(Ecns.cn)-- Names such as British Virgin Islands, Cayman Islands, and Samoa were not very familiar to Chinese people in the past, but they have now jumped onto the list of the top ten investing countries or regions for China. By meticulous research from the Ministry of Commerce, the offshore tax avoidance problem has to come to light.
According to statistics released by the Ministry of Commerce, among the top ten investing countries or regions (based on the actual investment made) for China in 2008, the British Virgin Islands ranked second with an investment of 15.95 billion USD, the Cayman Islands fifth with an investment of 3.15 billion USD, and Samoa eighth with 2.55 billion USD.
Early in 2004, a research team led by Mei Xinyu, researcher with the Ministry of Commerce, released a report on the impact of offshore financial centers and transnational capital flow. In the report, statistics showed that the British Virgin Islands ranked second in terms of the actual investment made for China in the first quarter of 2004 while the Cayman Islands and Samoa ranked eighth and ninth.
Mei's research exposed a sensitive issue. As nearly 4,000 corrupt officials and criminals have escaped to foreign countries with more than 50 billion USD since the 1980s, the capital was mainly transferred abroad through offshore companies.
On October 21, 2005, the State Administration of Foreign Exchange promulgated Relevant Issues Concerning Foreign Exchange Control on Domestic Residents' Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, commonly referred to as "Circular 75," which legalizes, and further regulates, the offshore holding company structure favored by private enterprises in their offshore fundraising activities with a view toward channeling foreign venture capital and private equity investments back into China's private sector.
On September 8, 2006, a six-ministry rule commonly referred to as "Circular 10" made the financial transactions more difficult as mergers with a related party is strictly controlled. When an offshore entity acquires the onshore company or assets (which, by definition, are related), Circular 10 requires the approval of the Ministry of Commerce.
Although Circular 75 and Circular 10 seemed to be the end of foreign investments in China, the companies that aim to avoid taxes always seem to find loopholes.
Offshore tax havens
Sending most of the profits to offshore companies and leaving deficits in domestic companies is an effective way to avoid value added tax in China. Admittedly, tax avoidance is the purpose of most offshore companies.
In August 2010, Goldman Sachs transferred the possession of its equity holdings in Henan Shuanghui Investment & Development Corporation, a leading meat processing company in Luohe, Henan Province, to the joint venture Rotary Vortex Limited.
Through investigation, it was discovered that Goldman Sachs and CDH Venture Partners registered Shine B Holdings I Limited in the British Virgin Islands in March 2006, which took full control of Rotary Vortex Limited. This means that Rotary Vortex Limited was in fact 51% owned by Goldman. By doing so, they avoided an amount of corporate income tax up to 420 million yuan (64.9 million USD).
Through Shine B in the British Virgin Islands, Goldman Sachs had successfully reduced its shareholding ratio in Henan Shuanghui to 3.3% by the end of 2009. Compared to the 33% in 2006, it was definitely a vast difference. According to the annual reports of Henan Shuanghui in 2006, 2007, and 2008, it was estimated that Goldman's profit from the meat processing company might reach 2.1 billion yuan ($324.7 million) during these three years.
This was a typical case of tax avoidance by indirect equity transfer. The logic is simple. If you leave the money in the British Virgin Islands, wait a while and then send it back, it can be made to look to the authorities like it is a foreign investment, and you do not have to pay taxes on it.
Before December 1, 2010, China had not abolished the practice of giving a corporate income tax deduction for foreign joint ventures. For a while, domestic capital flew to the British Virgin Islands and Cayman Islands to set up offshore companies, only for the favorable treatment for foreign investments. These countries and regions became perfect tax havens for domestic companies.
