Major Tax Reforms in China: Introduction of anti-tax avoidance clause in individual income tax

published on november 19, 2018 / reading time approx. 2 minutes
  
Since 2009, China has promulgated a series of anti-tax avoidance regulations. However, these regulations only aim at anti-tax avoidance issues at corporate level, and there is no clear anti-tax avoidance regulation for individuals, partnership and sole proprietorship enterprises. In China, the collection and management of the overdue tax as a result of anti-individual income tax (“IIT”) avoidance has been in a difficult situation for a long time due to flaws in legislation.
  

   

The new IIT Law in China passed on August 31, 2018 formally introduced a comprehensive anti-IIT avoidance clause covering the following commonly seen IIT avoidance situations:

• Shift profits to overseas through related party transactions that do not comply with the arm's length principle between individuals and affiliated parties;
• Use personal consumption expenditures incurred through offshore companies established in tax havens or countries with low tax rates to avoid distributing profits to domestic individuals or retain profits abroad for a long time to evade individual taxes;
• Individuals avoid IIT through other arrangements without reasonable commercial purposes, such as indirect transfer of Chinese assets.

In practice, arrangements through the establishment of enterprises in the low tax areas, the use of local taxation policies to convert profits into legal individual income, or deliberate arrangement of related party transactions to shift profits and deliberate avoidance of dividends to individuals under certain conditions, may be subject to the anti-tax avoidance investigation of the Chinese tax authorities.

The new Implementing Regulations of the IIT Law (draft for discussion) further clarify the definition of related parties, the determination of "control" and "obviously low effective tax burden" in the controlled foreign companies clauses, the definition of unreasonable business purposes, and the detailed calculation standard of interest on overdue tax payment. The above clauses refer to the current anti-tax avoidance provisions for enterprises in China to ensure the consistency of anti-tax avoidance clauses at individual and corporate income tax levels.

In addition, the new IIT Law has also changed the judgment condition for resident taxpayers from "one year" to the internationally conventional "183 days" to expand the applicable object of CRS tax information exchange. According to the new CRS regulations, the first batch of information on the overseas financial assets accounts of the Chinese individuals and their controlled companies was exchanged to China in September this year. This information will help the Chinese tax authorities to conduct risk assessments in order to make comprehensive judgments whether there is avoidance of tax collection and management in China, and take follow-up actions.

Therefore, it is recommendable that investors should carefully assess the tax risks with regard to the design and set up of transaction structure in which they individually participate. They should also pay close attention to the commercial rationality and economic substance of the transaction arrangements, and adjust the business plan in a timely manner to minimize potential IIT risks.