China launches reporting framework against tax evasion

The Common Reporting Standard (CRS) has become effective in China, a sign that the country is taking a full part in the OECD’s initiatives on the automatic exchange of information (AEOI). Soon the tax authorities there will have access to detailed information about the assets held overseas by Chinese taxpayers.

The legal framework, which began on July 1, was designed to tackle tax evasion by non-resident Chinese nationals by increasing tax transparency. The deadline for financial institutions in China to submit their first reports to the authorities about the assets in the accounts of non-residents under the CRS is May 31 2018. Under a global agreement, jurisdictions will then exchange such information about each other’s taxpayers.

While the move may add to compliance costs, observers see opportunities for financial institutions to use the information on clients to better tailor wealth management products. However, high net worth individuals will face increasing challenges in attempting to take advantage of tax shelters.

No fewer than six Chinese regulators or government departments - the State Administration of Taxation, Ministry of Finance, People’s Bank of China, China Banking Regulatory Commission, China Securities Regulatory Commission and the China Insurance Regulatory Commission jointly issued the implementing legal framework, called the Administrative Measures for Due Diligence on Non-resident Financial Account Information in Tax Matters, in May. This gives some idea about its impact on the whole of the financial services and banking industries.

Motivations for the framework

Shao Chunyang

Tax evasion occurs all over the world but is especially a problem for China because of the increase in the number of wealthy individuals there. They often use overseas financial institutions to manage their wealth and conceal their income in offshore accounts, avoiding tax on it in China by not declaring it. “At present, avoidance of double non-taxation has replaced avoidance of double taxation as the central concern for international taxation; therefore, tax authorities across the globe feel an urgent need to exchange tax-related information between each other and to safeguard their taxing rights,” says Shao Chunyang, partner at JunHe.

“There are no sufficient information sources for non-residents and their overseas assets and by getting the information, it can be used by different authorities to target problems such as anti-corruption,” says Bill Ye, partner at King & Wood Mallesons. “Financial institutions will face costs in implementation, but with more comprehensive tax information on high net worth individuals, there are opportunities for financial institutions to help wealthy clients to put together plans for wealth management and add transparency in compliance.”

“Those who will be most directly impacted are non-residents and passive non-financial institutions who have accounts in China, mostly high net worth individuals with overseas assets such as foreign investments, family trusts, or cash benefit insurance policies,” adds Shao.

Features of the framework

The framework requires a range of financial services companies, including banks, to collect information from account holders to identify non-residents. They include commercial banks and rural credit cooperatives; securities companies; futures companies; securities investment and private fund management companies; insurance companies offering cash value contracts and trust companies.

Reporting financial institutions (RFI) are required to register with the State Administration of Taxation by December 31 before filing their first report and are expected to perform compliance reviews annually. Due diligence for high value pre-existing individual customers (threshold is $1 million) must be completed by December 31 and complete due diligence for all pre-existing customers needs to be done by December 31 2018. New account openings can only be completed with valid self-certification of their non-resident status from customers. Non-compliance may lead to revoking of the RFI’s operating permit, and employees found to be directly responsible may be subject to disciplinary measures, including prohibition from working in the financial industry.

Challenges and opportunities

Bill Ye

Banks without the systems in place will need to create them to adapt to the rules. “Banks have been waiting for the rules to come out and existing databases may not be easy to change,” says Ye. “They must check their information to make sure their products remain compatible, otherwise they will lose clients.”

“Individuals need to spread out their wealth and avoid holding assets directly, or else they will have legal responsibility,” adds Ye. “They need to assess the regulation of different countries they have assets in and plan for the future. These rules are complicated and each country will have its own rules. This becomes problematic in cross-border issues and complicates how structures such as trusts would work.”

Though the framework is in place, how it will be implemented is still not clear. “Since the CRS measure is quite new, mainstream commercial banks have not announced due diligence procedures and operational processes in compliance with it,” says Shao. He notes that the six government agencies involved in creating the CRS measure will be introducing corresponding regulations to clarify the reporting channels, formats, standards and requirements, in order to help financial institutions report correctly.

Technical barriers for the data submission between financial institutions and tax authorities is likely to prove to be one of the biggest challenges in implementation. “So far, financial institutions have not fully connected with tax authorities in terms of domestic bank account information of resident enterprises and individuals, let alone reporting account information of the more unstandardised non-resident enterprises to tax authorities,” says Shao. “As this is China’s first attempt to try standardised exchange of account information on such a large scale, it remains to be a huge test on how to receive and deal with such massive data and reach reciprocal and mutually beneficial exchange of information.” 

China’s new framework to obtain information about non-residents will bring it into line with international standards and see it cooperate with other countries to exchange information to curtail abusive tax shelters. While the move may add implementation costs to financial institutions, it will also help them to expand their services according to customers’ needs. For high net worth individuals, it will become increasing challenging to evade tax as more countries introduce transparency and information exchange measures.