investigation and the closure of a case, as well as procedural rules which set out roles and responsibilities of Chinese tax authorities in different levels in each phase to ensure transparent and fair implementation of GAAR.

Where the in-charge local tax authority become suspicious of tax avoidance arrangements of one company, it shall report the case upwards through different levels to the provincial tax authority for approval, and then apply to the SAT in order to initiate the investigation process.
During the investigation process, in-charge tax authorities may verify the information provided by relevant companies through on-site investigation, issuing letters to request assistance of companies for the investigation, or utilizing public information, etc.

In-charge local tax authorities shall examine relevant documents obtained during the investigation process within 9 months after the approval of case filing, comprehensively judge whether relevant companies conduct tax avoidance arrangements, form opinions and reasons for "plans not to adjust" or "preliminary adjustment plans", and apply to the SAT for case closure after reporting such opinions and reasons level by level to the provincial tax authorities for approval.

7. Dispute Resolutions (Article 19 and Article 21)

On one hand, while the companies being investigated disagree with the GAAR assessments made by the in-charge tax authorities, they can apply for legal remedies in accordance with relevant laws and regulations.

On the other hand, if investigated companies consider that the general anti-tax avoidance adjustments made by tax authorities result in the international double taxation or the taxation is incompliant with provisions of tax treaties, investigated companies may initiate the mutual negotiation procedures according to tax treaties and relevant provisions thereof.

Comments

Generally, the Measures provide Chinese tax authorities a detailed guideline for the implementation of GAAR, build up a more transparent and consistent GAAR framework and create more specific practical methods in order to make the tax adjustments and crack down the international tax avoidance arrangements and evasion.

On the other hand, companies, especially multinational corporations, shall pay sufficient attention to the substantial rules and practical procedures in the Measures in order to conduct the proper tax arrangement for the international transactions.

However, as to tax adjustment methods in the Measures, the limitation of “economic substance” still remains ambiguous, which may confuse companies to some extent when they conduct tax arrangements. Therefore, more detailed rules for implementation are expected to facilitate the execution of the Measures in future.

by UBILLA & CIA