Editor's Note: Partnership enterprises follow a "distribute-first, tax-later" principle. Certain taxpayers have sought to reduce the overall tax burden on share-disposal income to extremely low levels by constructing multi-layer nested structures combined with deemed-profit assessment. Whether such structures can withstand scrutiny under the "legitimate business purpose" standard is the central focus of tax audit investigations. This article draws on a real case in which six natural persons established a multi-tier partnership structure and applied deemed-profit assessment to dispose of shares in a listed company. It reconstructs the full picture of how the structure was assembled and how the tax authority subsequently pierced it, analyzes the authority's reasoning for disqualifying deemed-profit assessment and imposing look-through taxation, maps out the systemic tax risks that multi-layer nested partnership structures face under the current regulatory environment, and offers comprehensive compliance recommendations.

01  Multi-Layer Nested Partnership Structure Combined with Deemed-Profit Assessment Used to Dispose of Shares

In 2015, six natural persons — Zhang, Li, Wang, Zhao, Qian, and Sun — jointly invested RMB 30 million to establish Partnership A in City L, with all contributed capital earmarked exclusively for purchasing shares in a listed company. Zhang, Li, and Wang each contributed RMB 7 million and each held a 23.33% interest in Partnership A; Zhao, Qian, and Sun each contributed RMB 3 million and each held a 10% interest. At the time of formation, all six natural persons held their interests in Partnership A directly as partners, representing a typical single-tier direct-holding structure.

In 2019, the six natural persons undertook a restructuring of their existing holding arrangement and established two upper-tier partnership enterprises in separate groups. Zhang, Li, and Wang jointly established Partnership Jia in City H, while Zhao, Qian, and Sun jointly established Partnership Yi in City H; both entities registered "commercial trading" as their primary business activity with the company registry. In January 2020, Partnership A completed the business-registration change procedures for all partners: the original six natural persons were removed from the partnership register and replaced by Partnership Jia (holding 70%) and Partnership Yi (holding 30%). The restructuring altered only the tier of ownership; the underlying economic interests remained unchanged. Zhang, Li, and Wang each held equal shares in Partnership Jia and thereby indirectly held 23.33% each in Partnership A (70% × 1/3); Zhao, Qian, and Sun each held equal shares in Partnership Yi and thereby indirectly held 10% each in Partnership A (30% × 1/3). Upon application, in March 2020, the competent tax sub-bureau of City H approved deemed-profit assessment for Partnership Jia and Partnership Yi under the "commercial" industry category, setting the deemed taxable income rate at 5%.

In June 2020, Partnership A disposed of all its listed-company shares, realizing total proceeds of RMB 90 million against an original investment cost of RMB 30 million. In the same year, Partnership A held a partners' meeting and issued a formal distribution resolution allocating the disposal proceeds in proportion to partnership interests: Partnership Jia received RMB 63 million (70%) and Partnership Yi received RMB 27 million (30%). Partnership Jia and Partnership Yi then each made a second-tier distribution in equal shares among their respective natural-person partners, with Zhang, Li, and Wang each ultimately receiving RMB 21 million and Zhao, Qian, and Sun each receiving RMB 9 million.

For tax filing purposes, both Partnership Jia and Partnership Yi applied the approved 5% deemed taxable income rate to calculate each natural-person partner's taxable income, which was then subjected to the five-bracket progressive tax rate schedule. The taxable income and individual income tax (IIT) paid by each natural-person investor were as follows:

As the figures show, by leveraging the multi-layer nested structure together with deemed-profit assessment, the six natural-person partners collectively paid only approximately RMB 1.1895 million in individual income tax — an effective tax rate of approximately 1.32% against the RMB 90 million in disposal proceeds, representing an exceptionally dramatic tax reduction. Yet could the tax logic underpinning this "ingenious" arrangement truly withstand scrutiny? Was deemed-profit assessment actually applicable to share-disposal income? Did the multi-tier structure have genuine commercial substance? These questions formed the very core of what the tax audit authority subsequently investigated and adjusted.

02  Tax Audit Authority Pierces Multi-Layer Partnership Structure, Disqualifies Deemed-Profit Assessment, and Recovers Tax

In August 2025, the Tax Audit Bureau of City L (the location of Partnership A) initiated a tax audit into the tax matters arising from Partnership A's share disposal. Based on the substance of the transactions and applicable tax laws and regulations, the audit authority determined that the multi-layer nested structure in question exhibited a clear intent to evade tax by improperly applying deemed-profit assessment. It pierced through the intermediate partnership tiers and assessed the relevant tax directly against the six ultimate natural-person partners.

The City L Tax Audit Bureau found that the central technique of the multi-layer nested structure was to use Partnership Jia and Partnership Yi — established in City H and registered with a commercial trading business scope — to recharacterize the share-disposal income flowing up from the underlying Partnership A, so as to qualify for deemed-profit assessment. In substance, the arrangement exploited inter-provincial information gaps in tax administration to create an opening for this scheme. After piercing through the structure, the audit bureau established that Partnership Jia and Partnership Yi had no substantive commercial trading business of their own whatsoever; the amounts flowing into their accounts were in essence the share-disposal income generated by the underlying Partnership A from selling listed-company shares, bearing no connection to any commercial trading activity. The parties had used a cross-province, multi-tier structure to exploit inter-provincial enforcement information gaps, disguising share-disposal income as commercial operating income — income whose character was entirely inconsistent with the actual source of the receipts — and had applied deemed-profit assessment to drastically reduce their tax liabilities, demonstrating a clear intent to evade tax. The authority therefore pierced through to the six ultimate natural-person partners for tax assessment purposes.

Accordingly, the audit bureau applied the Regulations on the Levy of Individual Income Tax on Investors in Sole Proprietorship Enterprises and Partnership Enterprises (Cai Shui [2000] No. 91) and, treating each partner as a separate taxpayer, determined each partner's taxable income based on the partnership's total operating income and the profit-sharing ratio set out in the partnership agreement, subjecting the income to the five-bracket progressive rate schedule of 5% to 35% for business income.

Under the actual-books assessment method, the overall business income from the share disposal equaled the disposal proceeds of RMB 90 million less the original investment cost of RMB 30 million, yielding aggregate taxable income of RMB 60 million. The tax authority allocated this among the six natural persons according to their look-through ownership percentages: Zhang, Li, and Wang each held 23.33%, giving each a taxable income of RMB 60,000,000 × 23.33% = RMB 13,998,000; Zhao, Qian, and Sun each held 10%, giving each a taxable income of RMB 60,000,000 × 10% = RMB 6,000,000. All income was taxed uniformly under the five-bracket progressive rate schedule for business income. The resulting tax assessments were as follows:

Comparing the two sets of figures, the difference in tax liability is striking. Zhang, Li, and Wang had each paid RMB 302,000 under deemed-profit assessment; the tax properly due under actual-books assessment is RMB 4,833,800 per person, leaving each with a shortfall of RMB 4,531,800. Zhao, Qian, and Sun had each paid RMB 94,500; the tax properly due is RMB 2,034,500 per person, leaving each with a shortfall of RMB 1,940,000. The six natural persons collectively paid only RMB 1.1895 million originally; after the look-through adjustment, the aggregate tax liability rises to RMB 20,604,900, a difference of RMB 19,415,400.

In handling this case, the tax authority directly denied the intermediate partnership tiers' independent taxpayer status and their eligibility for deemed-profit assessment, and used the natural persons' look-through beneficial ownership percentages as the basis for assessment. What tax risks does this case reveal about multi-layer nested partnership structures? The following section examines this question in depth.

03  Tax Risk Analysis of Multi-Layer Nested Partnership Structures

The full trajectory of the look-through adjustment in this case makes clear that the planning approach of suppressing equity-disposal tax liabilities through multi-layer nesting and deemed-profit assessment has become increasingly untenable under the current regulatory environment. Tax administration adheres firmly to the substance-over-form principle, piercing through structures layer by layer to examine the nature of transactions, the purpose behind them, and who ultimately benefits. The tax risks exposed in this case carry broad cautionary significance for similar structures.

First, shell-entity nesting with no legitimate business purpose will be subject to tax adjustment. Article 8 of the Individual Income Tax Law expressly provides that where an individual implements an arrangement lacking a legitimate business purpose and thereby obtains an improper tax benefit, the tax authority has the power to make a tax adjustment by a reasonable method; where additional tax is due, it shall be collected together with statutory interest. The assessment of whether a legitimate business purpose exists is the pivotal basis on which the tax authority intervenes to make adjustments. In February 2026, the State Taxation Administration, in its Q&A on Issues Concerning Small and Micro Enterprises Stacking Tax Preferential Policies, set out three criteria for determining "legitimate business purpose": (1) whether the motivation is reasonable; (2) whether the business is genuine; and (3) whether the transaction is conducted at arm's length. The STA also published positive and negative lists for the tax determination of "legitimate business purpose." Applying these criteria and lists, a multi-tier partnership arrangement should deliver tangible benefits such as improved management efficiency or enhanced market competitiveness, rather than having the reduction or deferral of tax as its sole or primary objective; each nested entity should possess independent production or business operations and a complete business process, without commingling of personnel, sharing of assets, or centralized control of decision-making; and transactions between related entities must comply with the arm's-length principle, be consistent with comparable market transactions, and be supported by verifiable documentary evidence.

In practice, structures such as employee share incentive platforms, venture capital funds and private equity funds, and family wealth management vehicles are generally found to have a legitimate business purpose because they serve genuine operating, asset management, or internal governance needs. By contrast, shell entities set up solely to reduce tax with no substantive change in business structure before and after the split, and with no actual operating personnel or business activity, represent the paradigmatic negative case. In this case, Partnership Jia and Partnership Yi, despite being registered with a commercial trading scope, functioned in reality only as conduits for passing through income; the cross-province structure was built around reducing the tax cost of the share disposal and cannot survive scrutiny under the legitimate business purpose standard, giving the tax authority a sound legal basis for the look-through adjustment.

Second, in an environment of data-driven tax administration and multi-agency coordinated enforcement, the approach previously used by some taxpayers — exploiting cross-regional enforcement disparities and local deemed-assessment policies together with multi-layer structures to temporarily fragment the supervisory chain — is no longer effective. Under the national tax big-data platform and the cross-province joint investigation framework, the tax authority can automatically flag combinations of features such as multi-tier shareholding, cross-province structuring, and large-scale share disposals as high-risk and prioritize them for targeted review. It is important to emphasize that structural tiers cannot insulate tax liabilities, and deregistration does not equate to closure: even where a partnership has completed its business deregistration, any outstanding taxes remain recoverable, and the tax authority can still pierce through the structure to pursue the ultimate natural-person beneficiaries.

Third, the Announcement on the Administration of Individual Income Tax on Operating Income from Equity Investments (Ministry of Finance and State Taxation Administration Announcement [2021] No. 41) expressly requires that partnership enterprises whose core business consists of equity interests or equity investments must uniformly apply the actual-books assessment method. This has definitively closed the policy loophole that allowed such structures to apply deemed-profit assessment. After the implementation of Announcement No. 41, similar arrangements no longer have even a nominally compliant path. It should also be noted that share disposals constitute transfers of financial instruments, giving rise to a VAT filing obligation of 6% at the partnership level. Under a multi-layer nested structure, the relationships between the income flow-through and the filing obligations at each tier are complex, creating a substantial risk of VAT under-reporting or omission that compounds the overall compliance burden — a matter warranting close attention.

04  Tax Compliance Recommendations for Multi-Layer Nested Partnership Structures

Against this backdrop, building compliant multi-tier partnership structures and effectively guarding against look-through adjustment risk has become a priority concern for participants in equity investment. The following compliance recommendations are offered.

First, at the structure-design stage, ensure the existence of a legitimate business purpose. Before establishing any tier of partnership structure, it is necessary to assess the substantive necessity of the arrangement against the positive and negative lists published by the STA. Nested structures serving employee incentives, risk segregation, regional operations, or family wealth succession typically have a substantive compliance basis; shell entities set up solely to reduce the tax cost of share disposals or to exploit local deemed-assessment policies represent the paradigmatic negative case. Once the structure is in place, care should also be taken to ensure that each tier of partnership enterprise is independent in terms of personnel, assets, business activities, and finances; that inter-entity pricing complies with the arm's-length principle; and that complete supporting documentation — partnership agreements, business contracts, lease agreements, and the like — is retained to be available for inspection.

Second, on the applicable income category and collection method, strictly observe the requirements of the Regulations on the Levy of Individual Income Tax on Investors in Sole Proprietorship Enterprises and Partnership Enterprises and the Announcement on the Administration of Individual Income Tax on Operating Income from Equity Investments, among other instruments. Partnership enterprises whose income derives from equity interests, share disposals, and similar equity returns must uniformly apply the actual-books assessment method. With respect to the characterization of income: dividends received by a single-tier partnership enterprise from investees may be taxed at the 20% rate applicable to interest, dividends, and bonus income; but within a multi-layer nested chain, share-disposal income at the bottom tier must be consolidated into operating income tier by tier and subjected to the five-bracket progressive rate schedule of 5% to 35%, with no misapplication of lower rates across tiers.

Third, proactively communicate and seek confirmation from the competent tax authority before any significant event. Prior to significant events such as large-scale share disposals, annual income distributions, structural changes, or cross-regional relocations, it is advisable to proactively engage the competent tax authority on a point-by-point basis regarding the applicable assessment method, the list of materials to be submitted, and the criteria for recognizing distributed income, and to retain written records for the file. Operational practices vary across local tax authorities, and advance engagement helps eliminate differences in policy interpretation; it can also serve as evidence of good-faith compliance in any subsequent audit.

Fourth, legacy business requires systematic review as well. Equity transactions, share disposals, income distributions, and structural reorganizations in recent years should be reviewed item by item to identify any unauthorized application of deemed-profit assessment, mischaracterization of income category, or under-reporting of income; any issues identified should be voluntarily corrected at the earliest opportunity. Where a partnership enterprise is to be deregistered, tax liquidation should be completed first — all outstanding taxes and late-payment surcharges settled — before the business deregistration is processed, so as to avoid leaving a legacy of long-tail recovery risk. Partnership enterprises and partners involved in equity investment or multi-layer structures are advised to conduct a systematic tax compliance self-review of their existing structures and historical projects, focusing particularly on whether historical income has been fully reported, whether the evidentiary chain is clear and complete, and whether pre-deregistration tax liquidation was duly carried out, with the goal of resolving compliance risks before any audit is initiated.