CHINA Law and Practice Contributed by: Mei Zhang, DaHui Lawyers
of these areas have adopted complete tax exemp - tion policies, meaning they exempt companies from paying CIT, instead implementing a minimal financial burden mechanism based on registration and administrative fees. 5.2 Anti-Avoidance Mechanisms China endows its tax authorities with extensive pow - ers for tax reassessment, including audits, penalties, and special tax adjustments. To effectively address cross-border tax fraud, evasion and avoidance, China actively expands its international governance net - work by negotiating bilateral treaties and participat - ing in multilateral initiatives, thereby gaining access to broader intelligence and enforcement authority. Legal Consequences Upon identifying fraudulent, evasive or avoidant activi - ties through audits or other means, tax authorities will initiate enforcement procedures, which may result in the following (among other things): • Administrative penalties – The authorities will recover unpaid taxes and impose late payment interest (0.05% per day). Additionally, a fine ranging from 50% to five times the amount of tax evaded may be levied. • Criminal liability – If the act constitutes a criminal violation, criminal proceedings will be initiated. Penalties can be severe, with the maximum penalty for serious cases of tax fraud being life imprison - ment. Tools Against Tax Base Erosion and Profit Shifting (“BEPS”) For transactions that, while not directly illegal, erode the tax base by lacking commercial substance, the tax authorities employ specific anti-avoidance measures, the core components of which include: • TP adjustments – If a business transaction between an enterprise and its related parties does not comply with the arm’s length principle, or if the enterprise implements other arrangements that do not have a reasonable commercial purpose, the tax authorities have the right to make a tax adjustment within ten years from the tax year in which the transaction occurred.
• Controlled foreign corporation (“CFC”) – Foreign- sourced profits controlled by domestic residents who retain such profits without reasonable busi - ness needs may be taxed as if the funds were distributed. • Thin capitalisation rules – When the ratio of debt investment to equity investment received from an enterprise’s related parties exceeds the prescribed standard (generally 5:1 for financial enterprises or 2:1 for other enterprises), interest expenses are no longer deductible before tax. • General Anti-Avoidance Rule (“GAAR”) – When determining whether an arrangement offers a tax benefit, the tax authorities should consider the economic substance of the arrangement, its outcome, and its impact on the enterprise, and compare it with alternative arrangements that achieve the same business objective without avoiding tax. When an enterprise and its related parties use agency or proxy arrangements to con - ceal related-party transactions, the tax authorities can determine related-party transactions based on economic substance. International Tax Co-Operation China actively strengthens its tax administration through deep engagement in the international tax governance system, primarily via three interconnect - ed channels – expanding its treaty network, enforcing transparency standards, and implementing evolving global rules. • Expanding DTAs network: China has built one of the world’s most extensive DTA networks, with over 100 comprehensive agreements in force. Modern treaties are increasingly equipped with robust anti- abuse provisions to prevent treaty shopping and improper claims of benefits. • Automating tax information exchange: As a com - mitted early adopter, China has fully implemented the Common Reporting Standard (“CRS”) for the automatic exchange of financial account infor - mation since 2018. It now engages in automatic information exchange with more than 100 jurisdic - tions, significantly enhancing transparency and its capability to detect offshore tax evasion. • Implementing evolving international standards: Chi - na is an active participant in the G20/OECD BEPS
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