Legal News

China’s Tax Authorities are Plotting to Take Over the World.

China independent contractor

Shanghaiist just posted my list of China’s top 5 business law trends of 2010, which list included China drastically stepping up its tax collection efforts.

Speaking of drastically, I just read a really excellent article by a swarm of international lawyers, entitled, China Adopts Controversial Vodafone-style Extraterritorial Tax and Disclosure Rule, This article summarizes an “amazing” part of China’s Tax Circular 698 as follows:

However, Article 5 of Circular 698 then takes an amazing leap. It [Article 5 of Circular 698] states that foreign entities are required to disclose all indirect transfers of PRC resident enterprises to the PRC tax authorities in cases where an intermediate holding company through which such transfers are made are located in a low tax jurisdiction or such jurisdiction exempts income tax on foreign-sourced income. In this case, the foreign enterprise making the indirect transfer must disclose the following documentation to the PRC tax authority in the location of the PRC resident enterprise within 30 days of executing the transfer contract:

i. Equity transfer agreement/contract;

ii. Representations regarding the relationship between the foreign entity and holding company being transferred in terms of “capital, operation, sales and purchase etc.”;

iii. Representation regarding the operation, employees, bookkeeping, and assets of the holding company being transferred by the ultimate foreign entity;

iv. Representations regarding the relationship between the holding company being transferred by the ultimate foreign entity and the PRC resident enterprise, in terms of “capital, operation, sales and purchases;”

v. Representations regarding the reasonable business purpose with respect to the transfer of the holding company; and

vi. Other materials requested by the tax authority.

The article then very nicely lays out some truly extreme examples of where foreign companies may be required to report to China on their foreign M&A activity and then asks the following series of questions relating to whether the circular is “even legal:”

(1) Is there a legal basis under any validly promulgated PRC law or administrative regulation which imposes information reporting obligations and tax with respect to such indirect transferors? How does an interpretive circular like 698 derive its PRC legal authority?

(2) Does the PRC general anti-abuse rule (“GAAR”) in the EIT grant virtually unlimited power to the PRC tax authorities concerning transactions, including matters of extraterritorial jurisdiction? How does one sentence in a quasi-civil law statute encapsulate an entire doctrine?

(3) Is there a colorable theory under international legal principles to assert extraterritorial jurisdiction over the numerous parties potentially described in Circular 698?

(4) Will the enormous administrative complexities and burdens created by the disclosure mean erratic compliance and result in grossly unfair application of the rule? Can most foreign entities comply?

(5) Will local PRC tax bureaus be staffed with the resources, training, and other administrative infrastructure to deal with those disclosure actually submitted?

This circular is so far out of the norm and so likely to cause an uproar I suspect much of it will never come to pass. It is though a great indicator of China’s strong desire to increase its taxing powers, especially of foreign companies.

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