Tax controversies in China generally refer to tax disputes that arise between tax authorities and taxpayers or tax-withholding agents. Tax controversies may arise in various circumstances, such as in response to administrative decisions made by the tax authority under a tax audit, transfer-pricing investigations, general anti-tax avoidance investigations, etc. Sometimes, dissatisfaction with the routine tax administrative activities of the tax authority, such as denial of preferential tax treatment, denial of a tax refund, or failure to perform tax administrative duties (ie, so-called administrative omission) may also lead to tax controversies.

Value-added tax, enterprise income tax and individual income tax constitute the main sources of tax revenue in China, and these taxes usually give rise to most tax controversy cases in China.

Land value-added tax is also an area that may create tax controversies due to the complexity of the land value-added tax regime.

Before delving into how to mitigate tax controversy in China, it is first necessary to understand why tax controversies arise in China.

Based on our observations, the main reasons for tax controversies in China are as follows.

• The lack of explicit tax guidance rules, which leaves for ambiguity regarding different interpretations and positions held by the tax authorities and the taxpayer – as China is a civil-law country, tax laws and regulations should be followed by tax authorities and taxpayers and any precedent cases related to tax controversies have no legally binding effects. However, tax legislation cannot cover all aspects of commercial activities. As a result, it is not uncommon that a taxpayer and the tax authority take different views on the application of tax rules to a specific case.
• Different understandings of the tax-related facts on which the tax assessment is made – there are quite often discrepancies between the tax authorities and taxpayers regarding the facts or the nature/characterisation of particular transactions. Different understandings of the facts may lead to different opinions on the tax treatment of the matter involved.
• The lack of a tax compliance system – corporate taxpayers failing to establish a sound internal tax compliance and risk-control system, meaning that they are not capable of detecting daily tax wrongdoing/misconduct or effecting preventative actions or rectifications in a timely manner.

To mitigate tax controversy risks, it is necessary for taxpayers to establish comprehensive, sound tax compliance management in their daily business operation, as detailed in the following.

• Before the implementation of a new transaction or project, taxpayers should not only carefully review the written tax rules, but also research the local practice of the tax authority, or enquire with the tax authority in advance, to ensure that the tax treatment for the new transaction or project is in line with the rules as well as local practice. If there is still any ambiguity after research, the taxpayer must make a more thorough assessment of the rules and the risk magnitude, and take any necessary proactive measures.
• To avoid any misunderstanding of the facts, it is always a good approach to document the key facts in a written form, such as in the relevant transactional agreement or in the corporate internal memorandum, meeting minutes, etc.
• Taxpayers should establish an internal tax control system and regularly update/reassess its implementation.
• Last but not least, where a taxpayer is aware of any potential tax audit or challenge posed by the tax authority, timing is of the essence. A taxpayer should reach out to tax counsel for advice before making any concrete contact with the tax authority.

As an active participant in the BEPS Action Plans, China takes the position that the BEPS achievements should be combined with the practical situation of the PRC. In line with the progress of BEPS, China issued administrative rules for general anti-tax avoidance in December 2014, updated rules governing the indirect transfer of Chinese taxable properties in February 2015 and introduced anti-tax avoidance rules into the individual income tax regime in August 2018. These measures set out a more comprehensive legal basis for tax authorities to combat anti-tax avoidance practice but, in the meantime, have caused an inevitable increase in the volume of tax controversies.

In addition, on the international side, China signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting in June 2017, aiming to amend Chinese double tax treaties/arrangements in an effective manner and implement the BEPS actions in relation to tax treaties, eg, anti-treaty shopping rules and dispute-resolution mechanisms. This convention is expected to serve as guidance for mitigating cross-border tax risk and the better resolving of international tax disputes. The convention is not yet in effect, so its practical impact is subject to further observation in the future.

If a taxpayer intends to contest an additional tax assessment imposed by its relevant tax authority, it must file an administrative review claim before initiating a judicial claim. To lodge an administrative review proceeding, it is necessary for the taxpayer to pay off the assessed tax and the interest surcharges or to provide an adequate guarantee within the prescribed time limit. Failure to do so will result in loss of the right to initiate the administrative review and the subsequent judicial claim proceeding.

If the taxpayer neither pays the assessed tax nor files an administrative review claim within the prescribed timeframe, the tax authority is empowered to initiate compulsory enforcement measures upon the approval of the competent tax bureau’s chief. More specifically, the tax authority may notify the bank to deduct and remit the outstanding tax from the bank account of the taxpayer/tax-withholding agent, or detain, seal up and dispose of the goods or other properties of the taxpayer/tax-withholding agent by auction or sale at an amount equivalent to the tax, etc. In addition, the tax authority may impose an administrative fine ranging from 50% to 500% of the outstanding tax.

China adopts a random selection system to select the targets of tax audits. Under this system, taxpayers are classified into:

• key tax-revenue source enterprises; and
• other taxpayers.

Around 20% of those classified as key tax-revenue source enterprises are selected for tax audit each year, which means that in principle a key tax-revenue source enterprise is subject to tax audit every five years.

Among those classified as other taxpayers, no more than 3% of enterprise taxpayers and no more than 1% of non-corporate taxpayers are selected for tax audit each year.

Despite these general rules, if a taxpayer has any bad tax records, such as abnormal status of tax filings for a long period, low tax credibility rating, a history of violation of tax laws, etc, it will be exposed to higher likelihood of being selected for a tax audit.

In addition to the above general tax audit selection approaches, there are a few other situations which may cause a taxpayer to become the subject of a tax audit.

• If there is clear evidence showing that a taxpayer has conducted activities in violation of tax rules by reporting or by instruction from a higher-level tax authority or by information from other authorities (eg, a public security authority, the People’s Procuratorate, etc), then a taxpayer will become a tax audit target.
• If a whistle-blower provides tipping information to the tax authority, the tax authority will make enquiries into or initiate a tax audit of the target.
• Under the current “Golden III” tax administration system, data selection, analysis and scrutiny have become more effective and efficient. The tax authorities set certain red-flagging thresholds in the system based on big data they have collected and accumulated during daily tax administration. Once a certain threshold is reached, a tax risk alert will pop up, according to which a taxpayer may be selected for tax assessment and further audit.

Theoretically speaking, a tax audit should be completed within 60 days of its starting date. This period can be extended once by approval of the chief of the tax audit bureau. In practice, however, it is common that some audit cases may last longer (even for a few years) due to the complexities of the case concerned.

A tax audit typically includes the following steps, including both on-site inspection and desktop review at the tax authority’s office.

Investigation

The tax audit bureau issues a Notice of Tax Investigation to the tax audit target and initiates the tax audit process.

The investigation is conducted by various means, including on-site inspection, review and collection of the relevant accounting books and other materials, making inquiries with the relevant personnel, examination of relevant bank accounts, collecting information or seeking assistance from other tax bureaux or governmental authorities, etc.

Assessment

Upon completion of the initial investigation process, the investigation bureau shall submit its internal work report to the assessment division of the tax audit bureau for review. The assessment division, upon completion of the review, shall formulate a written opinion for review by the division head. If the tax audit case is complicated or has a significant impact, a collective trial shall be conducted to decide the case.

If the assessment division intends to impose a tax administrative punishment on the target, it shall deliver a Notice of Tax Administrative Punishment and inform the target of its legal defence rights. If the target makes any statement or defence, this shall be properly documented and signed off by the target. In some cases, the target has the right to request a hearing.

Decision

Upon completion of the above assessment procedures, the tax audit bureau prepares the final notification letter(s). Depending on the results of the tax audit, the notification letter could be a Decision Letter on Tax Administrative Punishment, a Conclusion Notice of Tax Audit Case, etc.

Enforcement

The enforcement division of the tax audit bureau is responsible for delivering the final notification letter to the target. If the decision and notification letter require the target to pay additional tax, the target must pay off the outstanding tax, interest surcharges and/or the administrative fine within the stipulated time limit. Otherwise, the tax audit bureau may take compulsory enforcement measures upon approval by the head of the tax bureau, or apply to the People’s Court for compulsory enforcement, unless the target lodges an administrative review process in due course.

At the beginning of each year, the State Taxation Administration (STA) formulates the priorities of tax audit work nationwide for the year. This usually includes three aspects.

• Industries and transactions under special attention – normally, the STA selects three to six industries and transaction types as the key areas for tax audit. For instance, in recent years, export tax refunds, bulk commodities, the medical cosmetology industry, the entertainment and webcasting industry, and high net worth individuals have been under the spotlight.
• Illegal acts attracting special attention – based on the major tax cases published by the STA in recent years, the typical illegal acts include false issuance of VAT invoices, concealing revenue or falsifying costs, malicious tax planning making use of "tax preferential regions" and related party transactions, and tax evasion through new business models, etc. These areas are among the focus areas of tax audits.
• Designated key taxpayers and cases – the STA selects key taxpayers and cases which are to be audited by the tax audit bureau of the STA directly or assigned to the tax audit bureaux at the provincial level for handling.

With the enhancement of global collaboration in the exchange of information, and in order to combat cross-border tax avoidance, it is in no doubt that, going forward, more and more tax audit cases will arise from exchanged information, particularly in areas concerning Chinese tax residents’ offshore assets/transactions, and the onshore assets/transactions of foreign nationals.

When a taxpayer is faced with a tax audit, it is suggested to first and foremost contact competent tax counsel, which could help provide initial advice and tactics covering the aspects listed below. As the tax audit case progresses, the tax counsel could provide continuous legal support in all the following respects, and help achieve a relatively favourable audit result, to the extent possible.

• Understanding the tax audit procedures – the tax audit shall be conducted in line with the procedural requirements. A better understanding of some key procedures helps the taxpayer to protect its rights better. For example, when tax officials conduct on-site investigations, they must present certificates and notification letters; otherwise, the taxpayer has a right to deny the investigation.
• Formulating strategic and effective approaches to communicating with the tax officials – on the one hand, the taxpayer is legally obliged to accept inquiry from the tax authority; on the other, the inquiry gives the taxpayer a good opportunity to communicate with the tax authority to better understand the key tax issues being audited, and to present the taxpayer’s position (including the relevant facts, the legal grounds and the supporting items). Effective communication is the rule of thumb in resolving tax audit cases.
• Prudently preparing the materials requested by the tax authority – during the tax audit, the tax authority will request that the taxpayer submit the relevant materials. The taxpayer should take this seriously, carefully reviewing all materials prior to submission. These materials may not only become the evidence used by the tax audit bureau to support its conclusion, but may also become the key evidence during the subsequent administrative review or judicial litigation proceeding.
• Analysing and identifying the effective legal grounds to support the taxpayer’s position and preparing the relevant supporting materials – even though it is not mandatory for the taxpayer to submit its own statement letter defending the case during the tax audit process, it is strongly recommended that the taxpayer take proactive action to analyse the legal grounds in support of its position, lay out the relevant supporting facts and legal grounds in a written form such as a statement letter, and submit this to the tax authority, together with other supporting evidence. As long as the tax authority receives such a position letter, it shall take it into consideration when making its tax administrative decision.

A taxpayer may lodge an administrative appeal against the tax authorities in respect of a specific administrative act.

Where the specific administrative act relates to tax collection, an administrative appeal phase is compulsory before a judicial claim can be initiated. For other types of specific administrative acts conducted by tax authorities, eg, administrative punishment, compulsory enforcement measures, invoice administrative acts, failure to fulfil duties, etc, a taxpayer may elect to initiate a judicial claim directly without going through the administrative appeal phase.

As a general rule, a taxpayer must duly apply for an administrative appeal within 60 days of the date when it acknowledges the existence of the specific administrative act concerned. The taxpayer is required to pay off the assessed tax and the interest surcharges or provide an adequate guarantee within a specified time limit before filing an administrative review claim, which is usually 15 days in practice.

The administrative appeal application must be made to the competent tax administrative review authority, which in principle is the tax bureau at a higher level. There are some exceptions: for instance, an administrative claim against a specific administrative act conducted by a tax audit bureau must be made to the tax bureau to which the tax audit bureau is subordinate.

Upon receipt of the taxpayer’s application, the appeal authority shall review the application within five days to decide whether to accept or reject the application, or request that the applicant supplement or correct the application materials.

The respondent tax authority is required to submit a written reply to provide the relevant evidence, legal basis and other relevant materials. The appeal authority will review the applicant’s application and the respondent’s response. The applicant also has access to the respondent’s response materials, unless the materials involve any national secrets, commercial secrets or personal privacy. In addition, the respondent tax authority is not allowed to collect additional evidence from the taxpayer or other related parties during the review.

In principle, the administrative appeal shall be conducted on the basis of reviewing relevant written materials. However, if the taxpayer makes a request or the appeal authority considers it necessary, the appeal authority may hold a hearing in which the applicant and the respondent authority appear to present their positions.

In principle, the appeal authority should make a decision within 60 days of its acceptance of a claim. However, if the case is complicated and the appeal authority is unable to make a decision within the prescribed time limit, the time limit may be extended to 90 days upon approval by the head of the appeal authority.

It is not uncommon in China that tax administrative appeal cases are eventually settled by the applicant and the respondent authority through mediation. During the mediation process the administrative appeal period is suspended.

If the appeal authority fails to make a decision within the prescribed time limit, the tax officials who are directly in charge (and other persons directly responsible for the violation) shall be issued with administrative sanctions, eg, disciplinary warning, recording of a demerit or of a serious demerit. In addition, technically speaking, the applicant may lodge a separate administrative review or judicial claim against the appeal authority for its failure to make the decision on time.

Tax disputes between taxpayers and tax authorities are classified into two categories: tax collection actions and other tax-related actions.

In tax collection actions, such as a decision to pursue taxes and late payment interests, administrative appeal to the upper-level tax authority is a prerequisite for filing a lawsuit to court. If a taxpayer refuses to accept an appeal decision (either sustained or changed by the upper-level authority), it can file to court. It should be noted that, currently, a taxpayer should settle tax payment and late payment interest or provide a tax guarantee that is confirmed by the initial tax authority before it can file an administrative appeal to the upper-level tax authority. The tax guarantee precondition mechanism is now under discussion and review for amendment by China’s Tax Collection and Administration Law.

For other tax-related actions, such as administrative penalties or invoice administration measures, taxpayers are entitled either to claim an administrative appeal to the upper-level tax authority or to file to court straightaway.

The current judicial system in China oversees three categories of litigation:

• civil litigation concerning disputes between equal parties (eg, a sales contract dispute);
• administrative litigation concerning disputes between a regulated party and the regulatory authority; and
• criminal litigation concerning crimes.

It should be made clear that China does not yet have a specialised tax court, nor does it have an exclusive judicial procedure for tax litigation, though in recent years China has been studying the feasibility of establishing specialised tax tribunals. Currently, litigation concerning tax disputes between taxpayers and tax authorities takes the form of administrative litigation, whereas litigation concerning tax crimes initiated by public prosecutors against taxpayers is considered as criminal litigation. Since criminal tax cases (ie, concerning serious illegal behaviour relating to taxes) are much less common than administrative tax cases, what follows will focus on administrative tax litigation. References to criminal tax offences are made in 7. Administrative and Criminal Tax Offences.

The administrative tax litigation procedure is as follows.

Stage One – Initiation of Litigation and Acceptance of a Case

In tax collection cases, if a taxpayer refuses to accept the appeal decision, the taxpayer can, within 15 days of the date of receipt of the appeal decision, initiate litigation in the court which has jurisdiction. For other tax-related actions where the taxpayer decides to file directly to court, the court filing shall be made within six months of the date the taxpayer knew or ought to have been aware of the decision of the tax authority.

Before acceptance of a case, the court will review and consider whether the court filing satisfies statutory requirements, ie, the following.

• The plaintiff is the taxpayer, or any other party who has interests in the tax decision.
• There is a specific defendant (the initial tax authority being the defendant, if no appeal; the appeal tax authority being the defendant, if it has changed the action of the initial tax authority; the appeal tax authority and the initial tax authority being joint defendants, if the appeal tax authority sustains the action of the initial tax authority).
• There are specific claims and a corresponding factual basis.
• Additionally, the litigation falls within the scope of cases acceptable to the court and the jurisdiction of the court.

With respect to jurisdiction, administrative tax litigations should be filed to the court where the tax authority that initially undertook the tax decision is located, or also the court where the appeal tax authority is located if the case has been administratively appealed. In general, the primary courts (at the county level) will try first-instance cases, unless the case is of significant social impact and complexity.

Stage Two – Pre-trial Proceedings

When a case is accepted, the first-instance trial will formally begin. It proceeds in the following way.

• Establishment of collegial panel – generally, an administrative tax litigation applies an ordinary procedure, under which a collegial panel with an odd number of panellists (usually three) is established, consisting either entirely of judges or of a combination of judges and jurors. Nevertheless, upon consensus of parties, a simplified procedure can be applied, where a sole judge will try the case.
• Service of litigation documents to parties – the court will serve the defendant the statement of complaint, and serve the plaintiff the statement of response submitted by the defendant.
• Review of litigation documents and collection of evidence – if the court finds that the documents/evidence are insufficient, the court has the authority to notify the parties to supplement them, and the court has the authority to collect evidence from the administrative authority or other entity or individual, but the court shall not, for the purpose of proving the legitimacy of a specific administrative act, collect evidence which the defendant failed to collect at the time of the administrative act.
• Submission and exchange of evidence – the parties should submit evidence to court within a specified time limit or granted extension period. In complex cases, the court may initiate a pre-trial exchange of evidence.

Stage Three – Trial and Hearing

• Notice of commencement of trial – the court shall notify parties and other participants of the trial date three days in advance.
• Preparation of trial – the presiding judge checks identities of the parties and declares names of the panellists. If no party objects to the appearance of any other party or applies for recusal of any panellist, the substantive trial hearing begins.
• Court investigation – the plaintiff states its claims, facts and reasons; then the defendant states its responses. The parties, in order, present their own evidence, cross-examine the counterparty with regards to authenticity, legality and relevance of evidence, and cross-examine witnesses.
• Court debate – the presiding judge elicits the parties’ arguments concerning the disputed issues, and the parties debate with each other with several rounds of rebuttal.
• Closing statements of the parties – both parties summarise their claims and concluding opinions.
• Mediation procedure – in principle, mediation does not apply to tax litigations. However, for those cases concerning discretion of tax authorities (eg, administrative penalties, determination of deemed profit rate, etc), mediation can apply at the will of the parties.
• Collegial panel discussion – after adjournment of the hearing, the presiding judge will host the panel’s internal discussion of the case, which is carried out secretly and follows the principle of majority rule.

Stage Four – Court Decision

In general, the court decision will be pronounced in public within six months of the date of a case’s acceptance for a tax litigation applying the ordinary procedure, or 45 days for a litigation applying the simplified procedure.

Where the court concludes that the tax authority’s decision is inadequate in its essential evidence, erroneous in its application of laws and regulations, non-compliant in its legal procedures, ultra vires, constitutes a power abuse or is obviously unfair, the court will revoke or partially revoke the tax authority’s action and rule that the tax authority must make a new tax decision. Otherwise, the court will reject the claims of the plaintiff.

Evidence and/or witnesses must be cross-examined during the court investigation session, at the trial and hearing stage.

The relevance of evidence depends on the individual facts of each case. Pursuant to the pertinent laws, the court shall scrutinise each piece of evidence with respect to authenticity, legality and relevance. The court shall then conduct a comprehensive review of all evidence, and objectively and neutrally determine its degree of relevance to the case by following professional ethics (conscience) and using logical reasoning and life experience, excluding evidence that is not relevant, so as to determine accurately the facts of the case.

In principle, the defendant (ie, a tax authority) shall bear the burden of proof, and if it fails to provide evidence within the specified time limit, it will be deemed as having no evidence regarding the disputed tax decision. In individual cases, the plaintiff may also provide evidence proving the illegality of the tax decision, but the failure of the plaintiff to do so does not exempt the defendant’s burden of proof.

In addition, administrative tax litigation strictly follows the rule that evidence obtained after making a tax decision cannot be used as evidence to justify the tax decision.

Strategic options may include the following.

• Preparing litigation materials as early as possible – as time for a taxpayer’s litigation against the tax authority for a tax collection decision is limited (15 days upon service of an appeal decision), the taxpayer should prepare solid evidence/arguments, if any, from the moment it decides to refuse a tax decision. For evidence that is difficult to obtain, the taxpayer can apply for extension of evidence submission, and such evidence can be presented during the court investigation session at the latest, upon the court’s approval.
• Seeking the chance of settlement proactively – courts hear administrative cases on the legality of tax decisions made by a tax authority, so courts will not assess on discretionary issues if the decision is in line with tax laws. Accordingly, in disputes relating to discretion (eg, deemed profit rate within a given range) or a reasonableness assessment (eg, transfer-pricing adjustment), the taxpayer should try its best to negotiate with the tax authority to reach a settlement or mediation mutually acceptable to the parties.
• Presenting expert opinions where necessary – an expert report is not a statutory type of evidence, but in practice, for cases concerning a special technical issue, the plaintiff can apply for submission of expert opinion to facilitate the court in better understanding a technical issue.

Overall, administrative tax litigation demands highly technical and rich experience in both tax and litigation, and taxpayers should seek assistance from professional tax lawyers.

Chinese courts adjudicate cases based on applicable rules derived from existing statutory rules. Pursuant to administrative litigation laws, the court’s trial of an administrative litigation should be on the basis of laws (legislated by the National People’s Congress or its Standing Committee), administrative regulations (legislated by the State Council) and local regulations (legislated by the Provincial People’s Congresses or their Standing Committees).

Accordingly, when trying administrative tax cases, the courts will not rely on jurisprudence from international courts, doctrines or international guidelines; however, reference may be made to this jurisprudence where applicable under the framework of China’s tax laws and regulations.

China adopts a nationwide system of “four-tier courts and the second-instance judgment being the final judgment”. The four-tier court system includes the primary court at the county level, the intermediate court at the municipality level, the high court at the province level, and the Supreme People’s Court.

If either party to a case refuses to accept the first-instance judgment, then irrespective of the nature of the controversy or the value, it can file an appeal to the upper-level court for a second-instance trial. The appeal should be filed within 15 days of the date of service of the first-instance judgment (or 30 days for foreign parties).

A first-instance judgment which has not been appealed, or a second-instance appellate judgment, will effectively be a final judgment and should be executed. However, if either party believes the executed judgment is wrong (with respect to evidence, legal application, legal procedures, omission of claims, etc), it can initiate the procedure for trial supervision to the upper-level court within six months of the effective date.

In second-instance trials, the court shall form a collegial panel of judges (usually three) to try the case through a court session, following the trial and hearing procedures as in a first-instance case. Nonetheless, if after review of the case file, investigation and questioning of the parties, the collegial panel finds that no new fact, evidence or reason is raised, it may decide not to hold a court session. The appellate court will generally make a judgment within three months.

In a trial supervisory procedure, a separate collegial panel should be established to hear a supervisory case. The supervisory case relating to a first-instance judgment follows the procedures of a first-instance trial, and the supervisory case relating to a second-instance judgment follows the procedures of a second-instance trial.

At first instance, the ordinary procedure will generally be applied, under which a collegial panel with an odd number of panellists (usually three) should be established, consisting either entirely of judges or of a combination of judges and jurors. The presiding judge of a collegial panel is appointed by the president of the court or the chief judge of the administrative division within the court. When the president of the court or the chief judge of the administrative division participates in a trial, he or she shall be the presiding judge. The collegial panel will discuss the case internally and make a judgment following the principle of majority rule. Nevertheless, a simplified procedure can be applied upon consensus of the parties, in which a sole judge appointed by the president of the court will try the case and make a judgment.

At second instance, a collegial panel of judges (usually three) will be formed. The collegial panel of second instance cannot be a sole judge or a panel consisting of judges and jurors. The presiding judge of a collegial panel is appointed by the president of the appellate court or the chief judge of the administrative division within the appellate court.

Where the procedure for trial supervision is initiated, its establishment of judges follows the rule of first instance if it supervises a first-instance judgment, or second instance if it supervises a second-instance judgment.

China has no alternative dispute resolution (ADR) mechanism available for resolving tax controversy cases. However, it is possible for a taxpayer and a tax bureau to resolve their tax disputes through settlement or mediation, which can be initiated during an administrative appeal or a judicial litigation.

Before the appeal authority makes a decision in an administrative appeal proceeding, the taxpayer and the respondent tax authority may reach a settlement, or the review authority may hold mediation based upon the mutual willingness of the parties, provided that the specific administrative act in dispute is a matter concerning the rationality, rather than the legitimacy, of the administrative act.

With respect to a judicial litigation regarding tax dispute claims, mediation is not allowed in principle, with certain exceptions. For example, a tax dispute case involving administrative compensation may be settled by mediation provided that both parties reach the agreement, and no national interest, public interest or other party’s legitimate rights are adversely affected.

In a settlement or mediation agreement, the parties may only agree to reduce the assessed tax amount if the tax assessment in dispute was made by the tax authority in invoking its discretional rights; for instance, where the tax was assessed based on a profit rate deemed by the tax authority with certain discretion. Similarly, the amount of an administrative fine may be reduced through settlement or mediation, as the extent of administrative fines is generally determined at the discretion of the tax authority.

Notably, however, no settlement or mediation can be reached to reduce the amount of interest surcharges, as the interest surcharges are automatically calculated based on the overdue days and the outstanding tax amount. The tax authority has no discretion in determining the amount of interest surcharges.

China does not currently have a formal advance ruling mechanism in its tax laws. In the last two years, however, some local tax authorities, such as Shenzhen, Guangzhou, Shanghai, and Jiangsu province, have started exploring advance ruling practice for certain significant and complex transactions.

This is not applicable in China, as China does not have an ADR mechanism with respect to tax controversies.

This is not applicable in China. There are no ADR mechanisms for transfer-pricing cases or cases where taxes are determined by indirect methods.

If a tax authority makes a tax assessment requesting payment of overdue tax (or late payment interests or penalties), such a tax assessment does not in itself confer an administrative tax offence on the taxpayer, irrespective of whether it is based on a tax audit or special tax adjustment by applying general anti-avoidance rules (GAAR), specific anti-avoidance rules (SAAR), etc. This is because such an assessment is not final, given that the taxpayer is entitled to file an administrative appeal to the upper-level tax authority or to file administrative tax litigation to court, if the taxpayer believes the tax assessment is wrongful in its fact-finding, application of laws or due process, etc.

With respect to criminal tax offences, whether or not a tax crime has been committed should be exclusively determined by a court upon trial and hearing of a criminal litigation, which is initiated by a public prosecutor against a suspected taxpayer, rather than an assessment made by tax authorities, though the clues indicating tax crimes are generally provided by tax authorities.

There is no direct relationship between the administrative process and the criminal process.

The administrative process governs disputes between the taxpayer and the tax authority concerning whether or not taxes should be paid (or late payment interests or penalties) or whether the taxpayer has issued false invoices, etc, and follows the theory of judicial supervision of administrative power and protection of taxpayer rights.

The criminal process, meanwhile, deals with serious behaviour jeopardising tax collection and administration of the state, such as tax evasion, false issuance of invoices, or defrauding of export tax refunds, etc, which in principle are unlawful acts concerning large amounts of tax.

The administrative process is initiated once a tax authority makes an additional tax assessment. If the taxpayer refuses to accept the assessment, it can file an administrative appeal to the upper-level tax authority, or then file administrative tax litigation to court.

A criminal tax offence under a criminal hearing and trial generally results from tax assessment. This is because tax crimes refer to serious illegal tax behaviour, while in practice it is the tax authority that has first access to illegal tax acts information during its assessment. Pursuant to the relevant laws, tax authorities are obliged to transfer suspected criminal tax offences to public security bureaux for investigation, if the tax authority takes the view that a suspected tax crime has been committed during/after its assessment. If the public security bureau then identifies a suspected tax crime after investigation, it should file the case to the public prosecutor for criminal proceedings.

As mentioned above, there is not currently a specialised tax court in China, and accordingly, administrative tax litigation is tried by following the general administrative case process, whereas criminal tax offences are tried by following the general criminal case process, and there is no direct relationship between the two.

For the stages of administrative tax litigation, please refer to 4.2 Procedure of Judicial Tax Litigation.

The stages of criminal tax litigation mainly include:

• case filing by the public security bureau;
• investigation by the public security bureau;
• institution of public prosecution by the procuratorate (the Prosecutor General’s Office);
• trial and hearing in court (a first-instance judgment is subject to a second-instance trial or further supervisory procedure, upon application of either the accused or the public prosecutor); and
• final binding judgment and execution.

Compared to administrative litigation, criminal litigation follows stricter requirements for procedural rights of the suspect and adopts a higher standard of proof (beyond reasonable doubt).

Each level of court under the four-tier court system contains a civil division, an administrative division and a criminal division, and the three divisions respectively hear civil cases, administrative cases or criminal cases. As such, administrative tax litigation and criminal tax litigation may be heard by separate divisions of the same court.

Legally speaking, there is no statutory rule stating that upfront payment of an additional tax assessment can reduce corresponding fines. However, since the statutes usually stipulate fines in terms of a range and grant the tax authority discretion on the specific number of fines, the tax authority may, at its own discretion, apply a lower limit to the fine range if the taxpayer makes payment proactively.

The law does not allow entry into an agreement with a tax authority or the public prosecutor to prevent or stop a criminal tax trial.

Nevertheless, it should be noted that criminal law provides for exemption from criminal liabilities for tax evasion crime if certain requirements are met. Specifically, if the taxpayer who committed the tax evasion act has made up the taxes payable and late payment interests upon the request of the tax authority, and has been administratively punished, the taxpayer shall not be subject to criminal liability, except if the taxpayer has already been criminally punished for tax evasion within the preceding five years or has been administratively punished by tax authorities for tax evasion twice or more within the preceding five years.

Any party (the accused or the public prosecutor) refusing to accept the first-instance judgment on a criminal tax offence can appeal to the upper-level court for a second-instance trial within ten days of service of the first-instance judgment. The accused’s appeal can be made in writing or orally.

A supervisory procedure can be initiated for an effective judgment (ie, a first-instance judgment which has not been appealed, or a second-instance appellate judgment), upon application of either the accused or the public prosecutor, if they believe the executed judgment is wrong with respect to evidence, application of law, legal procedures, etc.

Tax authorities are empowered to make special tax adjustments on tax-avoidance transactions/operations, by applying GAAR or SAAR (eg, transfer pricing, thin capitalisation, controlled foreign corporations, etc). The tax authority will comprehensively assess the reasonable commercial purposes and economic substance of a transaction/operation, based on detailed analysis of the facts and particulars of each individual case.

Technically speaking, a taxpayer can appeal to the upper-level tax authority or file a lawsuit to court with respect to such a tax adjustment decision. In practice, however, there have only been a limited number of appeals or litigations in this regard. Two concerns may contribute to the situation: firstly, in common practice, a GAAR investigation or a transfer-pricing investigation will conduct substantial communication with taxpayers, and the decision may be internally reported to upper-level tax authorities for review or confirmation, given its complexity and the large amount of taxes concerned. After such an investigation process, the taxpayer will generally accept the tax-adjustment decision and the appellate tax authority would always sustain such a decision. Secondly, the tax adjustment on tax avoidance is more of a matter of reasonableness assessment than a legality issue, but the current administrative litigation allows a court to check the legality of a tax decision, unless it is obviously unfair. However, the court is not in a tax-professional position to determine the degree of unfairness of a special tax adjustment, such that the court will not easily overturn a special tax-adjustment decision.

Separately, tax avoidance cases, being different from tax evasion cases which involve intentionally evading taxes, generally do not give rise to criminal liabilities.

In cases where a double taxation situation occurs due to a tax assessment or tax adjustment in a cross-border situation, it is rare for the taxpayer to resort to domestic litigation. Double taxation generally originates from two tax jurisdictions’ different treatments of a tax matter, but the court will only check the legality of the Chinese tax authority’s decision. Hence, if the decision fully complies with domestic tax laws, it will be sustained by the court. Any double taxation resulting from the tax decision is supposed to be managed through communication between competent authorities of the two jurisdictions.

Taxpayers may make use of a mutual agreement procedure (MAP), which is stipulated in double tax treaties entered into by China, and domestic tax laws also provide guidance on initiation of MAPs by the taxpayer or a competent tax authority in other jurisdictions. The MLI is not yet in effect in China.

On a separate note, China does not currently accept any international tax arbitration mechanism.

GAAR or SAAR applies in cross-border situations covered by bilateral tax treaties. For example, the tax authority can perform transfer-pricing adjustment on transactions between a Chinese entity and its related party in a contracting state, and the tax authority can apply GAAR to deny entitlement of treaty benefits under a treaty-shopping arrangement, etc.

China has introduced the PPT test in some tax treaties, but it remains to be seen how it will be interpreted in practice.

Transfer-pricing adjustment cases are rarely presented to a domestic court. One of the important reasons for this is that a transfer-pricing adjustment focuses on the reasonableness of profit allocation between related parties, while the administrative litigation is currently restricted to legality censorship; hence, the chance of a taxpayer obtaining court support against a transfer-pricing adjustment is not high.

Most tax treaties entered into by China contain a mutual agreement procedure (MAP) clause, which allows the tax authorities of the contracting states to settle cross-border tax disputes, including transfer pricing, by agreement. According to China’s MAP statistics, 19 cases (including 15 transfer-pricing cases) were closed in 2019 and 15 cases (including five transfer-pricing cases) were closed in 2020. Most cases were agreed by bilateral tax authorities to eliminate completely or partially the impact of double taxation, and there were also cases withdrawn by the taxpayers or resolved via domestic remedy.

Since 2005, China has negotiated and entered into advance pricing agreements (APAs) with multinational enterprises. From 2005 to 2020, Chinese tax authorities signed a total of 116 unilateral APAs and 90 bilateral APAs. China has been steadily promoting APA negotiation work aiming at improving tax certainties, reducing tax administration costs, as well as avoidance of double taxation.

Enterprises whose related transaction volume exceeds CNY40 million per annum for the past three years are eligible to apply for APA negotiation with a tax authority. APA negotiation contains six main stages, as follows.

• Preparatory meetings in which the applicant briefly introduces elements of the proposed APA.
• A letter of intention in which the applicant submits its intention with a draft APA proposal.
• Analysis and assessment, in which the tax authority analyses the draft APA proposal and assesses whether or not it conforms to the arm’s-length principle.
• Formal application, at which point the applicant submits a formal APA proposal upon consent of the tax authority.
• Negotiation and signatures, when the tax authority reviews a formal APA proposal, and the parties reach a formal APA document for representatives of parties’ signatures.
• Supervision of implementation, when the tax authority monitors the implementation of the APA on an annual basis within the applicable APA period. Upon expiry of this period, the APA will automatically be terminated, or can be renewed upon application of the enterprise in advance.

In 2021, China announced a simplified procedure for unilateral APA negotiation with qualified taxpayers, involving three stages: application and evaluation, negotiation and signing, and implementation and monitoring.

Overall, the number of litigations against tax decisions in cross-border situations is quite small, given the reasonableness assessment nature of such tax adjustment and the shackle of legality censorship under the current judicial regime. The WHT concerning indirect transfer of Chinese taxable equities and assets generates more litigation.

In 2015, there was an attention-attracting administrative litigation filed by a foreign entity against tax authorities’ withholding of tax collection on an offshore share transfer, where the tax authority, by applying GAAR, deemed the transaction to be an indirect transfer of a Chinese entity without reasonable commercial purpose. The case went through first instance, second instance and the trial supervision procedure, and the courts determined that the plaintiff lacked sufficient evidence to prove that the tax decision was illegal, and thus upheld the tax authority’s GAAR adjustment.

To mitigate tax litigation, taxpayers should improve tax compliance in transactions/operations and duly keep relevant materials to substantiate a tax-compliance status; and the tax authority should strictly follow the laws and regulations in tax administration and conclude tax decisions accepted by taxpayers based on solid technical and sufficient evidence.

This does not apply to this jurisdiction.

This does not apply to this jurisdiction.

This does not apply to this jurisdiction.

This does not apply to this jurisdiction.

This topic is not applicable to this jurisdiction since the MLI is not yet in effect in China. Currently there is only some academic discussion on the application of international tax arbitration.

This does not apply to this jurisdiction.

This does not apply to this jurisdiction.

This does not apply to this jurisdiction.

This does not apply to this jurisdiction.

It is expected that the envisaged instruments to mitigate controversies and the tax certainty procedures will help prevent and resolve tax disputes. At the current stage, it is hard to foresee whether Pillars One and Two will take effect in China, but China has upheld the spirit of multilateralism and an open and co-operative attitude to actively participate in relevant work, and to promote the implementation of the “two-pillar” plan.

This does not apply to this jurisdiction.

A MAP under old DTTs is most commonly used to settle tax disputes, while the MLI is not yet in effect in China.

This does not apply to this jurisdiction.

No official charges are levied by the authorities in a tax administrative appeal proceeding.

The court charges a case acceptance fee at a fixed amount of RMB50 (USD8) for each instance of tax administrative litigation. The fee shall be prepaid by the taxpayer within seven days of receipt of the Notice for Litigation Fee Payment from the court before the beginning of the proceedings, and borne by the losing party at the end of the litigation, unless the winning party agrees to bear the fee voluntarily.

The applicant (eg, a taxpayer) may request an indemnity (ie, administrative compensation) in an administrative appeal claim. Where the applicant wins the administrative appeal case, the review authority will grant the taxpayer’s compensation claim, where the taxpayer will be compensated in accordance with the standards prescribed under China’s National Compensation Law.

Similarly, the taxpayer may claim for the indemnity (ie, administrative compensation) in a judicial litigation proceeding. If it is judged that the specific administrative act which caused damage to the taxpayer is illegal or invalid, the court may mediate on the compensation matter. If the mediation fails, the court may proceed to issue the judgment on the compensation matter; or, as an alternative, the court may inform the taxpayer to initiate a separate litigation on the compensation matter.

Where the taxpayer does not claim for an indemnity during the administrative review claim or judicial litigation proceeding, it may lodge a separate litigation with respect to the compensation claim.

As mentioned in 6.1 Mechanisms for Tax-Related ADR in this Jurisdiction, there is no ADR mechanism in China, and there are no fees charged under a settlement or mediation process.

Since China does not have a specialised tax court, litigation cases concerning tax disputes between taxpayers and tax authorities are uniformly heard by the administrative divisions of courts, who also hear administrative cases involving other government authorities. There is not currently a specific platform to disclose progress of pending tax cases.

According to statistics provided by the Supreme People’s Court from 2018 to 2020, there were 641 first-instance administrative tax cases in 2018, 659 in 2019, and 688 in 2020. The annual average of tax cases was 662, accounting for 0.25% of the annual average of all administrative cases (265,483).

There is no official public data on types of taxes or value involved in these tax cases. Unofficial statistics on case information provided by a third-party database show that, of administrative tax cases in the past decade, VAT (including business tax) cases accounted for about 30%, individual income tax cases accounted for about 15%, enterprise income tax cases accounted for about 15%, and cases relating to other taxes (social security fee, stamp duty, deed tax, land VAT, real estate tax, etc) aggregately account for about 40%. Also, according to database statistics, the average disputed value of tax cases is around RMB5 million, varying from RMB100 to RMB100 million.

Unofficial statistics on case information provided by a third-party database show that tax authorities succeed in almost 90% of administrative tax cases, while taxpayers succeed in around 10% of administrative tax cases. However, the number of taxpayers succeeding has been increasing in recent years, and this momentum is expected to continue, given the continuously improving tax judicial environment in China.

Key strategic guidelines to consider in a tax controversy are summarised as follows.

• To engage in effective communication with tax authorities – tax controversies often arise from taxpayers’ and tax authorities’ different viewpoints of the nature of a transaction/operation, or different interpretation of tax laws and regulations. In fact, such disagreement would be effectively mitigated or resolved by the elimination of information asymmetry. As such, taxpayers should engage in dialogue with tax authorities in a positive and constructive manner or even seek the possibility of mediation/reconciliation in order to achieve win-win settlements of disputes in a cost-efficient way.
• To devise tailor-made strategies for individual cases – tax controversies contain various types of tax issues and different cases demand different tactics. For those concerning tax in a complicated or uncommon transaction, the taxpayer should focus on a good explanation of the business facts, by means of providing legal and accounting documents or inviting tax authorities to field visit, etc. For those concerning different interpretations of laws and regulations, the taxpayer should place emphasis on the rationale and legal interpretation, common practice of a rule, legislative background and intention of a rule, etc. For those concerning tax authorities’ discretion on reasonableness, the taxpayer may consider which form of reconciliation is in its best interest.
• To present evidence in a logical way to substantiate a tax position – to assist the tax authority in clearly understanding a disputed issue, the taxpayer should duly sort evidence in a way that is logically established, instead of a massive amount of redundant materials. For evidence closely related to a case but omitted in the inspection/audit phase, the taxpayer can make presentations to the upper-level tax authority to prove the legality and reasonability of the taxpayer’s position.
• To make wise use of procedural rights – in addition to efforts on substantive aspects, taxpayers should also consider a wise use of procedural rights provided by the law. In a tax audit, the taxpayer may claim the right to a hearing during a tax penalty investigation; in a tax appeal, the taxpayer may consider how to provide a guaranty in an efficient way to mitigate cash flow concerns; in administrative tax litigation, the taxpayer may apply for suspension of execution of penalties, etc.