Glossary of Anti-Tax Avoidance Terms

I. Tax Avoidance vs. Tax Evasion
　　Tax avoidance refers to a taxpayer using related-party transactions to transfer profits through unreasonable pricing.
　　Tax evasion refers to a taxpayer using illegal means to reduce or eliminate their tax liability.
　　For example: A U.S. parent company (Company A) sets up a wholly-owned subsidiary (Company B) in China. Company A entrusts Company B to manufacture computers, which Company B sells to Company A at RMB 100 per unit. According to Chinese tax law, the transactions between Company A and Company B constitute related-party transactions. The tax authorities’ focus in anti-avoidance work is to analyze whether the price of RMB 100 per unit is reasonable. If investigation reveals that the actual price of the computers manufactured by Company B is RMB 200 per unit, the tax authorities have reason to believe that there is an issue of unreasonable pricing between Company A and Company B, shifting profits to the U.S., and will adjust the price per computer to RMB 200.

　　 II. Arm's Length Principle
　　Also known as the "Fair Transaction Principle" (armslength principle).
　　Transactions between foreign-invested enterprises or foreign enterprises operating in China and their related enterprises shall be conducted with regard to pricing and fees as if between independent enterprises.
Transactions between independent enterprises refer to business dealings conducted between unrelated enterprises at fair market prices and in accordance with normal business practices.

III. Transfer Pricing
　　If a tax authority of one country believes that two or more enterprises have direct or indirect ownership or control in operations, purchases, sales, or capital, the tax authority typically considers them related enterprises. The pricing behavior or arrangements of these enterprises in transactions such as selling goods, transferring technology, providing services, or loans is known as transfer pricing.

　　 IV. Thin Capitalization
　　Thin Capitalization refers to a company using loans instead of equity for investment or financing to reduce its taxable amount.
For example: A U.S. parent company (Company A) establishes a wholly-owned subsidiary (Company B) in China, creating a related-party relationship between A and B. If Company A provides the funds originally intended for investment as a loan to Company B, Company B must pay related loan interest to Company A. According to Chinese tax law, the interest paid by Company B can be deducted before calculating its corporate income tax. Although the interest paid by Company B is subject to a 10% withholding tax in China, since China's corporate income tax rate is 33%, this practice reduces the tax payable in China. Such a practice constitutes thin capitalization.

　　 V. Related Enterprises (Related Parties, Independent Parties)
　　Also known as "affiliated enterprises," these refer to companies, enterprises, or other economic organizations having one of the following relationships: (1) Direct or indirect ownership or control in capital, operations, purchases, or sales; (2) Being directly or indirectly owned or controlled by a third party; (3) Having other associated interests.

　　 VI. Controlled Foreign Corporation
　　An enterprise established in a low-tax country or region, directly or indirectly owned or controlled by a resident, which retains some or all profits without reasonable distribution, not for the purpose of engaging directly in business activities. If the resident is an enterprise and does not distribute or makes an unreasonable distribution of the above profits, the portion attributable to the resident enterprise shall be included in its current period's dividend and bonus income.

　　 VII. Cost Contribution Arrangement
　　A contractual agreement between enterprises, which entails parties sharing costs and risks in the development, production, or acquisition of products, services, or rights (technology), and reasonably defining each party's interest share in the said products, services, or rights (technology).

　　 VIII. General Anti-Avoidance Rule (GAAR)
　　Taxpayers use various means to avoid taxes, including transfer pricing, cost contribution arrangements, controlled foreign corporations, and thin capitalization, as well as abuse of tax treaties and multiple use of tax exemptions through enterprise restructuring. The General Anti-Avoidance Rule primarily provides a legal basis to combat the aforementioned tax avoidance behaviors. The main purpose of this clause is to serve as a deterrent rather than a frequently used provision.