Frequent Tax "Penetration" of Anonymous Shareholders: Tax Risks in Nominee Shareholding Warrant Attention

Editor's Note: Recently, tax authorities have continuously exposed multiple tax-related cases involving nominee shareholding, where several anonymous shareholders were pursued for Individual Income Tax after being "penetrated." As tax laws have not yet clearly stipulated the tax treatment for registered shareholders and anonymous shareholders, in practice, there are still many controversies regarding their tax obligations in various scenarios such as dividend distribution and the restoration of nominee-held shares. This has led to varying degrees of administrative and even criminal tax risks. This article aims to provide a brief overview and analysis of this issue.

I. Case Study: Determination of Tax Evasion under "Yin-Yang Contracts" and Nominee Structures

(A) Basic Facts

A certain individual reached a nominee shareholding arrangement with an Italian national, Mr. Xia, whereby Mr. Xia was the registered holder of 40% of the equity in a real estate company in Ningde City, with the individual being the actual owner. In January 2014, the two parties, in the name of Mr. Xia, signed an "Equity Transfer Agreement" with the transferee, stipulating an equity transfer price of 80 million RMB, and promptly completed the industrial and commercial registration change. In July 2015, the individual separately signed a "Supplementary Agreement" with the actual controller of the acquiring party, confirming the true transaction consideration for the equity was 140 million RMB, resulting in a price difference of 60 million RMB. This fact was later judicially confirmed by the (2021) Min Min Zhong No. 1278 "Civil Judgment," which recognized the individual as the true owner of the equity and that the equity in question had been effectively transferred.

(B) Tax Authority's View

The tax authority held that the individual, as the actual beneficiary of the equity transfer, was the statutory obligor for Individual Income Tax. By using the registered shareholder to sign a low-price transfer agreement and then receiving the price difference through a supplementary agreement, the individual concealed the true income, resulting in a massive loss of tax revenue. After the tax authority legally served a "Tax Matter Notification" ordering him to declare, he still refused to pay the tax on the differential amount, constituting the act of tax evasion characterized as "refusing to declare after being notified to do so."

(C) Case Outcome

The tax authority ultimately determined that the individual had underpaid nearly 12 million RMB in Individual Income Tax and 30,000 RMB in Stamp Duty, and pursued recovery accordingly, imposing penalties for tax evasion. This case clearly demonstrates that neither "Yin-Yang Contracts" nor "nominee structures" can shield the anonymous shareholder from tax obligations. Once the economic substance is established by judicial documents or other evidence, the anonymous shareholder's use of complex arrangements to conceal income will face severe legal consequences, including tax recovery and the characterization as tax evasion.

II. Controversies over Tax Obligations of Registered and Anonymous Shareholders in Different Scenarios

Currently, tax laws lack unified provisions on the tax obligations of different parties in nominee shareholding arrangements, leading to significant controversy in practice regarding who should pay tax and how. The following explanation uses the scenario where both the registered shareholder and the anonymous shareholder are individuals.

(A) During the Term of the Nominee Shareholding

When the registered shareholder receives dividends, it is generally accepted that the registered shareholder should pay income tax according to regulations. This is because the registered shareholder is the legal entity recorded in the company's articles of association, shareholder register, and industrial and commercial information. Based on the principle of commercial appearance, they are the legal taxpayer. The nominee agreement only binds the parties to the agreement and cannot be used against the tax authority. Furthermore, from a tax collection and administration perspective, taxing the registered shareholder aligns with the principle of collection efficiency.

When the anonymous shareholder receives the forwarded dividends, whether they should be taxed again is subject to three views in practice:

*   View 1: Tax it as "income from equity investment returns." This treats it consistently with dividends received directly by the anonymous shareholder. However, this approach may be challenged on the grounds that the income received does not meet the legal definition of "dividend," and it may lead to double taxation, violating the principle of tax fairness.

*   View 2: Tax it as "interest income." This treats it as if the registered shareholder borrowed from the anonymous shareholder for investment, and the transfer payment is considered interest. While this facilitates tax administration, it ignores the legal substance of the nominee relationship and also faces the issue of double taxation.

*   View 3: No taxation. This view is based on the transfer payment lacking commercial substance. For instance, one local authority explicitly stated that transfers by individual registered shareholders do not fall within the scope of Individual Income Tax. However, this approach may lead to tax inequity or loopholes due to differences in the parties' statuses (e.g., if the registered shareholder is an enterprise and the actual contributor is an individual).

We believe that Individual Income Tax is levied on the income actually received by an individual. In a nominee shareholding relationship, the anonymous shareholder, as the substantive beneficiary, is the ultimate recipient of the dividends. Based on the principle of "substance over form," if the registered shareholder has already paid income tax on the corresponding dividends, the payment received by the anonymous shareholder is essentially after-tax income and should not be taxed again. Otherwise, it constitutes double taxation, contrary to the principles of tax neutrality and fairness.

(B) Termination of the Nominee Shareholding

The nominee shareholding is typically terminated through two main avenues: transfer of shares at zero consideration or judicial confirmation to make the anonymous shareholder recorded, or transfer of the shares to a third party.

*   In the case of transfer at zero consideration, there is disagreement over whether a tax obligation arises. One view holds that the restoration is essentially an "act of property right registration," not a true equity transfer, and thus should not be taxed. Another view advocates taxing it as "income from property transfer" based on the legal form. While the latter can achieve balanced tax burden by adjusting the tax basis, it may harm the taxpayer's time value of money interests, creating cash flow pressure. It is worth noting that if the registered shareholder is a relative, it may be recognized as having legitimate reasons pursuant to Article 13 of Announcement [2014] 67, thereby avoiding the tax authority assessing the transfer income.

*   In the case of restoration through judicial confirmation, most cases currently do not impose tax. However, it is important to note that the claim must directly target the confirmation of ownership. If it is merely a claim for return of profits, it might not be recognized by the tax authority. Even with a judicial ruling, the tax authority may still, based on the "Administrative Measures for Individual Income Tax on Income from Equity Transfer (Trial)" (State Administration of Taxation Announcement [2014] No. 67, hereinafter "Announcement 67"), treat the judicially forced transfer as an equity transfer and assess tax accordingly.

*   In the case of transfer to a third party, the registered shareholder should, in principle, be the taxpayer fulfilling the declaration and payment obligation. In practice, when handling equity change registration, the market entity registration authority usually requires providing the Individual Income Tax payment certificate related to the transaction; otherwise, the industrial and commercial information change cannot be completed. However, in some cases, if the tax authority can prove through relevant evidence that the anonymous shareholder is the actual beneficiary of the transaction (as shown in the previous case), it may "pierce" through and determine the tax obligation of the anonymous shareholder based on the "substance over form" principle. In such cases, the registered shareholder may still be considered the withholding agent in legal form, bearing the corresponding withholding and remittance responsibility.

III. Potential Tax Risks Faced by Registered and Anonymous Shareholders in Different Scenarios

(A) Risk of Assessment for Restoration via Zero or Par Value Transfer

During the restoration process of nominee shareholding, if a zero or par value transfer is used, it may be subject to tax assessment and adjustment of taxable income for not complying with the arm's length principle. In practice, due to the complexity of verifying the economic substance of the restoration, tax authorities often, based on the principle of formal taxation, characterize such restoration acts as equity transfers and levy Individual Income Tax on the registered shareholder as the taxpayer. This approach is also consistent with the enforcement direction reflected in relevant replies from the Xiamen Municipal Tax Bureau (e.g., Xia Shui Han [2020] No. 125). In this context, if the consideration used in the equity restoration is significantly low and without legitimate reasons, the tax authority has the right to make tax adjustments based on the assessed value. Especially when the fair market value of the subject equity is high, the anonymous shareholder may face risks including tax recovery, late payment interest, and even penalties if deemed to have evaded tax.

(B) Risk of Judicial Confirmation Still Being Treated as a Transfer

In practice, some parties attempt to directly change the registration of nominee shares into the anonymous shareholder's name through judicial confirmation procedures, arguing that this process does not constitute an equity transfer to avoid Individual Income Tax obligations. However, this path carries significant tax risks.

According to Announcement 67, forced transfer of equity by judicial or administrative authorities explicitly falls under the category of "equity transfer." Therefore, even with an effective judicial document, the tax authority may still, based on the principle of substance taxation, characterize the nominee restoration as a taxable equity transfer and pursue Individual Income Tax from the registered shareholder (or the actual beneficiary). Furthermore, the judicial process itself is lengthy and uncertain. The anonymous shareholder not only bears litigation costs but may also face tax adjustments from the tax authority after confirmation, including tax recovery, late payment interest, and even penalties for failure to declare or false declaration.

(C) Termination via Transfer to a Third Party: Shared Legal Risks for Both Parties

When nominee-held equity is transferred to a third party, if the anonymous shareholder fails to declare and pay tax according to law after receiving the income, both the registered shareholder and the anonymous shareholder will face severe shared legal risks.

For the anonymous shareholder, as the ultimate beneficiary in economic substance, they are the statutory taxpayer. If the anonymous shareholder fails to file a tax declaration, the tax authority has the right to "pierce" through and identify them as the taxpayer based on the "substance over form" principle, recovering the Individual Income Tax. Furthermore, due to the act of "refusing to declare after being notified to do so," their actions may be characterized as tax evasion, resulting in penalties and even criminal liability.

For the registered shareholder, the risks are equally significant. As the formal shareholder recorded in legal documents, they are both a potential taxpayer and the statutory withholding agent. According to the "Tax Collection and Administration Law," if a withholding agent fails to withhold or collect taxes that should have been withheld or collected, the tax authority shall recover the taxes from the taxpayer, but may impose a fine on the withholding agent of between 50% and three times the amount of taxes that were not withheld or collected. This means that even if the registered shareholder did not actually receive the income, they may face high administrative fines for failing to fulfill their withholding obligations.

IV. Compliance Recommendations and Defense Strategies Regarding Nominee Shareholding

(A) Nominee Agreement Should Specify Tax Burden Allocation, Emphasize Evidence Retention and Clear Fund Trail

A nominee shareholding agreement signed and confirmed by both parties is the most direct and effective legal basis for establishing the nominee relationship. However, in specific relationships like among relatives or friends, parties often forego formal agreements due to trust, leading to disputes over equity ownership later. In such cases, if indirect evidence such as transfer records of the actual contribution, witness testimony, records of participation in company management, letters of intent signed between the anonymous shareholder and relevant parties, etc., exists and can form a complete chain of evidence, it may also help prove the existence of the nominee relationship.

However, the standard of proof for such indirect evidence is high. It requires the actual contributor to systematically retain various types of evidence and often requires cooperation from others for testimony. The entire proof process is uncertain, and judicial outcomes are difficult to predict.

To prevent tax disputes and loss of rights, it is recommended to clearly stipulate in the nominee agreement or related equity transfer documents how the tax burden arising from dividends or equity transfer income received by the registered shareholder will be borne. If necessary, a third party can be introduced to co-sign the agreement to strengthen the enforceability of the clause. Additionally, when paying equity transfer consideration, it should ideally be paid directly to the anonymous shareholder's account, avoiding multiple layers of fund flow through the registered shareholder, to reduce the tax authority's questioning of the transaction's substance and lower tax risks.

(B) Asserting Legitimate Reasons When Facing Equity Price Adjustments

According to Article 13 of Announcement 67, significantly low equity transfer income meeting any of the following conditions may be deemed to have legitimate reasons, and the tax authority may not adjust it:

1.  Policy Impact: Able to produce effective documents proving that the investee's production and operation are significantly affected due to national policy adjustments, necessitating a low-price transfer.

2.  Transfer to Close Relatives: Transfer to spouse, parents, children, grandparents, maternal grandparents, grandchildren, maternal grandchildren, siblings, or dependents or supporters who bear direct support or maintenance obligations towards the transferor, and able to provide legally effective proof of relationship.

3.  Internal Employee Transfer: Transfer of equity held by employees of the enterprise (typically restricted from external transfer) internally, based on relevant laws, government documents, or company charter provisions, with sufficient materials proving the transfer price is reasonable and genuine.

4.  Other Reasonable Circumstances: Other circumstances where both parties to the equity transfer can provide effective evidence proving their reasonableness.

Therefore, if the above circumstances exist, or if proof of nominee shareholding can be submitted, the shareholder should promptly submit complete supporting materials during tax verification. Otherwise, the tax authority has the right to assess the transfer income according to law.

(C) Accurately Defining Tax Evasion: Subjective Intent is a Necessary Condition

In practice, when characterizing tax evasion by an individual, the tax authority generally identifies situations where the individual made a false declaration or refused to declare after being notified by the tax authority. For the former, the "Tax Collection and Administration Law" does not explicitly list the taxpayer's subjective fault as one of the constitutive elements of tax evasion. However, the term "false" inherently includes the subjective state of the party. Furthermore, relevant official replies and numerous judicial cases also prove that the subjective intent of the party is one of the elements constituting tax evasion. Therefore, when the tax authority characterizes an individual's conduct as tax evasion based on "false declaration," the individual's subjective state should be considered. If the individual lacks the intent to make a false declaration—for example, an error in declaration due solely to a misunderstanding of policy—it should not be characterized as tax evasion. For the latter, if the individual merely failed to declare, resulting in non-payment or underpayment of tax, Article 64, Paragraph 2 of the "Tax Collection and Administration Law" should apply. If, after being notified by the tax authority, the individual still refuses to declare, then there is a risk of tax evasion characterization. Therefore, the tax authority should distinguish the specific circumstances and handle cases not constituting tax evasion according to Article 64, Paragraph 2.

(D) Taxes Beyond the Recovery Time Limit Should Not Be Recovered from Individual Shareholders

According to the "State Administration of Taxation Reply on the Recovery Time Limit for Undeclared Tax" (Guo Shui Han [2009] No. 326): The situation where a taxpayer fails to file a tax return, resulting in non-payment or underpayment of tax payable, as stipulated in Article 64, Paragraph 2 of the Tax Collection and Administration Law, does not constitute tax evasion, tax resistance, tax fraud, or tax arrears. Its recovery period, following the spirit of Article 52 of the Tax Collection and Administration Law, is generally three years, and under special circumstances, can be extended to five years. From this, it can be concluded that when an individual falls under Article 64, Paragraph 2 but there is no act of tax evasion, resistance, fraud, or arrears, the tax authority's recovery of taxes is limited by a maximum recovery period of five years. We believe that if an individual has matters that should have been declared but were not, and are discovered more than five years later, and there are no acts of tax evasion, resistance, fraud, or arrears, even if it results in non-payment or underpayment of tax, the tax authority should not recover the taxes from the individual.

V. Summary

The core issue in the tax treatment of nominee shareholding relationships lies in the conflict and balance between legal form and economic substance. In collection and administration practice, tax authorities, considering administrative efficiency, enforcement risks, and revenue protection, tend to prioritize the application of the principle of commercial appearance and formal taxation. This leads to the registered shareholder often being identified as the taxpayer, while the anonymous shareholder faces the risk of being "penetrated" for tax recovery. Whether it's the potential assessment adjustments triggered by restoration via zero or par value transfer, or the difficulty in changing the tax characterization through judicial confirmation paths, it demonstrates the relative independence of tax law from the effects of civil agreements. To effectively manage risks, relevant parties should establish a clear tax burden allocation mechanism through written agreements beforehand and focus on building and retaining a complete chain of evidence that can prove the authenticity of the nominee relationship. In the event of a dispute, the affected party can actively argue for the application of the legitimate reasons clause for equity restoration and present arguments based on the lack of subjective intent required for tax evasion, recovery period limitations, and other relevant provisions to protect their legitimate rights and interests.