Editor's Note: Due to the lack of clear provisions in the current law on the division of responsibility between the investor and the actual controller of a sole proprietorship enterprise, as well as the assumption of historical tax liabilities after the change of the investor, tax law enforcement disputes and enterprise compliance risks occur frequently in practice. This article analyzes from different dimensions and clarifies that the tax bureau cannot directly enforce the so-called "real controller" property of a sole proprietorship enterprise, and the tax liability of a sole proprietorship enterprise after the change of the investor needs to be differentiated from different situations, aiming to provide practical guidance for the standardization of the tax treatment of a sole proprietorship enterprise.

01 Introduction

According to article 2 of the Law on Sole Proprietorships, a sole proprietorship is a business entity established within the territory of China in accordance with this Law, in which a natural person invests, the property is owned by the investor personally, and the investor bears unlimited liability for the debts of the enterprise with his or her personal property. Article 102 of the Civil Code provides that an unincorporated organization is an organization that does not have legal personality but is able to engage in civil activities in its own name in accordance with the law. Unincorporated organizations include sole proprietorships. It can be seen that the sole proprietorship enterprise is an unincorporated organization, does not have legal personality, the investors of the sole proprietorship enterprise for the debts of the sole proprietorship enterprise to bear unlimited joint and several liability. Specifically, when the enterprise is faced with external debt, first by the enterprise in its own name and property to pay off. If the property of the enterprise is insufficient to settle the debt, the investor is required to use other personal property to fulfill the obligation of settlement.

In terms of tax liability, according to paragraph 2 of article 1 of the Enterprise Income Tax Law and item 5 of article 6 of the Regulations for the Implementation of the Individual Income Tax Law, a sole proprietorship is not required to pay enterprise income tax, and its operating income is subject to individual income tax paid by the investors in their personal names. However, in the tax obligations of other taxes, the sole proprietor enterprise acts as an independent taxpayer subject. In this context, two key issues need to be clarified: first, how the tax liability is defined when the registered investor is not the same as the actual controller; second, who should bear the historical tax arrears if the investor changes after the enterprise owes tax. As the tax authorities may take compulsory measures such as withholding deposits, seizing property and exercising subrogation rights against taxpayers with tax debts, clarifying the above liability boundaries is not only related to the law enforcement compliance of the tax authorities, but also directly affects the tax risk management of the enterprise and the investor.

02. Tax authorities cannot directly enforce the property of so-called "beneficial owners" of sole proprietorships

Whether the tax authorities can directly enforce the property of the so-called "real controller" when the identity of the investor and the real controller of the sole proprietorship enterprise are separated is a controversial issue in practice. The "investor" in Article 2 of the Sole Proprietorship Law refers to the registered investor, i.e., the responsible subject of the business registration, which does not cover the unregistered "real controller". Article 40 of the Tax Collection and Management Law limits the object of enforcement to "taxpayers, withholding agents, tax guarantors", while the actual controller is not registered as an investor, and is not the subject of legal tax obligations. Under this legal framework, if the tax authorities hastily enforce the property of the so-called "real controller", it not only lacks a clear legal basis, but also may cause procedural violations due to the lack of evidence of administrative behavior, and face the legal risks of administrative behavior being revoked and administrative compensation.

In addition, the Supreme People's Court also has jurisprudence that does not support the addition of the actual controller of a sole proprietorship enterprise as an enforcer. （The (2019) Supreme Court Enforcement Ruling No. 35 states that "according to the principle of separation of trial and enforcement, the addition of an executor in the enforcement procedure should be made strictly in accordance with the registered form of the enterprise", emphasizing that if an applicant for enforcement claims that the actual controller bears the responsibility, it should do so at the litigation stage rather than at the stage of enforcement, and denying the direct This negates the legitimacy of directly adding the actual controller as the executor in the execution procedure. Therefore, the tax authorities cannot, without authorization, add the "real controller" of a sole proprietorship enterprise as an object of execution for property enforcement in the execution procedure.

Although the tax authorities cannot directly enforce the property of the "real controller" of a sole proprietorship enterprise, when the investigation reveals that the real controller and the sole proprietorship enterprise have a large amount of financial transactions or borrowing relationship, they can recover the tax, late payment fees and fines through the statutory civil remedies. Article 50 of the Tax Administration Law provides a legal basis for the tax authorities to exercise the subrogation and revocation rights, "If a taxpayer who owes tax is negligent in exercising its due claims, or abandons its due claims, or transfers its property without compensation, or transfers its property at an obviously unreasonably low price and the transferee is aware of the situation, which causes damage to the state tax, the tax authorities may, in accordance with the provisions of Articles 73 and 74 of the Contract Law, impose a fine on the taxpayer and the tax authority. Articles 73 and 74 of the Contract Law to exercise the right of subrogation and the right of avoidance."

Specifically, if a sole proprietorship enterprise is in default of tax payment, and the controller has a mature claim on the sole proprietorship enterprise and the sole proprietorship enterprise is negligent in exercising the claim resulting in damage to the national tax revenue, the tax authority may, in accordance with the above provisions, request the people's court to subrogate its name to exercise the sole proprietorship enterprise's claim on the controller to realize the tax recovery through the subrogation litigation; and if it is found that there are behaviors affecting national tax revenue such as transferring property at obviously unreasonable and low prices, the tax authority may request the people's court to revoke the relevant behaviors to realize the tax recovery through judicial proceedings. If it is found that the real controller and the sole proprietor have transferred property without compensation, transferred property at an obviously unreasonably low price and other behaviors affecting the national tax revenue, the tax authority may request the people's court to revoke the relevant behaviors and realize the tax recovery through judicial procedures.

03The liability for tax arrears after the change of investor in a sole proprietorship enterprise needs to be differentiated in different situations

After the change of the investor of a sole proprietorship enterprise, who should bear the taxes, late payment fees and penalties owed by the enterprise before the change is also a controversial issue in the current tax enforcement practice. Due to the lack of clear provisions in the current law, two kinds of situations need to be dealt with in practice in conjunction with the relevant provisions of the sole proprietorship enterprise: one is the tax obligation directly attributable to the investor's individual, with personal income tax being the most typical; and the other is the tax burden borne by the enterprise as the main body, such as value-added tax, stamp duty, etc. This difference directly affects the attribution and liability of tax owed by the enterprise. This difference directly affects the attribution and assumption of tax liabilities.

If the tax owed by the sole proprietorship enterprise is personal income tax, then the tax, late payment fee and penalty belong to the original investor debt, which is actually not a debt of the sole proprietorship enterprise. Article 3 of the Provisions on Individual Income Tax for Investors in Sole Proprietorships and Partnerships (Cai Shui [2000] No. 91) provides that "Sole Proprietorships shall take the investor as the taxpayer, and Partnerships shall take each partner as the taxpayer." This means that such tax arrears essentially belong to the personal debt of the original investor and have nothing to do with the enterprise and the new investor. Therefore, the tax authorities can only enforce the personal property of the original investor to pay the tax, but not the property of the new investor. In addition, since the sole proprietorship enterprise has been changed to the ownership of the new investor and no longer belongs to the property of the original investor, the property of the sole proprietorship enterprise should no longer be enforced.

If the tax owed by the sole proprietorship enterprise is value-added tax, stamp duty, etc., then the tax, late payment and fine belong to the debt of the sole proprietorship enterprise, and its liability is more complicated. According to Article 31 of the Sole Proprietorship Law, "if the property of the sole proprietorship enterprise is insufficient to settle the debts, the investor shall settle the debts with his other personal property", the new investor, as the successor of the enterprise's rights and obligations, shall be jointly and severally liable for the debts of the enterprise before the change. According to the relevant judicial cases of the People's Court, the original investor shall bear supplementary liability. Taking (2022) Beijing 02 civil final 7719 case as an example, the court held that, "the sole proprietorship enterprise is not a legal person, its civil rights and obligations by the investor to enjoy and bear, the property of the sole proprietorship enterprise is not enough to liquidate the debt, the investor shall liquidate the debt with his other personal property. In the case of personal investment enterprise transfer, the original investor on the transfer of enterprise debt formed before should also bear the responsibility of liquidation. If only the current investor is taken as the bearer of the debt of the sole proprietorship enterprise, it may easily lead to the original investor, in order to evade the debt, maliciously transferring the sole proprietorship enterprise to a third party without any solvency, to the detriment of the interests of the creditors." The logic of this decision reflects the principle of fairness in commercial transactions. When the new investor takes over the enterprise, he inherits the assets of the enterprise and should also bear the potential debt risk, so he needs to bear the joint and several liability for underwriting; the original investor, as the actual controller during the period of debt incurrence, although he has transferred the enterprise, based on the time correlation of the debt formation, he needs to bear the supplemental liability for the part of the enterprise and the new investor's insufficient liquidation. The internal agreement between the old and new investors shall not be binding on third parties, and the recovery of the relevant debt may be resolved by separate negotiation after the assumption of external liability.

In the specific implementation, the tax authority shall prioritize the existing property of the enterprise to settle the tax arrears, and may claim joint and several liability from the new investor for the shortfall; if the property of the new investor still fails to cover the debt completely, the tax authority needs to prove that the debt arose in the operation period of the original investor through litigation proceedings and has not yet been settled through the previous execution, and then ask the court to decide that the original investor shall bear the responsibility of supplemental liquidation of the remaining debt. Special attention should be paid to the fact that the tax authorities shall not directly add the original investor as an executor in the execution stage without confirmation in the trial procedure, so as to ensure the procedural legitimacy of the determination of liability.

04 Conclusion

The determination of the tax liability of a sole proprietorship enterprise is essentially a matter of balancing legal form and economic substance. For the tax authorities, it is necessary to strictly abide by the legal enforcement boundaries. When the registered investor is separated from the actual controller, the tax should be recovered through civil remedies such as subrogation and revocation, instead of directly enforcing the property of the actual controller; for the tax arrears after the change of investors, the liability should be divided according to the nature of the tax, i.e., personal income tax should be borne independently by the original investor, and VAT and other debts should be settled by the enterprise's property first, with the shortfall borne jointly and severally by the new investor and the original investor should be responsible for the supplemental liability. The original investor is responsible for the additional liability. For the enterprise operator and the transferee, tax risk prevention and control should be carried out throughout the whole transaction process. The change of investor does not mean that the historical tax liability is exempted. Before taking over the enterprise, the transferee should comprehensively verify the record of tax liabilities, the standardization of account books and other issues, and explicitly agree on the main body of the tax liabilities and the way of sharing in the transfer contract, so as to avoid undertaking potential risks due to the failure to fulfill the obligation of investigation. For the market entity, the titular investment needs to be cautious, and should sign a written agreement and clear recovery terms when it is necessary to hold on behalf of the real controller should avoid transferring the tax burden through the titular investment, and the financial transactions with the enterprise need to standardize the signing of the agreement. Only if the tax authorities standardize the law enforcement and the enterprises comply with the operation, can we safeguard the tax rights and interests of the country and maintain the stable order of commercial transactions.