Editor's Note: For a long time, some local governments have been granting partnership enterprises the approved levy policy as a condition for attracting investments, and many investors have enjoyed the policy dividend of low tax burden through equity transfer and other premium transactions through partnership enterprise shareholding platforms. The Announcement on the Administration of Collection of Individual Income Tax on Income from Equity Investment and Operation (Announcement No. 41 of 2021 by the Ministry of Finance and the State Administration of Taxation) stipulates that partnerships with shareholding platforms are subject to individual tax in accordance with the method of account-checking levy, which effectively curbed this kind of tax avoidance operation. Recently, some investors have been notified by the tax authorities in their place of residence that they have been investigated and asked to pay back taxes and penalties in respect of the authorized collection of partnership share transfers in a foreign place several years ago. Whether the authorized tax payment for partnership equity transfer is necessarily illegal, whether the tax authority of the investor's place of residence has the right to investigate and deal with the matter retrospectively, and how the investor should properly deal with such risks? This article analyzes the above practical issues.

01 Case Sharing

In 2017, Li, who resides in City A, was invited by the GP (general partner) of Partnership A (private equity investment) to invest RMB 5 million in Partnership A to become the LP (limited partner) of Partnership A. The GP (general partner) of Partnership A was invited to invest RMB 5 million in Partnership A. The GP (general partner) of Partnership A was invited to invest RMB 5 million in Partnership A. Partnership A, which is registered in City B, raised a total of RMB 100 million to invest in Company B, which is located in City C, and holds a 20% equity interest in Company B.

In January 2020, Partnership A transferred all of its equity interests in Company B to the outside world and obtained equity transfer income of 250 million yuan. At the time of filing the tax return, due to the investment promotion agreement signed between Enterprise A and the municipal government of Company B, which allows Enterprise A to approve the taxable income at 10%, Enterprise A calculates Li's taxable income of 1.25 million Yuan based on 10% of the 250 million Yuan of income from the transfer of the shares, i.e., the taxable income of 25 million Yuan, calculated based on the 5% partnership share held by Li. February 2020, Enterprise A applies the ultra-progressive tax rate for Li's income from production and operation of an individual businessman in the municipality of Company B in accordance with the tax rate of the individual businessman. City has filed a tax return of RMB372,000 for Li under the application of the excess progressive tax rate on the production and business income of an individual entrepreneur. Enterprise A recognized Li's investment return of RMB7.5 million based on the partnership share held by Li, paid RMB7.12 million to Li after paying tax on behalf of Li to the tax authorities in City B, and delivered Li's tax clearance certificate to Li. In March 2020, Enterprise A completed the write-off.

In March 2025, the tax authorities of City A received the reporting materials of Li's suspected tax evasion and launched an investigation into Li's acquisition of investment income of more than RMB 7.12 million in 2020.The tax authorities of City A, after the investigation, considered that there were tax avoidance behaviors of Li's investment in Partnership A which illegally utilized the approved levy, resulting in Li's actual tax burden rate of only about 5%, which was far lower than the statutory tax burden and should be subjected to a tax adjustment, and Li was required to file an individual income tax return of RMB 809,500,000 in City A in accordance with the progressive tax rate for income from production and operation applicable to income of RMB 7.5 million in revenues, RMB 5 million in costs and RMB 2.5 million in taxable income, to pay RMB 437,500,000 in retroactive individual tax, and to propose to add the corresponding late payment fees and to impose a fine of 0.5 times according to the tax evasion.

There are three aspects of this case that are worth exploring:

One of them is whether the place of tax liability for the investment income realized by Li in Partnership A is in City A or City B, i.e., whether the tax authorities in City A have the right to levy taxes and impose penalties on Li's such income.

The second is whether Partnership A constitutes a withholding agent for Li.

The third is whether the conduct of Partnership A in using the approved levy to reduce Li's actual tax liability is necessarily illegal, and if there is an illegal phenomenon, whether it can be regarded as tax evasion committed by Li and penalized, and whether the period for recovery of the corresponding tax of Li can be indefinite, and whether a late payment fee should be added.

02 Partner's tax source is attributed to the place where the partnership actually operates and manages the business, not related to the partner's place of residence

In the introduced case, Li's usual place of residence is A city, his investment in the A partnership in B city, the investment target B company is in C city, then Li made investment income should be tax declaration by whom, is it Li's own tax declaration, or by the A partnership or the B company for tax declaration? Should Li go to the tax authorities of City A, City B or City C to file the tax return? The Ministry of Finance and the State Administration of Taxation (SAT) have clear regulations on these two issues.

 Paragraph 1 of Article 20 of the Provisions of the Ministry of Finance and the State Administration of Taxation on the Collection of Individual Income Tax by Investors of Sole Proprietorship Enterprises and Partnership Enterprises (Cai Shui [2000] No. 91) stipulates that, "The investor shall declare and pay the individual income tax to the tax authority in charge of the place where the enterprise is actually operated and managed. The production and operation income obtained by an investor from a partnership enterprise shall be declared and paid by the partnership enterprise to the competent tax authorities in the place where the enterprise is actually operated and managed for the payment of the individual income tax payable by the investor, and the individual income tax return shall be copied to the investor."

According to this provision, after the individual partner obtains the production and operation income from the partnership enterprise, the main body of tax declaration is the partner, the main body of tax declaration is the partnership enterprise, and the source of tax belongs to the competent tax authority of the place where the partnership enterprise actually operates and manages, i.e., the place where the partnership enterprise is registered in the usual sense. As for the present case, although Li's usual place of residence is in A city, the place of registration and actual operation and management of A partnership is in B city, therefore, the tax source of Li's investment income belongs to the tax authority of B city, not to the tax authority of A city.

Therefore, from the perspective of the legality of tax administration, although the tax authorities of City A have the right to manage and investigate Li's property income and tax payment, if it is only found that the tax payment of Li's investment income derived from Partnership A is illegal or non-compliant, the case should be referred to the tax authorities of City B for further investigation and handling, and the recovery of tax cannot be directly dealt with, let alone the imposition of direct administrative penalties.

In addition, from the point of view of reasonableness and legitimacy of tax collection and management, since the tax-related matters of Li's investment income occurred in City B, all the information and behaviors related to income, cost, gain and transaction also occurred in City B, and the tax authorities of City B had accepted the tax declaration of Enterprise A for Li and received the corresponding tax, the tax authorities of City B had already carried out the normal management of Li's tax obligations. B city tax authorities have already implemented normal management of Li's tax obligations, and also have more comprehensive understanding and mastery of tax-related matters, and are more qualified in judging whether A partnership and Li's tax declaration obligations are in compliance and whether there is any violation of law, therefore, it is more reasonable and justified for A city tax authorities to take the initiative in handing over Li's tax evasion tip to B city tax authorities for investigation.

03 The partnership is not the partner's withholding agent, it is the partner's tax return associate

In the introduced case, Partnership A may have violated the law by using the approved levy to avoid tax, so will Li be characterized and penalized for tax evasion due to the violations existing in Partnership A? To answer this question, it is first necessary to clarify the relationship between the partnership and the natural person partner, i.e., whether the partnership constitutes a statutory withholding agent for the natural person partner.

Partnership A transferred its investment in Company B. The equity transferee did not pay the equity transfer price directly to each partner of Partnership A, but paid it directly to Partnership A, which in turn paid it to each partner. Obviously, the equity transferee must not constitute the partner's withholding obligation, and whether the A partnership constitutes the partner's withholding obligation in the levy management practice, there is a different caliber of implementation of the local tax bureaus.

Firstly, the relevant documents of the Ministry of Finance and the State Administration of Taxation on partnerships do not explicitly stipulate that partnerships should fulfill their withholding obligations on partners' income from production and operation, but only emphasize the need to share before tax and to declare and pay tax on behalf of partners, thus not constituting withholding obligations but tax declaration co-participants.

Article 2 of the Administrative Measures for Individual Income Tax Withholding and Payment Declarations (for Trial Implementation) provides that "A withholding agent is a unit or individual that pays income to an individual. The withholding agent shall, in accordance with the law, handle full and complete withholding declarations." Article 4 stipulates, "The taxable income for which full individual income tax withholding declarations are implemented includes: (1) wages and salaries; (2) remuneration for labor; (3) remuneration for manuscripts; (4) royalties; (5) interest, dividends, and bonuses; (6) income from leasing of property; (7) income from the transfer of property; and (8) accidental income. " Note that the above list of types of income subject to tax withholding does not include income from production and business operations, therefore, the partnership does not have a statutory obligation to withhold and pay tax when it pays income from production and business operations to its partners after the end of each year, but only has a statutory obligation to file a declaration on behalf of the partners to pay the tax.

Secondly, if the income obtained by the partnership is the dividend and bonus income distributed by the investee company, then it constitutes a withholding obligation when it then pays the partners. Cai Shui [2000] No. 91, Article 4, paragraph 2, provides for one of the tax basis of the partner's income from production and operation of the scope of income, including sales income, operating income, labor service income, project price income, income from the rental and transfer of property, interest income, other business income. Dividend and bonus income is not included here, i.e. dividend and bonus income does not belong to the scope of income from production and operation. Article 2 of the Circular of the State Administration of Taxation on the Implementation Caliber of the Provisions on Individual Income Tax for Investors of Wholly Owned Enterprises and Partnership Enterprises (State Taxation Letter [2001] No. 84) stipulates that the interest, dividends and bonuses returned by a partnership enterprise from foreign investment shall not be incorporated into the income of the enterprise and shall be separately calculated and paid as a taxable item for the interest, dividends and bonuses obtained by the individual investor. Individual Income Tax. Note that not only does it clarify that dividend income does not belong to the income from production and operation, but it also removes the interest income from the income from production and operation and handles it separately in the tax declaration.

On April 29, 2021, the Henan Provincial Tax Bureau had replied to the online message consultation in the interactive exchange section of 12366 official website, saying, "The dividends distributed to the partnership by the investment company, the individual income tax on dividend and bonus income payable by individual partners shall be withheld and paid by the partnership enterprise which directly pays the income to the individual partners." The articles published by some public officials of the tax authorities in the China Taxation News also clearly stated that when a partnership obtains dividend and bonus income from dividend distribution, even if it has not yet been distributed to the partners, it has to fulfill the obligation of withholding and paying to the individual partners within the 15th day of the following month.

Combined with the above provisions, it can be seen that the partnership shall bear the collaborative obligation of "declaration" and "payment" of tax on the production and business income of the partners, but it does not constitute the obligation of withholding. In practice, the compliance process of the partnership for the partners to declare and pay the tax is mainly presented as four steps, i.e., within 30 days after the end of the year, firstly, according to the share of the partnership to confirm the profit of each partner, and then calculate the tax payable by each partner, and then handle the tax declaration and payment of tax for each partner, and finally, the after-tax profit will be paid to each partner. However, this kind of operation similar to withholding tax is not equivalent to the withholding obligation in the tax law.

04 It is not necessarily unlawful for a partnership to utilize an approved policy to file and pay taxes

The behavior of the partnership using the approved policy to declare on behalf of the release of tax payment is not necessarily illegal, and moreover, it cannot be determined across-the-board that the partnership and the partners constitute tax evasion to be punished, the author combined with the practice of the two situations that often occur to analyze the specifics.

Scenario 1: The partnership applies for approval in accordance with the regulations and requirements of the tax authorities and is appraised and approved by the tax authorities.

Articles 7 to 9 of Cai Shui [2000] No. 91 provide for the scope and standards of authorized collection of individual income tax. According to the Tax Administration Law, the tax authorities have the right to appraise the approved levies, and can either initiate the appraisal on their own initiative or appraise the taxpayers when they apply for the appraisal and grant the approval. Currently, there are no relevant regulations on the appraisal of approved levies for individual income tax at the national level, and only some provinces and municipalities have issued specific operational circulars. For example, Beijing Municipality's Notice on Adjusting the Identification of Approved Collection Methods of Individual Income Tax for Wholly Owned Individual Enterprises and Partnership Enterprises Investors (Beijing Cai Shui [2011] No. 625) stipulates that, "The competent tax authorities shall carry out the identification of approved collection methods for the following year in December each year. Except for special circumstances, no changes will be made within a tax year after the collection method is determined; for newly established sole proprietorships and partnerships, the competent tax authorities shall complete the appraisal work within 10 working days after the enterprises report for duty."

If the partnership truthfully declares to the competent tax authority to approve the levy, the competent tax authority makes a notice of approval after appraisal and examination, and the income obtained by the partnership in the approved levy period does not exceed the type of income listed in the declaration, then the tax authority can not arbitrarily change the way of tax levy to check and make up for the tax, and moreover can not arbitrarily accuse the partnership of violating the law in approving the payment of tax, or even characterize the tax evasion. Penalties.

Scenario 2: Local governments grant investment promotion policies such as authorized levies or preferential tax rates to partnerships.

If a partnership enters into an investment promotion agreement with a local government, the agreement explicitly agrees to grant the partnership a certain percentage of its taxable income to be approved as a supportive policy, or directly promises the partnership preferential treatment in terms of the effective tax burden rate. Or the local government directly introduces investment promotion policies to the outside world, stipulating that new enterprises in a specific industrial park can enjoy the approved policies or preferential tax burden rate policies. In this case, when the partnership enterprise directly makes tax declaration in accordance with the approved way, or calculates income and cost and makes tax declaration to settle tax in accordance with the way of inverse squeezing of the actual tax burden rate, and the tax authority in charge of the local government's investment attraction practice adopts a tacit attitude, i.e., it does not appraise the audit beforehand, nor prompts the risk in the middle of the process, and does not investigate and make up for the tax after the fact. The implementation of the approved declaration of the partnership may not comply with the provisions of Article 7 of Cai Shui [2000] No. 91, and the consequences of underpayment of tax, but neither the partnership nor the partners have the subjective intent to evade tax, but based on the subjective knowledge and will to enjoy the preferential treatment of investment promotion to implement the approved declaration of tax, then the tax authorities can not be determined across the board that the partnership and the partners constitute tax evasion to be punished. partners constitute tax evasion to be penalized.

05 What is the liability of a partner in a situation where the utilization of an approved policy by a partnership is challenged?

According to Paragraph 1 of Article 20 of Cai Shui [2000] No.91, "the partnership enterprise shall declare and pay the personal income tax payable by the investor to the competent tax authority of the place where the enterprise actually operates and manages and copy the personal income tax return to the investor" and Paragraph 2 of Article 21, "the investor shall submit the "Personal Income Tax Return for Individual Sole Proprietorship Enterprises and Partnership Enterprises Investors" to the competent tax authority within 3 Within 0 days after the end of the year, the investor shall submit to the competent tax authorities, "sole proprietorship enterprise and partnership investors individual income tax return", and attached to the annual accounting statements and prepaid individual income tax vouchers "provisions, can see, for the production and operation income of the partners, the partners are the main body of the obligation of tax declaration, the partnership is the main body of the obligation of tax declaration. Then, for the truthfulness, accuracy and completeness of the tax declaration of the production and business income, the partnership enterprise and the partners shall bear the joint responsibility, if there is no underpayment of tax, the responsibility for the back tax shall be borne by the partners.

At the same time, the tax authorities should be cautious in determining whether the partners constitute tax evasion, especially in the organizational form of limited partnership, and should not determine across-the-board that the underpayment of tax by the partners constitutes tax evasion, nor should they blindly pursue the collection of tax and late charges indefinitely, and should specifically examine the following aspects.

First, whether partners participate in the business management activities of the partnership. In practice, some partners of a partnership often only have the status of investors and do not participate in the business management affairs of the partnership, thus they cannot grasp the operating costs and revenues of the partnership, and can only understand the investment benefits based on the limited information disclosed by the partnership. The tax authorities may go beyond the objective ability of the partners to require them to be responsible for the truthfulness, accuracy and completeness of their tax returns. If the information involved in the tax declaration is untrue, inaccurate or incomplete, it cannot be directly presumed that Li has the subjective fault of tax evasion.

Second, the specific manner in which partners file their tax returns. As mentioned above, the tax declaration of the partner's production and business income is completed by the partnership enterprise, and the two are not establishing a prior entrusted agency relationship, but a legal mimicry relationship. If the partnership has committed illegal acts such as fictitious, falsified information, under-reporting income and over-listing costs in the process of making tax declaration for the partners, the tax evasion of the partnership cannot be directly presumed to be the tax evasion of the partners. Unless there is sufficient evidence of conspiracy and willfulness on the part of the partners to commit tax evasion.

Third, the role of partners in obtaining authorized collection policies. The partnership faced a legality test for using the approved levy to declare and pay taxes, but the partners could not be held liable for legality across the board. In the introduction of the case, the reason why the A partnership can obtain the approved levy policy, is due to the A partnership with the local government signed an investment promotion agreement, in obtaining the approved policy on the LiMou actually did not play any role, for the application of the approved levy declaration of tax payment also did not play any role in decision-making, and even less have the right of denial.

Fourth, relationship between partners and tax-related intermediaries. In practice, in addition to the circumstances of the case introduced, there is another common situation in which the investor accepts tax planning advice from tax-related intermediaries and commissions the intermediaries to implement the tax declaration of the equity transfer transaction in the manner approved by the partnership. In this case, the investor often does not directly interface with the local government and the competent tax authorities, but the tax-related intermediary organization negotiates with the local government on preferential treatment for investment attraction, and the intermediary organization registers and establishes a partnership enterprise on behalf of the investor and handles the tax declaration with the competent local tax authorities. In this case, the investor often has the purpose and intention of saving tax, but does not necessarily have the subjective intention of obtaining the approved policy in violation of the law as well as cheating and fraudulent tax evasion.

Comprehensively examining the above four aspects, for the partnership enterprise to violate the use of approved policies resulting in partners to pay less tax, the tax authorities should be inclined to the partner is not in accordance with the tax evasion penalties, such as determining that the partner constitutes tax evasion and to be punished, should provide sufficient evidence to prove that the partner to implement specific tax evasion, and has the subjective intention of tax evasion, neither the presumption of fault, nor objective attribution of responsibility. In addition, the change of tax payable due to the change of tax collection method from authorized to account checking is not based on the truth or falsehood of the declared income data, and if the tax authorities fail to effectively implement the supervision beforehand, during and after the event, the consequences of underpayment of tax shall bear the responsibility of inaction in the enforcement of the law. According to Article 52 of the Tax Administration Law, for the situation where the taxpayer is not at fault and the tax authority has certain enforcement responsibilities, the three-year tax recovery period due to the responsibility of the tax authority shall be applied. If the partnership's authorized declaration of tax payment has been completed for more than three years, the tax authorities cannot investigate and recover the tax in accordance with the law. Even if the tax recovery period has not been exceeded, the tax authorities cannot add late fees when recovering the tax.

Conclusion: Although the provisions of the Announcement on the Administration of Collection of Individual Income Tax on Income from Equity Investment and Operation (Announcement No. 41 of the Ministry of Finance and the State Administration of Taxation of 2021) on the prohibition of approved levy for partnerships with shareholding platforms have come into force since January 1, 2022, there are still some tax authorities in practice that have already canceled the partnerships before January 1, 2022 and have made use of the approved levy to file tax returns to investigate retroactively. However, in practice, there are still some tax authorities that have retroactively investigated and dealt with the behavior of partnerships that have been written off before 1 January 2022 using the approved levy to declare tax, and the phenomenon of tax authorities of the place of residence and the place of operation competing for the tax source has occurred, which has brought a greater tax risk and even the criminal risk of tax evasion for the investors, and it should be highly valued. In the face of tax inspection, it should prudently assess its own liability risk, comprehensively collect evidence materials, actively cooperate with the tax authorities to investigate and collect evidence, defend itself in accordance with the law, and actively seek tax lawyers to provide legal remedies and professional support.