Authored by Ryan Yan

This article examines the landmark GSCP tax dispute to illustrate China’s evolving approach to treaty abuse and cross-border tax avoidance. Drawing on the court’s reasoning and the OECD’s BEPS framework, it explores the shift from the “beneficial ownership” standard toward the “principal purpose test” (PPT), and how China’s anti-avoidance regime integrates both treaty-based and domestic measures.

I. Case Overview

GSCP Bouquet Holdings SRL (“GSCP”), a company incorporated under the laws of Barbados and affiliated with Goldman Sachs Capital, held 25.27% of the shares in Anhui Kouzi Distillery Co., Ltd. (“Kouzi Distillery”).

In August 2009, Kouzi Distillery distributed dividends of RMB 10 million to GSCP and withheld enterprise income tax (“EIT”) at a rate of 10% in accordance with the Enterprise Income Tax Law of the People’s Republic of China. Through its authorized representative, Ernst & Young (China) Advisory Services Limited, GSCP applied to the Chinese tax authorities for a reduced withholding rate of 5% under Article 10 of the Agreement Between the Government of the People’s Republic of China and the Government of Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (hereinafter the “China–Barbados Tax Treaty”).

On October 31, 2012, the Chinese tax authorities denied the application, concluding that GSCP did not qualify as a “beneficial owner.” The authorities noted that GSCP, registered as an “International SRL” under Barbados’s Societies with Restricted Liability Act of 1995, enjoyed a preferential tax regime under which capital gains were exempt from tax. The tax returns submitted by GSCP further showed that the dividends received from Kouzi Distillery were not subject to corporate income tax in Barbados.

Citing the Circular of the State Administration of Taxation on How to Understand and Determine the “Beneficial Owner” in Tax Treaties (Guo Shui Han [2009] No. 601) and the Announcement of the State Administration of Taxation on the Recognition of “Beneficial Owners” under Tax Treaties (SAT Announcement [2012] No. 30), the authorities concluded that GSCP was considered to fall within the circumstances where the other Contracting State either exempted the relevant income from tax or applied an extremely low effective tax rate. Accordingly, GSCP did not qualify as a “beneficial owner” and was denied treaty relief.

Between June 30, 2016 and March 15, 2018, GSCP gradually disposed of its entire shareholding in Kouzi Distillery, transferring a total of 136,458,000 shares. After deducting transaction costs and the original investment, GSCP realized a total net gain of RMB 4,656,418,519.77.

On August 10, 2018, the Chinese tax authorities issued an assessment for enterprise income tax (“EIT”) amounting to RMB 465,641,851.98. GSCP brought a lawsuit before the court, arguing that, as a tax resident of Barbados, it was taxable only in Barbados under Article 13 of the China–Barbados Tax Treaty, which grants the exclusive taxing right over such capital gains to the Contracting State of which the alienator is a resident. GSCP maintained that it was not a Chinese tax resident and therefore not liable for enterprise income tax in China on the share transfer gains.

The court dismissed the claim. It reasoned that the purpose of the treaty was to avoid double taxation and prevent tax evasion or avoidance. Article 4 of the Protocol to the China–Barbados Tax Treaty (hereinafter “the Protocol”) provides that “the provisions of this Agreement shall in no case prevent a Contracting State from the application of the provisions of its domestic laws aiming at the prevention of fiscal evasion and avoidance”.

On this basis, the court held that China’s anti-avoidance rules were not constrained by the treaty. As GSCP’s arrangement resulted in double non-taxation, its position contradicted both the object and purpose of the treaty and the relevant Chinese anti-avoidance provisions. The court therefore upheld the tax authorities’ assessment.

While the Chinese tax authorities denied GSCP’s status as a “beneficial owner” in 2012, they did not at that time challenge its tax residency in Barbados.

However, in 2024, when addressing GSCP’s gain from the transfer of shares in Kouzi Distillery, the Chinese court went further and rejected GSCP’s Barbados tax residency altogether.

This shift in approach appears closely linked to the Principal Purpose Test (“PPT”) introduced under Action 6 of the OECD’s Base Erosion and Profit Shifting (BEPS) Project—Preventing the Granting of Treaty Benefits in Inappropriate Circumstances.

Why did two different standards apply to the same taxpayer under the same treaty framework? Does this signal a transition in China’s treaty practice—from the  “beneficial ownership” test toward the Principal Purpose Test (“PPT”) ?

II. Legal Analysis

1. Limitations of the Beneficial Ownership Test

1.1 Narrow Scope and Limited Coverage of Emerging Avoidance Scenarios

The “beneficial ownership” test primarily governs income from dividends, interest, and royalties, but it does not directly address capital gains or other categories of income. In the GSCP case, the gain from the share transfer constituted capital gains and therefore fell outside the direct scope of the beneficial ownership rule. Consequently, the tax authorities instead relied on Article 4 of the Protocol and the Principal Purpose Test (PPT) framework to address treaty abuse.

Beneficial-ownership analysis depends on whether the intermediary carries out substantive business activities. This invites form-driven compliance: multinationals can artificially split transactions or assign nominal functions to circumvent substance-based scrutiny. For instance, PRC assets may be held through a BVI entity that formally satisfies the shareholding thresholds, while effective management and risk control remain with the group’s ultimate parent. As a result, the beneficial-ownership test is poorly equipped to identify such treaty-shopping arrangements.

1.2 Misalignment Between Formal Criteria and Substantive Economic Activity

In practice, tax authorities often rely on objective indicators—such as scale of assets, staffing, and office premises—to assess beneficial ownership. These quantitative metrics, as reflected in the five “negative factors” under SAT Announcement [2018] No. 9, can be satisfied through superficial compliance. A shell company might, for example, hire a part-time employee in a low-tax jurisdiction merely to create the appearance of business substance, while in reality conducting no substantive business activity.

As tax planning strategies evolve from simple “conduit structures” to hybrid mismatches and the artificial avoidance of permanent establishment status in the digital economy, the beneficial-ownership framework has become increasingly inadequate. Multinational enterprises now employ arrangements such as hybrid instruments that disguise dividends as interest, or virtual structures that shift profits across jurisdictions. The beneficial ownership test alone can no longer effectively capture these new forms of tax avoidance.

1.3 Practical Challenges in Tax Administration

Effective enforcement requires access to foreign financial statements and functional and risk analyses, which are often not readily accessible to domestic tax authorities. Despite improvements in international tax information exchange, limitations in data timeliness continue to hinder comprehensive verification.

2. The Application of the Principal Purpose Test (PPT)

2.1 From Formal Compliance to Substantive Purpose

The PPT represents a paradigm shift from form to substance. It integrates both subjective intent—whether “one of the principal purposes of transactions or arrangements is to obtain treaty benefits”—and objective outcome—whether such an arrangement leads to double non-taxation. This dual focus enables a more precise approach to addressing treaty abuse.

In the GSCP case, the court determined that GSCP’s holding structure was primarily designed to avoid Chinese taxation. Even though the arrangement formally complied with the treaty provisions, its main purpose was to obtain unwarranted tax benefits, thereby justifying the denial of treaty relief.

The flexibility of the PPT allows it to address new forms of tax avoidance in the digital economy and cross-border restructuring. For example, a multinational enterprise shifting profits or advertising revenue to a low-tax jurisdiction through a so-called “user participation value” model may not involve dividends or royalties, yet could still be captured by the PPT if the arrangement’s principal purpose is tax avoidance.

2.2 Integration with China’s Domestic Anti-Avoidance Regime

The PPT operates in tandem with the General Anti-Avoidance Rule (GAAR) under Article 47 of China’s Enterprise Income Tax Law, which empowers tax authorities to recharacterize arrangements lacking valid commercial reasons. When an enterprise shifts profits through a shell company established in a tax haven, tax authorities may invoke both the PPT and GAAR concurrently, thereby enhancing enforcement effectiveness.

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (hereinafter the “BEPS MLI”) requires Parties to incorporate the Principal Purpose Test (PPT) into their Covered Tax Agreement and clarifies that the Covered Tax Agreement does not prevent the application of domestic anti-abuse rules.

In the GSCP case, the court relied directly on Article 4 of the Protocol to apply domestic anti-avoidance rules, departing from the traditional principle of treaty precedence and illustrating how the PPT framework reinforces domestic anti-abuse enforcement.

2.3 Strengthening International Coordination in Tax Governance

In June 2013, the OECD and G20 jointly launched the Base Erosion and Profit Shifting (BEPS) Project to tackle tax avoidance strategies that erode the tax base and shift profits to low-tax jurisdictions. In November 2015, G20 leaders endorsed the 15 BEPS Actions, including Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), which introduced a minimum standard for preventing treaty abuse and recommended the Principal Purpose Test (PPT) as the primary mechanism to meet that standard.

Under Article 16 of the BEPS Multilateral Instrument (MLI), Contracting States may apply the PPT alone or in conjunction with a simplified Limitation-on-Benefits (LOB) provision. China signed the MLI in 2017 and, through its position paper, opted for the PPT-only approach, which covers 100 of its 102 effective tax treaties and arrangements, including the China–Barbados Tax Treaty. Following the MLI’s entry into force, these covered agreements automatically meet the BEPS minimum standard, providing a clear legal basis for Chinese courts to apply the PPT in treaty-abuse cases.

III. Future Trends under the BEPS Framework

1. Complementarity between the Beneficial Ownership Test and the PPT

China’s current approach reflects a dual-layer defense against treaty abuse. The revised 2018 Beneficial Ownership Rules (SAT Announcement [2018] No. 9) incorporated BEPS principles by broadening the scope of safe-harbor provisions (simplified eligibility criteria for treaty benefits) and reinforcing the assessment of substantive business activities. Meanwhile, the Principal Purpose Test (PPT) serves as a backstop mechanism, supplementing the beneficial ownership test in scenarios it does not directly cover. Together, they form a multi-dimensional anti-abuse framework that combines categorized management with holistic review.

In administrative practice, both rules are applied in a coordinated manner. For example,when an enterprise holds Chinese assets through a Hong Kong subsidiary, the tax authority would first examine whether the Hong Kong entity qualifies as the beneficial owner. If not, it may further assess—under the PPT—whether the overall structure was primarily designed for tax avoidance purposes.

2. Evolving Rules in a Digital and Globalized Economy

As the global economy becomes increasingly digitalized, tax authorities face novel challenges in allocating taxing rights and identifying avoidance arrangements that lack physical presence. The PPT offers a flexible tool to address these issues. It can be applied to cases involving user participation value or marketing intangibles—for instance, when a social media company shifts advertising revenue to a low-tax jurisdiction through virtual arrangements, the tax authority may invoke the PPT to conclude the arrangement was primarily designed for tax avoidance purposes and assert source-based taxing rights.

China’s adoption of the “PPT-only” approach under the BEPS MLI sets an example for developing countries to participate in global tax governance. Going forward, as the OECD’s Two-Pillar Solution takes shape, the PPT may operate in coordination with the Global Minimum Tax and Market Jurisdiction Taxing Rights, together forming a more coherent and effective anti-avoidance framework.

3. China’s Approach: Toward a Three-Dimensional Anti-Avoidance System

The transition from the beneficial ownership test to the Principal Purpose Test (PPT) represents a pivotal step in China’s modernization of international tax governance and its pursuit of more precise anti-avoidance enforcement. The inherent limitations of the beneficial ownership standard have led to the broader application of the PPT, which—through its focus on subjective intent, comprehensive reach, and coordination with domestic law—provides a systematic deterrence against treaty abuse.

In the Kouzi Distillery case, the combined application of these two rules, alongside the enhanced application of domestic anti-avoidance provisions, demonstrates China’s balanced approach in safeguarding tax sovereignty while maintaining a competitive business environment.

Looking ahead, as digitalization and globalization continue to reshape cross-border taxation, China is expected to further refine its three-dimensional anti-abuse framework integrating the beneficial ownership rule, the PPT, and domestic law—contributing a distinctive “China approach” to global tax governance.