China alert - Issue 17, June 2011
According to recent Chinese media reports, the Shenzhen Local Tax Bureau (Shenzhen LTB) recently collected tax in the amount of RMB 13.68 million from the indirect disposal of shares in a Chinese enterprise by a non-resident individual. It is, however, unclear as to whether it is Individual Income Tax (IIT) or Corporate Income Tax (CIT) which was collected.
The general anti-avoidance rule (GAAR), contained in Article 47 of the CIT Law, may be used, pursuant to Circular 698, to re-characterise an offshore indirect transfer as a direct disposal of the underlying equity interest in the Chinese company by the non-resident disposer (typically being a foreign corporation). Such re-characterisation is applied to arrangements involving an abusive use of organisational forms, where the taxpayer is unable to demonstrate economic substance in the offshore company. While Circular 698 has been used by the Chinese tax authorities in a number of high-profile cases involving non-resident corporate sellers, the position adopted by some practitioners has been that the GAAR provision, contained solely within the CIT Law, should not apply to individuals, as they should be subject to IIT on their taxable gains pursuant to the IIT Law, which, prima facie, does not contain an equivalent GAAR provision. This new case appears to indicate that the State Administration of Taxation (SAT) (which, under Circular 2, must approve any application of the GAAR by a local tax bureau) does not view this technical reading as an insurmountable hurdle to the application of the GAAR to tax a non-resident individual disposer.