More SPVs are Being Challenged: China Brings the General Anti-Avoidance Rules from Concept to Reality

January 1, 0001


Historically, PRC tax authorities have generally respected the legal form of transactions and rarely disregarded the legal form based on the underlying substance. This is not true anymore. The doctrines of economic substance and business purpose embedded in the general anti-avoidance rules of the new PRC Enterprise Income Tax Law (“EIT”) are now a part of administrative practice in China.

Anti-avoidance Rules

Article 47 of the EIT law provides that: “where an enterprise implements any other arrangement with no reasonable business purpose to reduce the amount of its taxable income, the tax authority shall have the right to make adjustments through reasonable means.”

On January 8, 2009, the State Administration of Taxation issued the long-awaited Implementation Regulations for Special Tax Adjustments (Trial) to interpret the general anti-abuse clause. Among other things, it provides that the tax authorities may initiate a general anti-avoidance investigation to enterprises with the following tax avoidance arrangements: (i) abuse of tax incentives; (ii) abuse of tax treaties; (iii) abuse of a company’s legal form; (iv) tax avoidance through a tax haven; and (v) other arrangements without bona fide business purpose. The tax authorities will consider the following factors based on the “substance over form” principle in determining whether a transaction is arranged for tax avoidance purposes:

  • Form and substance of the arrangement;
  • Conclusion time and execution period of the arrangement;
  • Connection between each step or part of the arrangement;
  • Changes of financial status of each party involved in the arrangement; and
  • Tax consequence of the arrangement.

Two Significant Cases

In two recent tax cases (discussed below), PRC tax authorities either disregarded or denied treaty benefits to an offshore special purpose vehicle that they found to lack substance. Although not specifically stated in the cases, tax practitioners generally believe that the general anti-abuse clause in the new EIT law (i.e., Article 47) was the underlying rationale and legal basis in deciding the following two cases.

  • Chongqing Case - Legal Form of SPV Disregarded

The Chongqing Yuzhong district-level State Tax Bureau published a tax case in late November 2008 in which the PRC tax authorities looked beyond the legal form of a transaction and disregarded a Singapore special purpose vehicle (“SPV”).

According to the published case, Chongqing tax authorities imposed a withholding tax on capital gains derived by a Singapore holding company from the sale of its shares in a wholly-owned Singapore subsidiary (i.e., the SPV) to a Chinese buyer. The SPV held a 31.6% equity interest in the Chinese target company. The Chongqing tax authorities found that the SPV had no real business other than holding the 31.6% equity interest in the Chinese target company and the total capital of the SPV was only 100 Singapore dollars. Based strictly on the legal form of the transaction, China did not have tax jurisdiction over the Singapore holding company. However, Chongqing tax authorities looked beyond the legal form of the transaction and decided that this transaction was a transfer of Chinese onshore stock through the SPV in substance and therefore the SPV should be disregarded for tax purposes.

  • Xinjiang Case - Barbados Tax Treaty Benefits Denied

A Barbados-based SPV, established by a US company, derived capital gains from the sale of its equity interests in a Chinese company located in Xinjiang. In general, such capital gains are protected by the China/Barbados income tax treaty and should not be taxed in China. However, in this case, PRC tax authorities denied the benefits of the Barbados income tax treaty and imposed tax on the SPV because the tax authorities found that the purported seller had no substance in Barbados.

The following facts were identified by the tax authorities as suspicious: the Barbados SPV purchased the equity interest in the Chinese company only after one month of its formation and sold the equity interest after approximately one year from the date of the purchase; the SPV’s return on its investment in the Chinese company was 36%, which was not achieved by business operation of the Chinese company but instead was based on a pre-arranged contractual arrangement as if the SPV had made a disguised loan rather than an equity investment; and, all directors of the Barbados SPV were US citizens.


With the new Implementation Regulations and the two recent cases discussed above, it is clear that PRC tax authorities will look beyond the legal form of a transaction in assessing whether a transaction is a tax-avoidance arrangement. Investors are advised to review their current structure to assess whether they are vulnerable to the application of the anti-avoidance rules. In particular, investors should closely examine their offshore special purpose vehicles. If the two cases discussed above are indicative of PRC tax authorities’ position on offshore special purpose vehicles, then those that lack substance will likely be completely disregarded or denied treaty benefits. More generally, investors should be aware of the risks involved in engaging in transactions that may be perceived as tax avoidance arrangements.