In 2018, the individual income tax law was amended to add article 8 anti-tax avoidance provisions, which are respectively made from three aspects: arm's length principle, controlled foreign corporation, and general anti-avoidance. Compared with the individual income tax law before, it is a new clause. For the first time, it is proposed that the tax authorities have the right to adjust the individual income tax, which is basically the same as the concept of "special tax adjustment" in the enterprise income tax law. The high net worth individuals must be more careful when making inside China or cross-border tax planning because of this amendment, otherwise, it may be considered by the tax authorities as tax avoidance deliberately, and then pay an overdue tax or even fined. Article 8 of the individual income tax law stipulates that under any of the following circumstances, the tax authority shall have the right to make tax adjustments based on reasonable methods:
（1） Business that is not carried out under the arm's length principle between an individual and his or her affiliated party results in the lower amount of the individual's or his or her affiliated party's taxable income, without any justifiable causes;
（2） An enterprise established in a country (region) where the actual tax is obviously lower, which is controlled by a resident individual or jointly controlled by a resident individual and a resident enterprise, does not distribute profits that belong to such resident individual or distributes such profits in a smaller amount, without reasonable business needs;
（3） An individual makes other arrangements, without justifiable business purposes, to seek unjustified tax benefits.
Where it is required to make additional tax payments due to tax adjustments made by the tax authority in accordance with the provisions of the preceding paragraph, additional tax payments due shall be made, plus the interest thereon.
We will explain as follows:
（1）ALP (Arm’s Length Principle) rule
"Business that is not carried out under the arm's length principle between an individual and his or her affiliated party results in the lower amount of the individual's or his or her affiliated party's taxable income, without any justifiable causes"; it can be understood that the unreasonable related party transaction pricing may face the risk of being anti-tax avoidance investigated. For example, if an individual transfers a certain asset held by him to a related enterprise at an artificially low transfer price, resulting in a decrease in tax amount payable on the income from the transfer of personal property, the tax authorities have the right to adjust it. For cross-border, when overseas related parties collect payment for goods, interest, service fee or royalty from domestic related parties, they artificially raise the price, so as to transfer domestic taxable income abroad and evade domestic taxes.
Although it is a related party transaction, it can still be accepted by the tax law. Take the stock right transfer as an example, please refer to Article 13 of the Administrative Measures for Individual Income Tax on Incomes from Equity Transfer (Trial). If the price of individual equity is low, there is no "justifiable reason" for adjustment:
（1） Effective document is provided to prove that equities are transferred at a low price because the production and management of the invested enterprise are significantly affected due to the adjustment of the policy of the State;
（2）The equities are inherited by or transferred to the spouse, parents, children, grandparents, grandchildren, siblings and the person assuming the obligation to provide direct support to the transferor as proven by the legally effective personal status relationship certificates;
（3） As stipulated in relevant laws, government documents or the articles of association and fully proven by relevant materials, with the internal transfer of the equities which are held by employees of the enterprise and may not be transferred to external parties, the transfer price is reasonable and true; and
（4） Other reasonable circumstances which may be justified by valid evidence provided by the transferor and the transferee.
（2） Controlled foreign corporation rules
"An enterprise established in a country (region) where the actual tax is obviously lower, which is controlled by a resident individual or jointly controlled by a resident individual and a resident enterprise, does not distribute profits that belong to such resident individual or distributes such profits in a smaller amount, without reasonable business needs"; to understand this Chinese tax law article, we need to make clear the following two concepts: first, what is control? The control here means:
The resident individual or resident enterprise directly or indirectly holds more than 10% of the voting shares of the foreign enterprise, and they jointly hold more than 50% of the shares of the foreign enterprise;
The shareholding ratio of individual residents and resident enterprises does not meet the standards specified in the first paragraph but possesses substantial control over the foreign enterprise in terms of shares, capital, operation, purchase, and sale, etc.
Second, what is the obvious low actual tax? It means that the actual tax is lower than 50% of the tax rate stipulated in the Enterprise Income Tax Law of P. R. C. According to the order of the president of P.R.C No. 63 enterprise income tax law of the P.R.C in 2007: Article 4 the enterprise income tax rate shall be 25%, and the actual tax referred to in this article is lower than 50% of the tax rate stipulated in the enterprise income tax law of the P.R.C, that is, 12.5% and below. Many taxes havens, such as the Virgin Islands, British Jersey, Bermuda, Nauru, Panama, and Luxembourg, have a tax burden of less than 12.5%.
This clause and CRS information exchange is a powerful combination to crack down on previous overseas tax avoidance arrangements. For example, individual A, a tax resident of China, has set up an offshore company in BVI for operating investment, and the offshore company holds several financial accounts. In the past, it was very difficult for Chinese tax authorities to grasp the information of A’s offshore company, in a particular situation, they could only through exchanging international information, which was complicated and time-consuming. Now and in the future, after the implementation of CRS, the tax-related information of offshore companies will be exchanged, and the new individual tax levying has already been supplemented with the CFC anti-avoidance clause. BVI is obviously a country with a significantly lower actual tax. In the name of controlled related companies, Chinese tax authorities can treat the profits of BVI companies which is no commercial substance as directly obtained by individuals and levy an individual income tax, which is undoubtedly great to promote the anti-tax avoidance work.
（3） General anti-avoidance rule
"An individual makes other arrangements, without justifiable business purposes, to seek unjustified tax benefits."
This is a saving clause, which sets up the final barrier of individual income tax management, and provides an institutional guarantee for the continuous improvement of the individual income tax anti-tax avoidance system in the future. The general anti-avoidance clause is used to make up for the deficiency of the special anti-avoidance clause, which is helpful to enhance the deterrence of tax law. Facing all kinds of new tax avoidance methods, we must have corresponding solutions. The general anti-avoidance provisions regulate to adjust the arrangements that have no reasonable business purpose, which means that the tax authorities have the right to adjust the arrangements with the main purpose of reducing, exempting, or delaying the payment of tax. Arrangements that do not have a reasonable business purpose usually have the following characteristics:
First, there must be an arrangement, that is, a planned action or a series of transactions;
Second, the enterprise must obtain "tax benefits" from this arrangement, that is, to reduce the taxable income or amount of income;
Third, the main purpose of the arrangement is to obtain tax benefits.
The arrangement met the above three characteristics, it can be inferred that this arrangement has constituted a tax avoidance fact.
Conclusion:
The substance over form is an unmodifiable trend for the current home and abroad tax environment. Before the first information exchange under CRS (September 2018), China has completed the revision and implementation of the individual income tax law partially. The combination of two blockbuster tax regulations will surely have a profound impact on the tax of high net worth individuals.
