The most recent CFC case in China


Anti-abuse mechanism increase in the era of BEPS

In a recent CFC case the Suzhou Industrial Zone Tax Bureau of Jiangshu Province attributed the undistributed profits of a Hong Kong company (“HK HoldCo”) to its Chinese resident parent company (“ParentCo”). The tax authorities attributed the profits based on China’s controlled foreign corporation (“CFC”) rules and collected more than RMB 7.7788 million (approx. USD 1.14 million) in taxes from the ParentCo. This is the most recent case on record of China enforcing CFC rules after the 2014 Shandong case and may predict a trend of strengthening anti-abuse mechanisms in line with the OECD BEPS action measures.


The CFC rules have been in existence since 1 January 2008 when the Enterprise Income Tax Law took effect in China. The rules were created to prevent Chinese enterprises from leaving profits in low tax jurisdictions through various arrangements without business substance in those jurisdictions. However, these were rarely if ever enforced until 2014 with the case by the Shandong Tax Bureau.

According to the CFC rules, the profits of a CFC established in a low-tax jurisdiction will be included in the Chinese corporate shareholder’s taxable income in the current year if the CFC does not distribute profits without valid business reasons for the decision not to distribute the profits. A low-tax jurisdiction refers to a jurisdiction where the effective income tax rate is lower than 50 percent of the EIT rate (in other words 12.5% or less).

A CFC is defined as a non-Chinese company if:

  1. Each shareholder that is a Chinese resident (enterprise or an individual) directly or indirectly holds at least 10 percent of the voting shares of the foreign company;
  2. Those shareholders with 10 percent or more of voting shares jointly own more than 50 percent of all shares; or
  3. The Chinese-resident enterprise or individual has actual control over the foreign company by virtue of shares, capital, business operations, or purchases and sales in any other situation.

Exceptions for CFC rules include:

  1. The CFC is located in white-listed jurisdictions, for instance Australia, Canada, France, Germany, India, Italy, Japan, New Zealand, Norway, South Africa, the UK and the US;
  2. The CFC’s income is generated mainly from active business operations; or
  3. The annual profits of the CFC are lower than RBM 5 million.

Case facts

Hong Kong Subsidiary (HK SubCo), incorporated in September 2009, was a wholly owned subsidiary of ParentCo, which was registered in a Suzhou Industrial Zone.

Starting from 2014, HK SubCo turned to be profitable. Its net profit at the end of 2015 was RMB 31.156 million (USD 4.5 million), however it didn’t make any distribution to Parent Co. Subsequently, the Suzhou Industrial Zone Tax Bureau launched an investigation. Uncooperative as ParentCo was in providing detailed financial information of HK SubCo, the tax authority was able to gather from other sources the outbound investment information that HoldCo had submitted. From the shared information, Suzhou tax authority concluded that the majority of HK SubCo’s 2014 and 2015 income were from investment and equity transfer, which was unrelated to its main operation of business. With that, ParentCo afterwards provided HK SubCo’s financial information, and Suzhou tax authority further found out HK SubCo had never paid Hong Kong tax on the gain since the gain was from offshore.

After several rounds of negotiations, Suzhou tax authority concluded:

  • HK SubCo was a CFC since it was wholly owned by the ParentCo;
  • HK SubCo was established in Hong Kong where the effective income tax rate is lower than 12.5 percent, which was HK Holdco’s effective tax rate rather than its Hong Kong headline rate; and
  • HK HoldCo only derived passive income and did not utilize the profits in business development thus undistributed without reasonable commercial need.

Though the ParentCo tried to challenge the tax bureau’s ruling for applicable invoking exceptions to CFC rules, with no success it eventually agreed to pay more than RMB7.788 million (USD 1.14 million) in Enterprise Income Tax (EIT).


The Suzhou tax authority seemingly used a company’s effective income tax rate rather than the headline rate in a particular jurisdiction when applying the CFC rules. Since the headline income tax rate in Hong Kong is 16.5%. Further, the key condition of applying CFC rules, i.e., without valid business reasons, was explained to some degree. Most importantly, the company’s attempt to apply for exception of “income derived from active trade or business” was denied for the reason that the gain had been passive income.

In addition to explaining how the tax authorities will apply the CFC rules, this case may more generally indicate their increasing willingness to enforce the CFC rules with the support of shared information and resources in their investigations, due to increased global transparency.


The CFC legislation is one of the general-anti avoidance rules (GAAR) that is being implemented in China, its purpose is not to create obstacles for overseas investments but rather it is aimed to promote a fair business environment for all tax payers. Chinese tax payers should be aware of such anti avoidance measures when structuring their foreign investments, so as to comply with the local tax legislations and also manage their tax risks.

In order to mitigate Chinese CFC risks, we may suggest that Chinese tax payers to carefully structure their foreign investments so that they do not fall into the scope of CFC, amongst others this may include:

  1. Directly or indirectly does not hold 10% or more control in the foreign entity, for example, by establishing an irrevocable Foreign Trust may suggest that the Chinese tax payers do not legally own or having control over the foreign assets;
  2. The foreign entity is incorporated in a white list jurisdiction, provided this meets other commercial objectives of the company’s business;
  3. The foreign entity conducts active business that generate sufficient income which satisfy the active business test;
  4. The foreign entity makes reasonable distribution to the Chinese parent company so that some profits are taxed timely in China;
  5. The foreign entity has an annual profit of under RMB 5 million (approx. USD 730k).

Furthermore, a company established in a foreign country in accordance with the legislation of that country may still triggers Chinese taxation, if such foreign entity deemed to have it POEM in China, in which case, such foreign entity will be subject to enterprise income tax in China. The Chinese tax authorities apply the totality of facts when assessing POEM. Such factors include the place of the board meetings, the place where the strategic decisions are made, the place where the board of directors carries out their duties in their position as board of directors, etc. There is no single factor which would determine whether the POEM is in China. To mitigate the POEM risks in China, we would recommend that the business decisions of such foreign entities should not be made in China, and it would be best to consider having all decisions made locally in that foreign jurisdiction or engage local directors.

For further information, please contact:

Neville Cen

Neville Cen

Director, Business development, Head of private clients – North Asia
Amicorp Hong Kong Limited
+852 2161 1902
Jinqian (Jane) Wang

Jinqian (Jane) Wang

Director, Corporate structuring and product development
Amicorp Hong Kong Limited
+86 755 2382 2952