To the Extent that Ayn Rand Makes Sense to Me

On a flight to Beijing last weekend, I, being myself, checked out the (female) cabin crew. I wasn't disappointed. One air hostess stood out from the rest. With a face your heart will palpitate for, she was also taller, curvier, and coyer.

She, however, was not the only aesthetic highlight of the flight. The other aesthetic highlight of the flight was reading Ayn Rand’s "Philosophy: Who Needs It". I bought the book 4 years ago but it made no sense to me then. I was not at all familiar with this Russian novelist/philosopher’s works (or anything philosophical, for that matter), other than knowing her allegedly pernicious influence on the former U.S. Federal Reserve Chairman Alan Greenspan in formulating monetary policy, and her superb mastery of the English language.

So who needs a philosophy? To answer the captioned question, Ayn Rand stated: 

“A philosophic system is an integrated view of existence. As a human being, you have no choice about the fact that you need a philosophy. Your only choice is whether you define your philosophy by a conscious, rational, disciplined process of thought … or let your subconscious accumulate a junk heap of unwarranted conclusions, false generalizations, undefined contradictions, undigested slogans, unidentified wishes, doubts and fears, thrown together by chance, but integrated by your subconscious into a kind of mongrel philosophy and fused into a single, solid weight: self-doubt…” (p7)

Rather than ‘need’ a philosophy, you already ‘have’ one. What you do need is a philosophic system under which to articulate your philosophy. The alternative will be “self-doubt”, and - so reasoning runs - lack of confidence, and ultimately, unhappiness. Just like my Cantonese.

But what is philosophy? It has 5 branches:

1.  Metaphysics: the study of existence
2.  Epistemology: the theory of knowledge
3.  Ethics: i.e. morality
4.  Politics: the principles of a proper social system
5.  Esthetics: the study of art

Think philosophy is too abstract to be useful?

“…abstract ideas are conceptual integrations which subsume an incalculable number of concretes – and that without abstract ideas you would not be able to deal with concrete, particular, real-life problems. You would be in the position of a newborn infant, to whom every object is a unique, unprecedented phenomenon. The difference between his mental state and yours lie in the number of conceptual integrations your mind has performed.” (p6)

This must be epistemology. And this again makes sense to me. An incident at work can attest to this. When a manager tried to explain to me the accounting of a ‘cluster’ program under which different corporate entities distribute its profits. I looked at the ephemeron he wrote on the paper and had an epiphany, “Just like a partnership!” He nodded with approval, “A very complicated one, yes.” I must have some vague idea (i.e. abstract ideas) about the accounting of partnership to ‘subsume’ the concrete workings of the program thereunder.

So how to study philosophy? Ayn Rand advocates approaching philosophy as one approaches a detective story. “Follow every trail, clue and implication, in order to discover who is a murderer and who is a hero.”  One will not always find the immediate answers, but he “will acquire an invaluable characteristic: the ability to think in terms of essentials”.

To “think in terms of essentials”, one need to avoid the layman’s error of tending to “take the end result of a long sequence of thought as the given and to regard it as ‘self-evident’, or as an ‘irreducible primary’”.. And nothing is “self-evident” except the material of sensory perception.

This relates to me. An application in life will be: never take your so-called expert’s advice at face value. For example, when seeking legal advice, an intelligent client should be given the legal authorities - the ‘irreducible primary’ - upon which his advisors base their opinions. What they tell you to do is not, and should not be taken as, "self-evident". As the saying goes, "a fool and his money are soon parted." Only the gullible and the ignorant can't see the emptiness under the pomposity of their "experts" living off their clients' gullibility, ignorance and deep pockets. Likewise, when establishing the facts of a criminal case, the prosecution had better adduce direct evidence (e.g. CCTV record of a murder) rather than circumstantial evidence (e.g. a finger print at the crime scene).

But how about emotions? Are they ‘irreducible primaries’ upon which to base one’s course of actions? Ayn Rand thinks that an emotion is not a primary, but a “complex, derivative sum”. And it allows men to practice the “ugliest psychological phenomenon” of rationalization. A description of that process of rationalizing is “I can’t prove it, but I feel it’s true.” Men who rationalize “do not judge the truth of a statement by its correspondence to reality – they judge reality by its correspondence to their feelings.“ So self-help books that makes readers feel good about themselves by way of self-deceit, thus ‘judge reality by its correspondence to their feelings’ are, according to Ayn Rand, evil philosophical systems of rationalization. The cure is “introspection”, the conceptual identification of one’s inner states. 

Ever since I took up legal studies, I have grappled with reconciling two opposing conceptual integrations:  the difference between ‘feeling’ and ‘thinking’. Years of schooling taught me that thinking is the antithesis of feeling. The words of my high school math teacher still reverberates in my head, “When confronted with a problem, you will have some initial ‘gut feeling’ (感性认识) about it, but you need ‘rational thinking’ (理性思考) to prove that feeling.” But the boundary between the two may be blurred. For starters, when you see a word in interpreting a statute, do you ‘feel’ or ‘think’ about what it means? When the problem at hand involves a value judgment, a matter of tastes or personal preferences, it should be left to the democratic processes, as Justice Scalia would agree. The nitty-gritty of dealing with emotions, therefore, is to be absolutely honest about one’s feelings towards the issues: is it wrong, or you just don’t like it?

Starting to make sense of what was gobbledegook a few years ago is encouraging. It evidences my intellectual growth after I was done with formal schooling (from which I took pains to prevent interfering with my education!). Now that's called being "introspective", my friend.

My Amateurish Impression of the American Judge Justice Scalia’s Jurisprudence

This summer, as Obergefell v. Hodges flooded social media with rainbows and kissing gays, it also became the first US Supreme Court decision I have ever looked at [1]. In this otherwise (expectedly) dull piece of legal opinion couched in forbidding jargons and headache-inducing (and eye-rolling) abstraction, that of some ‘SCALIA, J., dissenting’ caught my eyes with colloquial ‘huh?’, ‘really?’ and ‘whatever that means’[2]. Immersed in the studies of the English law for the past 2 years, I found the adoption of these phrases amusingly refreshing.

Hours of Youtube clips later, I learned that this American judge is truly a curiosity. A ‘conservative maverick’ may sound like an oxymoron in the UK, but it aptly describes Justice Antonin Scalia[3]. As the most conservative member of the bench, he is also the most polarizing. Many fear that his reactionary jurisprudence will return America to the dark ages.

His fundamental philosophy is simple. Judges are to decide what the law means, not to (re-)write it. The British, as I recall from my public law studies, call it 'the declaratory theory of law'. As an 'originalist', he believes that the Constitution means the same thing today as it did when it was written in the summer of 1787. As he quipped vividly, there is no living Constitution, but a dead one, much to the amusement of the young audience during a speech at Oxford. 

He wrote a book [4]  on statutory interpretation of the 'textualism' breed which dictates that judges should not distort the meanings of the text of the Constitution that the Founding Fathers could not have intended. This, according to Scalia, WAS orthodox until some professors came along and poisoned judges' minds with the seductive idea that the US Constitution is a living one and "changes from decade to decade to comport with the evolving standards of decency that mark the progress of a maturing society". "Like societies will only mature," Scalia indignantly said, "not rot!" The audience again lost it.

As he put it in Obergefell v. Hodges:

“This is a naked judicial claim to legislative—indeed, super-legislative—power; a claim fundamentally at odds with our system of government.”

Again, only in America would a conservative judge faithful to the original text of the law be the odd man out, rather than the norm. Scalia, in his signature wrath, claims that 9 judges effectively rewriting the Constitution is dictatorlike, as he opened his opinion with:

“I write separately to call attention to this Court’s threat to American democracy.”

The coherence of his reasoning I am not in a position to comment upon. Yet, some anecdotes are interesting. During the Q&A session at one of Scalia’s non-judicial speeches, a member of the audience questioned that, if textualism should be followed, then "We the People" in the opening words of the US Constitution would never include African Americans or women. How would you lawyer this absurdity away?

Scalia equivocated by talking (eloquently) about something else. 

Another asked, if the judges are ill equipped for decisions which should have been left to the people, why not hold a referendum every time such a decision is called for? 

Scalia said he didn't understand this question. Next please.

Finally, the always charming Scalia was at his weakest when he sheepishly admitted that it is no easy feat for people to change the Constitution. It would take only 3% of electorate to veto any such attempt. 

I have no doubt about Scalia’s sincerity. But sometimes I imagine Scalia lying awake in his bed late at night, with his beloved wife of 50 years in sound sleep beside him, ever harbors ANY second thoughts about his judicial philosophy. Even once? Maybe? When someone like Scalia spends their entire life espousing a cause, I guess, there will never be turning back. 

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[1] Let me not abuse the word "read"!

[2] http://www.supremecourt.gov/opinions/14pdf/14-556_3204.pdf

[3] And Donald J. Trump in the political arena.
[4] Reading Law: The Interpretation of Legal Texts

Writing like a judge is DISGUSTING

Long sentences, complex structures, hard words only feel right in the hands of skilled English writers. 

But when an unskilled writer mistakenly thinks he too has mastered those advanced skills, he will risk making a fool of himself.

He will look like trying to speak a fake polished accent. 

In others words, he will be DISGUSTING.

Look at this CLOWN: 

Revelation from Lord Sumption and Sherlock Holmes

'The law is easy. Facts are complicated. Once one eliminates 95% of facts that are irrelevant, what the law should be is common sense. ' (Lord Sumption v Professor Graham Virgo debate at Cambridge University, per Lord Sumption)1

'I have no date yet. It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts.' (The Adventures of Sherlock Holmes, per Sherlock Holmes)

The key to solving a problem is to grasp its facts. Someone should have told me this two years ago.

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1. 'Those Who Wish to Practise Law Should Not Study Law at University'?(https://youtu.be/uMR1NIEifWM)

News updates: Accelerated Depreciation Policy Fine-tuned for Fixed Assets

On 20 October 2014, the Ministry of Finance and the State Taxation of Administration of China jointly issued Notice of Complementing Corporate Income Tax Policy of Accelerated Depreciation for Fixed Assets (Caishui [2014] No.75. or “Notice 75”)1.

According to Notice 75, for corporate income tax purposes, accelerated depreciation can be accomplished by way of either (i) full deduction, or (ii) shortened depreciation periods or accelerated depreciation methods.

Full deduction

Fixed assets are eligible for full deduction, rather than being annually depreciated, if they fall into one of the categories below:

1. The fixed asset has a unit cost equal to or less than RMB5,000; 
2. The fixed asset is apparatus or equipment purchased after 1 January 2014 for the specific purpose of research and development (“R&D”) and has a unit cost equal to or less than RMB1,000,000; 
3. The fixed asset is apparatus or equipment purchased by “small-scale or small-profit enterprises” belonging to the “6 designated industries”2 after 1 January 2014 for the dual purposes of R&D and manufacturing operation, and has a unit cost equal to or less than RMB1,000,000.

Shortened depreciation periods or accelerated depreciation methods

Fixed assets are eligible for shortened depreciation periods or accelerated depreciation methods. If they fall into one of the categories below:

1. The fixed assets is apparatus or equipment purchased after 1 January 2014 for the specific purpose of research and development and has a unit cost more than RMB1,000,000; 
2. The fixed asset is apparatus or equipment purchased by “small-scale or small-profit enterprises” belonging to the “6 designated industries” after 1 January 2014 for the dual purposes of R&D and manufacturing operation, and has a unit cost more than RMB1,000,000.

Prevailing tax policies on fixed assets are still applicable to fixed assets not falling to any of the above categories.

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1. 财政部 国家税务总局 关于完善固定资产加速折旧企业所得税政策的通知
(http://www.chinatax.gov.cn/n810341/n810755/c1260992/content.html)

2. The 6 designated industries are (1) biopharmaceutical manufacturing, (2) special equipment manufacturing, (3) railroad, marine, aerospace and other transportation equipment manufacturing, (4) computer, communications and other electronic equipment manufacturing, (5) instruments and meters manufacturing and (6) information transmission, software and IT services.

News updates: Shenzhen Lays Down VAT Exemption Rules for Small-scale Taxpayers

On 23 October 2014, the Shenzhen Municipal Office of the State Administration of Taxation (“SZ SAT”) issued Announcement on Exemption of VAT Small-scale Taxpayers and Related Issues (SZ SAT Announcement [2014] No.15, or “Announcement 15”)[1] in response to relevant circulars issued by the SAT at the state level.

Pursuant to Announcement 15, VAT small-scale taxpayers are exempt from VAT if their quarterly sales are equal to or less than 60,000 yuan. For VAT small-scale taxpayers with quarterly sales ranging from 60,000 to 90,000 yuan, VAT is also exempted for the period from 1 October 2014 to 31 December 2015. 

In China’s VAT regime, VAT small-scale taxpayers are to be contrasted with VAT general taxpayers. VAT small-scale taxpayers are generally subject to VAT at 3% on their sales with neither deductions of input VAT credits or issuance of VAT invoices allowed. VAT general taxpayers, on the other hand, are subject to a diverse range of VAT rates and have neither of the aforementioned restrictions on small-scale taxpayers regarding VAT credits and invoice issuance. To qualify for VAT general taxpayers, taxpayers shall meet the standard of either operation scale, or adequate accounting system.

Announcement 15 also dictates that VAT small-scale taxpayers in Shenzhen shall lodge their VAT returns on a quarterly basis. And the above-said exemption is applicable to VAT small taxpayers which also include both sole proprietors and individuals with temporary tax registrations, and which file their returns quarterly.

Also, VAT exemptions may also be available for VAT small-scale taxpayers when they just turn VAT general taxpayers. In the event that a VAT small-scale taxpayer qualifies for, and is recognized as, a VAT general taxpayer within a tax filing quarter, VAT shall be exempt for this tax filing quarter, if in the month preceding to the month when the VAT general taxpayer status takes effect, the taxpayer is a VAT small-scale taxpayer with its sales in that preceding month less than or equal to 30,000 yuan. 

Besides articulating the requirements for the VAT exemption, Announcement 15 also touches on the procedural and administrative issues such as invoice issuance and tax filing. Specifically, it reiterates that VAT small-scale taxpayers are not allowed to request tax authorities to issue “VAT special invoices” (which can be used by purchasers/service recipients to credit against their own VAT liabilities) on their behalf for the VAT exempted sales or services. Instead, tax authorities can only issue “VAT ordinary invoices” (which cannot be credited against one’s VAT liabilities) on VAT small-scale taxpayers’ request and behalf with no prepaid tax imposed thereon.

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[1] 深圳市国家税务局关于增值税小规模纳税人免征增值税有关事项的公告 (http://www.szgs.gov.cn/szgs/tzgg/201410/9be050fea0534b1ab092bb85f6cacd19.shtml)

News updates: China's response to BEPS deliverables

On 17 September, China’s State Administration of Taxation (SAT) responded to the first batch of deliverables in connection with base erosion and profit shifting (BEPS) hours after its release by the Organization for Economic Cooperation and Development (OECD).

The BEPS Action Plan endorsed by the G20 in July 2013identified 15 key areas to be addressed by 2015, with the following 7 delivered in September 2014, and endorsed by the Finance Ministers of G20 countries at their meeting in Cairns, Australia on 20 and 21 September. The SAT provided a full Chinese translation of the reports of the 7 deliverables and its commentary thereon is as follows:

Action 1: digital economy

The SAT noted that the report recognized that because the digital economy is increasingly becoming the economy itself, it would not be feasible to ring-fence the digital economy from the rest of the economy for tax purposes. The report’s conclusion is that it will be hard to formulate stand-alone, specific policies tackling tax risks posed by the digital economy, which will be addressed by the work on the other Actions in the BEPS Action Plan.

The SAT expressed disappointment over the lack of solutions in the report, and commented that the failure to achieve consensus was also due to the vastly different interests pursued by participating states.

Action 2: hybrid mismatch arrangements

Hybrid mismatch arrangements exploit differences in the tax treatment of instruments, entities or transfers between two or more countries, and often lead to “double non-taxation” or long-term tax deferrals. The report suggested changes to both domestic laws and the OECD Model Tax Convention.

The SAT expressed no view on this report.

Action 5: harmful tax practices

Countries engaged in harmful tax practices to get a leg up in the “race to the bottom” by reducing tax burdens in order to attract or retain highly mobile economic activity in their jurisdictions. Harmful tax practices are harmful in that they erode the tax bases of other jurisdictions, distort the flows of capitals, and result in tax burdens shifted to lowly mobile tax bases such as labour forces, fixed assets and consumers.

The SAT noted that, as a Key Partner of the OECD, China’s own tax incentive regime will be reviewed and discussed at the meeting of the OECD's Forum on Harmful Tax Practices (FHTP) in November 2014.

Action 6: treaty abuse

Tax treaties are abused by artificial arrangements to gain tax benefits, e.g. double non-taxation, unintended by the treaties. This report includes proposed changes to the OECD Model Tax Convention and domestic laws to prevent treaty abuse. The report also clarifies that tax treaties are not intended to be used to generate double non-taxation and identifies the tax policy considerations that countries should consider before deciding to enter into a tax treaty with another country.

The SAT expressed no view on this report.

Action 8: transfer pricing issues in intangibles

This intermediate report contains revisions to the OECD Transfer Pricing Guidelines to align transfer pricing outcomes with value creation in the area of intangibles.The report is based on the principle that profits arising from intangible assets should be ascribed to different entities from the perspectives of global supply chain and value creation.

The SAT noted that the report has considered and incorporated important points proposed by China, paving the way and providing the international legal authorities for China’s future anti-avoidance practices.

Action 13: transfer pricing documentation and country-by-country reporting

The OECD endorsed the three-tier approach for transfer pricing documentation which comprises a master file, a local file and a separate country-by-country report ofrevenues, profit before income tax, income tax paid, current year income tax accrual and stated capital, accumulated earnings, number of employees, and tangible assets.

The SAT expressed no view on this report. But it is noted that the SAT is currently revising the implementation rules of “special tax adjustments”, which is expected to provide guidance for China’s domestic transfer pricing documentation.

Action 15: multilateral instrument

The report identified the issues arising from the development of a multilateral instrument, a mechanism to swiftly implement changes to model tax conventions to the content of actual tax treaties.

The SAT noted that this was an intermediary report emphasizing the necessity of such a mechanism, and would closely watch its latest development at a meeting in 2015.

The SAT concluded its response by observing that this new round of international tax reform gave fairness a chance, that is, tax liability should be aligned with tax substance of economic activities and value creation. The SAT also vowed to seize the rare historical opportunity as an emerging economy to participate in the formulation of international tax rule, which had hitherto been dominated by developed countries for almost a century.

Are You "Carrying on Business" or "Carrying on a Business"? (Are You Grammatically or Legally Confused?)

The Hong Kong Inland Revenue Department seems to use "carrying on business" and "carrying on a business", interchangeably.1

But, are they interchangeable?

I can easily fathom where this confusion arose.

Section 14(1) of the Inland Revenue Ordinance provides that:

"Subject to the provisions of this Ordinance, profits tax shall be charged for each year of assessment at the standard rate on every person carrying on a trade, profession or business in Hong Kong in respect of his assessable profits arising in or derived from Hong Kong for that year from such trade, profession or business (excluding profits arising from the sale of capital assets) as ascertained in accordance with this Part. (Replaced 2 of 1971 s. 9. Amended 7 of 1986 s. 12; 56 of 1993 s. 8)" (emphasis mine) 

The drafting makes it unclear whether the indefinite article "a", besides undoubtedly pointing to the immediately following "trade", also points to the subsequent "profession" and "business".  But don't blame the draftsmen. Their job is to articulate policy intentions in black and white, not to teach you grammar.

Accepted grammatical rules dictate that "a" shall precede a countable noun, not an uncountable one. This begs the question of in which category "business" falls.

The answer is, it depends on the meaning of the word "business" you intend it to have in a particular context. When you use the word "business" to mean a "a specific commercial enterprise or establishment", the word is countable, as in "Sony’s TV and game businesses". On the other hand, the word "business" is uncountable when you want it to mean "commercial, industrial, or professional activity", as in "we do business all over the world".2

The grammatical rules are clear, which, in turn, leads to the legal question whether the draftsmen intended to impose profits tax on persons carrying on "an establishment", or some "activity" in Hong Kong.

Or, are the two the same thing?

Without citing authorities, I consider it settled law that the mere establishment of an office in Hong Kong will not attract Hong Kong tax liabilities. It follows that it is the "activity", instead of the "establishment" that will.

Fortunately, the IRD is likely to be grammatically, rather than legally, confused.

How about you?

Footnotes:

1. Para 10, Departmental Interpretation and Practice Notes No. 13, (http://www.ird.gov.hk/eng/pdf/e_dipn13.pdf)


2. http://en.wiktionary.org/wiki/business

3. It later came to my attention that prominent judges used “carrying on of a business”:

“ … In the case of a company incorporated for the purpose of making profits for its shareholders any gainful use to which it puts any of its assets prima facie amounts to the carrying on of a business.” (Lord Diplock, page 565, American Leaf Blending Co. Sd Bhd v. Director General of Inland Revenue [1978] STC 561 )

Assuming Lord Diplock is not grammatically or (God forbid) legally confused, a likely conclusion may be that the line between an “establishment of business” and “business activity” is blurred, in somuch as "carrying on business" and "carrying on a business" can be used interchangeably after all.

Jesus Christ, I even confused myself.

The Peril of Cliches: a Chinese “totality of facts” approach?

Cliches are bad because they are products of lazy, careless thinking. At worst, cliches are culpable for the horrible linguistic crime of inaccurate expression.

I smelled, with respect, such a crime in a Big-4 accounting firm's commentary on the Chinese government's then newly-issued legislation (State Administration of Taxation of China (“SAT”) Announcement [2012] No.30):

“It is encouraging to see that [the Chinese tax authority] suggest to the local tax authorities that they should not narrowly focus on certain individual factors in determining the beneficial ownership of dividends; instead they should take a “totality of facts” approach on a case-by-case basis”1 (emphasis mine)

The blunt employment of the expression “totality of facts” stemming from the English common law in an article about the Chinese law reminds me of a beginner of English trying to impress his teacher with some fancy hard words in an otherwise typo-riddled, grammatically unsound essay.

As its effect of trying to impress backfired, the expression is also wrongly adopted. Let's first look at what “totality of facts” really means.

What “totality of facts” means

In the Hong Kong salaries tax case CIR v George Andrew Goepfert, Macdougall J explained the term as follows:

“There can be no doubt therefore that in deciding the crucial issue, the Commissioner may need to look further than the external or superficial features of the employment. Appearance may be deceptive. He may need to examine other factors that point to the real locus of the source of income, the employment.

It occurs to me that sometimes when reference is made to the so called ‘totality of facts’ test it may be that what is meant is this very process. If that is what it means then it is not an enquiry of a nature different from that to which the English cases refer, but is descriptive of the process adopted to ascertain the true answer to the question that arises under section 8(1).” (page 237) (emphasis mine)

 

In the Hong Kong profits tax case CIR v Magna Industrial Company Limited, Litton V-P approved the “totality of facts” approach by the lower court as follows:

“This was, in essence, the Board of Review's approach. At para 7.23 of the stated case the Board said:

'This is a case of a trading profit and the purchase and the sale are the important factors. We place on record that we have included in our deliberations all of the relevant facts and not just the purchase and sale of the products. Clearly everything must be weighed by a Board when reaching its factual decision as to the true source of the profit. We must look at the totality of the facts and find out what the Taxpayer did to earn the profit.' (emphasis mine)

No criticism can be made of this approach. Nor has it been suggested that the findings of fact made by the Board were not based upon evidence adduced before it. If the Commissioner's appeal on point of law were to succeed it must be because the Board had misunderstood the law in some relevant particular or because, on the facts found, the only reasonable conclusion was that the profits in question arose outside Hong Kong: Edwards v. Bairstow [1956] AC 14.”

In a nutshell, the “totality of facts” approach describes an enquiry process to take into consideration all relevant facts and factors to find the true answer to a question, not to be deceived by appearance.

What the Chinese tax authority meant

But is this the same approach the Chinese tax authority intended to employ? I refer to the original Chinese law (Article 1 of SAT Announcement [2012] No.30, or “Announcement 30”):

“When ascertaining the status of beneficial ownership of a resident of a contracting jurisdiction, comprehensive regards should be had to every factor listed in [an article of a previous law] ...” 2 (emphasis mine)

On the one hand, the “Announcement 30” approach is similar to the English “totality of facts” approach in HK tax cases in that both describe an enquiry process to grasp the substance of individual cases, not to be fooled by its form. 

On the other hand, the “Announcement 30” approach is different in its methodology, in that the “factors” have already been fixed in black and white in the relevant law (that is, the 6 “adverse factors”). In the HK tax cases I cites earlier, however, the relevant factors will turn on the facts of each individual case and therefore have not been ascertained.

As a result, as the factors in the “Announcement 30” approach have been fixed and limited, it is in theory more lenient than the original English “totality of facts” approach.

Differences in methodologies aside, linguistically the word "facts" connotes a much wider scope than "factors", contrary to what the SAT's intention as expressed in Announcement 30. In that sense the common sensical, linguistic scope of "factors" is commensurate with the legal scope of those two approaches.

This leads to my suggested alternative: “totality of factors”.

Footnotes:

1. https://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Newsletters/ChinaAlerts/Documents/china-tax-alert-1305-10-dividends-tax-treaty-benefits-v1.pdf

2. "一、在判定缔约对方居民的受益所有人身份时，应按照国税函[2009]601号文件第二条规定的各项因素进行综合分析和判断，不应仅因某项不利因素的存在，或者第一条所述“逃避或减少税收、转移或累积利润等目的”的不存在，而做出否定或肯定的认定。" （http://www.chinatax.gov.cn/n8136506/n8136593/n8137537/n8138502/12003183.html）

A Primer of China's Anti-treaty Shopping Regime

Tax treaties are often abused by way of setting up shell companies in a treaty state in order to enjoy the tax benefits under the tax treaty between that treaty state and the source state. This is neatly named “treaty shopping”.

Some anti-treaty shopping provisions are embedded in tax treaties. The requirement of being a “beneficial owner”, for example, the fulfillment of which entitles foreign investors to preferential withholding tax rates, is prevalent in most modern tax treaties in force. How such a “beneficial owner” is determined, on the other hand, is subject to domestic laws and the discretion of tax authorities of each tax jurisdiction, which plays a much larger part in cracking down on treaty shopping, or to invoke a trendy term, “BEPS” (Base Erosion and Profit Shifting).

This article serves as a primer of the legislative development of China's anti-treaty shopping regime over the past 5 years.

Circular 601

In 2009, the State Administration of Taxation (“SAT”) of China issued Circular on How to Determine the “Beneficial Owner” in Tax Treaties (Guoshuihan [2009] No.601 or “Circular 601”), and thereby brought the concept of “beneficial ownership” into China’s domestic law. As one of China’s earliest attempts to cramp down on treaty shopping, Circular 601 provided the legal authority and rules of thumb for China's local tax authorities in determining whether a tax treaty applicant qualifies as beneficial owner so as to grant preferential withholding tax rates on royalties, interest or dividends paid or payable to that applicant.

Endorsing the “substance over form” principle, Circular 601 defined “beneficial owner” (“BO”) in the following terms:

1. It owns or controls the income or the rights or assets from which the income is derived;
2. It must also be engaged in substantial business activities; and
3. It does not include an agent or a “conduit company”, incorporated for the purpose of avoiding or reducing taxation, transferring or accumulating profit without any substantial business activities.

It also identified 6 “adverse factors”, the presence of which should negatively affect the application for beneficial ownership:

1. The applicant has an obligation to distribute most of its income (e.g., more than 60%) to a resident of a third country within a prescribed time period (e.g., within 12 months from the date of receipt;
2. The applicant has no or minimal business activities;
3. The applicant’s assets, scale of operations and deployment of personnel are not commensurate with its income;
4. The applicant has no or minimal control and decision-making rights, and does not bear any risk;
5. The applicant has non-taxable income or is subject to a low effective tax rate;
6. In the case of interest income, there is a loan or deposit contract between the applicant and a third party, the terms of which are similar or close to those of the loan contract under which the interest income is received; and
   In the case of royalty income, there is a license or transfer agreement between the applicant and a third party, the terms of which are similar to the terms under which the royalty income is received.

Announcement 30

Three years after the issuance of Circular 601, the SAT sought to clarify what it meant therein by releasing “Announcement Regarding Determination of Beneficial Ownership under Tax Treaties” (SAT Announcement [2012] No.30, or “Announcement 30”) . The following constitute the gist of this announcement.

Article 1 - “Totality of factors” approach

Article 1 emphasized a “totality of factors” approach in determining beneficial ownership. That is, regards should be had to all 6 “adverse factors” listed in Circular 601. And none of the 6 factors has the status of a “super factor”, the existence of which supposedly leads to an automatic denial of the beneficial ownership status. Neither is a strong case for a lack of “the objective to avoid or diminish tax revenue, shift or accumulate profits” (the very words that Circular 601 used to define a “conduit company”) per se sufficient for an applicant to put forth in order to qualify as a beneficial owner.

Article 3 - “Safe harbour” Rule

Article 3 is in effect a “safe harbour” provision regarding dividend payments, the fulfillment of which shall be followed by a “reflex action” of granting the beneficial owner status, without the pain of having to go through the 6 “adverse factors”.

Article 3 describes two scenarios which will comply with the “safe harbour” rule.

Scenario 1:

In Scenario 1, the applicant company will be granted the beneficial owner status if it is a listed company and tax resident in the contracting jurisdiction.

Scenario 2:

In spite of the lengthy drafting which renders the second limb of Article 3 somewhat baffling, Scenario 2 appears to be the case where the applicant company, being a tax resident of and listed in the contracting jurisdiction, holds 100% of the shares of the Chinese company, either directly or indirectly. And in the case of indirect shareholding, the intermediary holding entities (between the applicant and the Chinese company) are subject to the additional condition that they shall be tax residents of either China or the contracting state.

Article 4 - “Look-through” treatment for agency arrangement

Article 4 provides that where an “agent or designated payee” receives income, in an agency or nominee capacity for the applicant company (the principal), this should not affect the identification of the true beneficial owner. And whether the agent or designated payee is a tax resident of the contracting jurisdiction is irrelevant. However, the “agent or designated payee” shall disclaim its beneficial ownership local tax authorities in writing. A sample form to make such a disclaimer is also attached to Announcement 30.

Circular 165

Less than a year later, in 2013 the SAT issued Opinion Letter on the Determination of Beneficial Ownership Cases under the Dividend Article of the PRC-HK Double Taxation Arrangement (Shuizonghan [2013] No.165, or “Circular 165”) in response to several provincial and municipal state tax bureaus' requests to ascertain the BO statuses of a handful of Hong Kong applicants. Circular 165 re-affirmed the “totality of factors” approach and shed more light on how the 6 “adverse factors” should be assessed.

Article 1 - profits retention

Article 1 clarified that, the beneficial owner status of the applicant should not be adversely affected where the applicant does not make any distribution to a non-HK tax resident.

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Article 2 – Business activities

A single-investment holding company should not be denied its beneficial owner status solely based on this adverse factor that it was set up for only one project. The presence of other factors, or the lack thereof, should be taken into account as well.

Article 3 – Assets

Tax authorities should not equate “assets” with the registered capital of the applicant. They should consider other sources of funding of, and risks born by, the applicant.

Also tax authorities should not only consider the number of staff and the size of staff costs of the applicant in assessing whether its staffing level is commensurate with its income. They should also take into account the responsibilities and nature of the work of the staff.

Article 4 - Rights of control and disposal

The mere fact that the applicant’s shares are controlled by a higher-level corporation should not negate the existence of rights of control or disposal of the applicant.

Article 5 – Home jurisdiction taxation

The fact that offshore income of a HK applicant company is exempt from HK Profits Tax under HK's territorial tax system should not have a negative implication for determining the beneficial ownership of the income. The applicant's actual tax filing in HK of its income other than that paid by the Chinese company should be taken into account.

Article 6 – clarification of the “safe harbour” rule

Also, Article 6 of Circular 165 served to correct the misinterpretation (and, in some unfortunate cases, misapplication) on the part of some local tax authorities of the “safe harbour” rule introduced in Announcement 30. Since the legislative intent behind the “safe harbor” rule was to provide relief, instead of imposing more restrictions, a failure to comply with the “safe harbor” rule does not in itself means a denial of the beneficial owner status altogether. Article 6(1) provides that there shall not be a “ reflex action” of denying its beneficial ownership if the applicant is directly or indirectly 100% owned by a non-listed HK Company, or that intermediate offshore companies were incorporated in jurisdictions other than Hong Kong and China.

Announcement 53

The SAT issued Announcement on Determining Tax Residency Status under the PRC-HK DTA (SAT Announcement [2013] No.53, or “Announcement 53”) to streamline the procedures when HK applicants are trying to apply for tax benefits under the PRC-HK DTA.

Announcement 53 freed HK applicants of the burden of producing Certificates of Resident Status if they were incorporated or registered in HK. Instead, incorporation or Business Registration Certificates should suffice, unless, inter alia:

1. the PRC tax authorities are suspicions of, and deem its submitted information insufficient to prove, an applicant’s claimed resident status, including the case where the applicant company was incorporated outside of HK but claims to have its management and control in HK; or
2. the applicant intending to apply for its beneficial owner status under the “safe harbour” rule pursuant to Announcement 30.

Announcement 53 also clarified the application procedure for a HK Certificates of Resident Status in which an applicant would need a referral letter issued by the PRC tax authorities to apply for the certificate from the HK Inland Revenue Department.

A word of caution: Announcement 53 is only applicable to tax treaty relief claims by HK residents under the PRC-HK DTA, and should not be taken as binding on claims under China's tax treaties with other jurisdictions. This is but one legislative manifestation of the central government's preferential treatment towards Hong Kong, its long estranged, unruly son.

Announcement 24

The latest piece of legislation is a further supplementary clarification on the issue of determining beneficial owners. Announcement on Determining Beneficial Ownership for Entrusted Investments (SAT Announcement [2014] No.24, or “Announcement 24”) was released for “entrusted investments” arrangements where applicants entrust their investment funds with “Overseas Professional Institutions” which charge commissions or service fees from the former. Investment income and risks rest sole with applicant companies.

The rules for determining beneficial ownership for entrusted investments are as follows:

1. If the nature of the investment income is dividend or interest, and that nature does not change when remitted layer by layer to the non-resident applicant, as proved by documentary evidence, then the applicant shall be deemed the beneficial owner;
2. If any entity (other than the applicant) on the chain of investment charges any expenses and remuneration related to the dividend or interest, then the applicant shall not be deemed the beneficial owner;
3. If the nature of the investment income is capital gain, or other income to which the beneficial ownership rules do not apply, then the income shall be treated according to the relevant provisions in the DTA.

Conclusion

By trial and error, public consultations and public outcries, China gradually fine-tuned its approach to tackling anti-treaty shopping and anti-avoidance, enhancing legal certainties and raising cross-border investors' confidence along the way. Rest assured that more “announcements” are down the road, clearing the anti-avoidance regime for the pros, while muddying the water for the laymen.