China tightens tax evasion rules amid increased CRS enforcement

Fri, Mar 29, 2019

As Beijing increases its efforts to prevent tax evasion, wealthy Chinese are facing a variety of new tax rules both at home and abroad. The increased focus on reporting comes as the country experiences a boom in wealth, with some experts reporting that personal wealth in China skyrocketed to $24 trillion and $1 trillion of that is held outside the country.  
                                                                    Increased global cooperation through the CRS
At the forefront of worldwide anti-tax evasion efforts is the introduction of a global financial disclosure system – the Common Reporting Standard, or CRS – through which participating jurisdictions automatically share annual reports detailing reportable accounts, their balances, and their beneficiaries. For example, if a Chinese tax resident opens a bank account in the U.K., the CRS requires British authorities to send the information to Beijing as part of their report, and vice versa.                                                                      

The CRS casts a broad net, with any entity or individual who’s a resident of a CRS signatory state being considered a reportable person (although real estate is an excluded asset). The process has become so common that even several tax-favorable jurisdictions have agreed to sign up for CRS. Last year, China started sharing information with approximately 100 participating jurisdictions.                                                                      

 However, there are holdouts – most of which are unsuitable as tax havens due to political, economic or social instability. Another notable exception is the U.S., as the country chose to maintain its own framework, the Foreign Account Tax Compliance Act (FATCA), through 113 bilateral agreements.                                                                                                              
                                                                      Domestic regulations tightened following the CRS
In addition to participating in the CRS framework, China is continuing its efforts to close loopholes in the system. Previously, wealthy Chinese citizens were not required to pay taxes on overseas earnings by acquiring a foreign passport or green card while maintaining Chinese citizenship. However, China recently began taxing global income from all holders of “hukou” household registrations, regardless of whether they may be citizens elsewhere.                                                                        
Additionally, the government has implemented the “Golden Tax System Phase III,” a new data platform that gives it a more complete picture of a taxpayer’s finances. The government is hoping to stem the loss of tax revenue through means such as underground banks that facilitate illegal foreign exchange transactions. Uncertainty over those new rules has led certain Chinese taxpayers to create overseas trusts. For example, in late 2018, four Chinese tycoons transferred more than $17 billion into family trusts with ownership structures involving entities solely in the British Virgin Islands.  
Participation in CRS, changes to the “hukou” system, and the implementation of the Golden Tax System together signal the Chinese government is tightening its anti-tax evasion legislation and enforcement. Chinese taxpayers with investments or property overseas should be aware of the new disclosure requirements and seek professional advice.                                    

                                   Treasury proposes changes to foreign tax credit rules                                  

Fri, Mar 29, 2019

In November 2018, the IRS and Treasury Department released proposed regulations on the determination of foreign tax credits. The proposed regulations provide guidance to a number of taxpayers who are having difficulty figuring out the impact of provisions introduced by the 2017 Tax Cuts and Jobs Act.

The 2017 tax act made several changes to the foreign tax credit scheme, including:

* creating the global intangible low-taxed income (GILTI) and foreign branch income baskets of income;

* reducing the foreign tax credit limitation to account for the new 100 percent dividends received deduction on certain dividends received from foreign subsidiaries;repealing indirect credits for deemed-paid foreign taxes related to dividends from foreign subsidiaries;

* modifying the rules for deemed-paid foreign taxes related to Subpart F and GILTI income inclusions;

* andeliminating the fair market value method for interest expense apportionment.

The November 2018 proposed regulations address questions related to these changes and will be applicable to taxable years beginning after December 22, 2017 and will apply to the 2018 taxable year.

The regulations address numerous issues, including:

Allocation and Apportionment of Deductions:
The proposed regulations characterize the portion of GILTI offset by the foreign-derived intangible income and GILTI deduction as “exempt income.” Therefore, it isn’t taken into consideration for the purposes of allocating and apportioning deductible expenses, increasing the foreign tax credit limit in the GILTI basket. However, this limited relief won’t prevent residual U.S. Taxation on GILTI income where material expenses are allocated to the GILTI income basket.

The Foreign Branch Income Bracket:
Foreign branch income is also clarified to include income of a U.S. person attributable to foreign branches held by that person – where a foreign branch includes the activities of a corporation, partnership or individual that constitute the conduct of a trade or business outside the United States and where a separate set of books and records is maintained. If a taxpayer has more than one foreign branch, all income of the different branches will be aggregated into a single foreign branch income category. The regulations also include an anti-abuse rule through which an income item can be reattributed by the IRS to the foreign branch owner if tax avoidance is suspected.

Transition Rules for Foreign Tax Credit Carryovers and Carrybacks:
Carryovers of pre-2018 excess foreign tax credits can be allocated to the foreign branch income basket if the tax had been paid in 2018 or later. Additionally, excess foreign tax credits in the foreign branch income basket for a post-2017 tax act taxable year can be carried back to a pre-tax act taxable year and will be allocated to the general basket.
The proposed regulations include other miscellaneous provisions not strictly related to changes introduced by the 2017 tax act, such as changes to the look-through rule, special rules for certain partnership loans, and the Subpart F high-tax exception.  

As these proposed changes come into effect, taxpayers will need to prepare for not only the new foreign tax credit baskets but also the alterations to interest expense allocation rules, the elimination of the fair market value method and other changes.