China’s crackdown on tax evasion to impact cross-border transactions

Multinationals told to be more cautious about intra-group transactions as Beijing imposes stiff measures against avoidance and evasion

Multinationals have been advised to take notice of Beijing’s New Year resolution to crack down on tax avoidance and evasion, especially after the announcement of the general anti-avoidance rule (GAAR) and new penalties last month.

Beijing’s determination to strike hard at tax evasion is underscored by the recent signing by 21 ministries and departments of an interdepartmental memorandum of understanding on disciplinary measures against such offences, announced on the website of the State Administration of Taxation.

Serious offenders, including individuals and companies, face 18 disciplinary measures, including a ban from leaving the country, bar from issuing bonds, restrictions on access to state funds and being named and shamed in the media.

Matthew Mui, the China leader of national tax policy services at PwC, clarified that tax avoidance was the use of legal loopholes to reduce tax liabilities, while evasion was illegal.

The GAAR measures take effect on February 1.

A KPMG report said more measures to combat tax avoidance would be announced.

“As the GAAR measures are simply the first volley in a series of announcements and measures, we encourage multinationals to monitor upcoming tax law developments,” it said.

“Multinational companies, including banks with global operations, must be more cautious about their intra-group transactions, especially those operating in China with large amounts of investment and negative taxable income,” said Spark Wang, a senior regulatory intelligence expert at Wolters Kluwer Financial Services, a US provider of risk and compliance services.

With the announcement of GAAR, the transfer of cross-border funds had become a critical area subject to inspection by the Chinese government, Wang said.

“Multinationals must review their approach to transfer pricing and cost allocation. All transactions must be kept fully transparent. To avoid operational risk, the firm must enhance its internal control as well,” he said.

Multinationals can lower their taxes by shifting their profits from high-tax jurisdictions, such as the mainland, to lower-tax jurisdictions using transfer pricing, which involves setting prices of goods and services sold between different subsidiaries in different jurisdictions.

“The recent anti-avoidance measures could have a significant impact on enforcement of international tax arrangements in China and close monitoring by multinationals is certainly advisable,” said Christopher Xing, a KPMG China tax partner. “The GAAR rules are important as they set the scene for enforcement by tax authorities in future.”

The authorities announced GAAR shortly after the Group of 20 leaders’ summit in Australia in November last year, when President Xi Jinping called for international collaboration to crack down on cross-border tax avoidance.

“It is the first time that tax matters were noted in an important statement by China’s paramount leader in such a high-profile international political context,” the tax administration said.

“An increasing number of multinationals are avoiding their liabilities through sophisticated tax schemes,” it said. “This has eroded the tax base of many countries. Against such a backdrop, the G20 entrusted the Organisation for Economic Cooperation and Development to execute plans to counteract base erosion and profit shifting (BEPS), which has brought together a global effort.”

Mui said BEPS was a good opportunity for China to shift its role from international tax rule follower to an influencer. “Many of China’s positions have been adopted in OECD BEPS reports. It is inevitable that multinationals may face greater uncertainty when determining their tax strategies,” he said.

The GAAR measures provided more details and clarifications on tax evasion laws, said the tax administration. They clarified the definition of “tax benefit” and the major features of a “tax avoidance arrangement”.

Any avoidance arrangement intended to obtain a benefit without reasonable commercial purpose should be subject to GAAR, it said.

Multinationals needed to review whether their profits in China are commensurate with their activities, Mui said.

“Taxpayers need to be alert to the likelihood that greater numbers of transactions, perceived as artificial by the tax authorities, may now be subject to scrutiny,” KPMG said.

Multinationals were unlikely to reduce their investments in the mainland simply because Beijing was cracking down on tax avoidance, said Patrick Yip at Deloitte Touche Tohmatsu.