Taxing indirect equity transfers in China

In the past, China rarely taxed foreign investors on capital gains realized from selling their Chinese equity interests through offshore holding companies due to data and resource constraints. With the outset of a controversial policy adopted by the tax administration in late 2009, China began to tax such gains on the grounds that these offshore holding companies were vehicles to avoid China's income taxes. However, voluntary taxpayer compliance has been a problem due to the lack of a statutory basis for taxing indirect equity transfers, other than the general anti-avoidance rule (GAAR) of the income tax law. Moreover, the GAAR has been unpredictable and difficult to implement because uncertainty often arises as to how acceptable tax planning is distinguished from unacceptable tax avoidance and which transactions fall under the GAAR. The authors suggest that the tax authorities design better rules for taxing indirect equity transfers to ensure adequate compliance with the withholding and reporting requirements by nonresident taxpayers.