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13.1. GAAR and General Anti-Avoidance Measures

China began to advance its general anti-avoidance law with the implementation of the China Corporate Income Tax Law in 2008. In the law, special tax adjustment rules were put into place to strengthen the Chinese tax authorities’ ability to take action against business activities. The anti-avoidance provisions permit the China tax authorities to make adjustments when enterprises enter into business arrangements that give rise to a reduction of taxable income and are not supported by a bona fide business purpose.

Business arrangements without a bona fide business purpose refer to arrangements for which the primary purpose is to reduce, avoid, or defer tax payments. In addition to the rules outlined in the Corporate Income Tax law, additional guidance has been issued by the Chinese tax authorities providing broad coverage in a variety of contexts, including abuse of tax incentive policies, tax treaty provisions, legal vehicle forms or structures, tax havens, and other arrangements without bona fide business purposes.

China’s GAAR provides tax authorities with the power to make adjustments to certain transactions or deny tax benefits and allows local tax bureaus to disregard legal entities that are deemed to lack substance. In general, China tax authorities are giving an increased focus on substance over form and are increasingly willing to disregard structures, entities, and transactions perceived as being tax-motivated.

Summary of China GAAR

If any business transaction between an enterprise and a related party does not comply with arm’s length principles, thereby reducing taxable income or revenue, Chinese tax authorities are enabled to make adjustments using reasonable methods. Tax authorities will have the right to make tax adjustments within 10 years of the year in which a non-complying transaction takes place (see Sec. 13.4. for details on China’s transfer pricing rules).

GAAR Administrative Measures

In December 2014, China’s State Administration of Taxation (SAT) issued Decree 32/2014, which includes the administrative measures for special tax adjustments made in regard to enterprise income tax avoidance arrangements.

Determination of a Tax Avoidance Arrangement

The main features of a tax avoidance arrangement subject to GAAR are defined as transactions where:

  • Its sole or main purpose is to obtain tax benefits, which refers to the reduction, avoidance, or deferral of enterprise income tax; and
  • It complies with the tax law in legal form but lacks economic substance.

Transactions excluded include tax arrangements not connected with cross-border transactions and cross-border payments and illegal tax evasions cases, such as failure to make tax payments and forgery of invoices.

In addition, other applicable rules will take precedence over the application of GAAR, such as the special rules for transfer pricing, cost-sharing arrangements, controlled foreign companies, and thin capitalization, as well as relevant tax treaty provisions such as for beneficial ownership and limitation on benefits. (details below)

Adjustment Methods

In making special tax adjustments, the tax authorities must adhere to the substance-over-form principle and refer to similar arrangements with a reasonable commercial purpose and economic substance.

The main methods for making a tax adjustment for avoidance arrangements include:

  • Re-characterization of the whole or part of the arrangement;
  • Denial of the existence of a party to the transaction for tax purposes, or treating one of the parties and other parties to the transaction as one entity;
  • Re-characterization of the income, deductions, tax incentives or foreign tax credit or reallocation of them between the parties to the transaction; and
  • Any other reasonable method.

Detecting Tax Avoidance Cases

The Chinese tax authorities will detect possible tax avoidance cases through examination of tax returns, tax assessments, contemporaneous transfer pricing documentation, cross-border payments, transfer of equities, and implementation of the provisions of tax treaties. When a suspected case is discovered at the local level, the case is referred to the tax authority at the provincial level and then to the SAT for approval to begin the investigation proceedings.


Once approval for an investigation is granted, an inspection notice must be sent to the taxpayer requesting documentation that proves the arrangement is compliant. The types of documentation to be submitted by the taxpayer include:

  • Details of the background of the arrangement;
  • Explanatory documents justifying the business purposes of the arrangement;
  • Internal documents relating to the arrangement’s strategies and administration, such as resolutions of the board of directors, memos and email exchanges, etc.;
  • Transactional documentation relating to the arrangement, such as contracts, supplemental contracts, evidence of payments, etc.;
  • Communications between the taxpayer and other parties to the transaction;
  • Other documents proving that the arrangement was not tax avoidant in nature; and
  • Any other documents requested by the tax authority.

The taxpayer’s tax planners/advisors related to an arrangement may also receive requests for documentation.

Requested documentation should be provided to the tax authorities within 60 days of request, although a 30 days' extension can be applied for.

Investigation Conclusion

Once the investigation is complete, the local tax authority will judge whether the taxpayer’s arrangement was tax avoidant or not. This conclusion must be reached within nine months from the date the investigation was initially approved by the SAT.

If the local authority deems that the arrangement was tax avoidant in nature, a special tax adjustment proposal will be passed to the provincial tax authority for review and approval and then passed to the SAT to close the investigation. The SAT will then respond in one of three ways:

  • If the SAT denies the proposed special tax adjustment, a notice of such conclusion is given to the taxpayer;
  • If the SAT approves the proposed special tax adjustment, a notice of preliminary determination on the special tax adjustment is given to the taxpayer; or
  • If the SAT has other comments on the adjustment, the local tax authority will adjust and resubmit the proposal to the SAT for further review.

If notice of preliminary determination is given, the taxpayer may file an objection within seven days. If the objection is rejected by the local authority, it will be passed to the provincial authority and on to the SAT for final review. If the SAT rejects the objection or no objection is made within the seven days period, a final determination notice will be issued.

Dispute Resolution

Taxpayers may appeal a special tax adjustment through administrative and judicial procedures. If a taxpayer believes an adjustment violates an applicable tax treaty or other relevant bilateral arrangements, mutual agreement proceedings (MAP) may be initiated.


When additional tax is levied to recoup underpaid taxes as per China GAAR, the additional tax shall be collected, and additional interest can be levied. Interest on underpaid taxes will be imposed on a daily basis beginning 1 June  of the year following the taxable year in which a transaction was deemed not in compliance with China GAAR.

The interest rate is based on the CNY loan base rate issued by the People’s Bank of China in the tax year in which the transaction occurred, and for a loan of the same period that additional tax is payable, plus 5%. For enterprises that submitted all documentation required during the annual audit and any other documentation required during avoidance investigation, interest can be calculated using only the base rate for a loan in the same period.