In my reading of the works of Fazang 法藏 (643–712) I have come to understand his position on the matter. Fazang's position is essentially that arhats and pratyekabuddhas are under the mistaken notion that their nirvāṇa is an absolute cessation of existence and that in fact they are reborn outside the three realms in a pure land, whereupon they receive a 'transformation body' and start the Mahāyāna path. Fazang cites numerous sūtras and śāstras to prove his point. He also makes use of a metaphysical explanation, asserting that if a sentient being had an ultimate end, it should have an ultimate beginning from which a 'non-sentient entity' would become a sentient entity.
Here I will outline in brief his canonical citations and his metaphysical reasoning.
First of all let us consider his summary of canonical citations proving his assertion that arhats and pratyekabuddhas are reborn outside the three realms.
《大乘法界無差別論疏》卷1：「又勝鬘經。無上依經。佛性論。寶性論。皆同說三界外。聲聞緣覺及大力菩薩。受三種變易身。又智論九十三。引法華第三釋云。有妙淨土。出過三界。阿羅漢當生其中。是故定知入滅二乘。滅麁分段名入涅槃。實有變易在淨土中。受佛教化行菩薩道。若不爾者。未迴心時既無變易。迴心已去。即是漸悟菩薩。不名二乘。故知於三界外所受變易。小乘以為涅槃。大乘深說。實是變易。本無涅槃。勝鬘云。聲聞緣覺。實無涅槃。唯如來有涅槃故。此論下云。應知唯有一乘道。若不爾者。異此應有餘涅槃故。同一法界。豈有下劣涅槃。勝妙涅槃耶。以此當知二乘之人既無涅槃。無不皆當得菩提故。一切眾生皆是所為也。」(CBETA, T44, no. 1838, p. 62, a26-b11)
Furthermore, the Śrīmālā-sūtra, Anuttarāśraya-sūtra, Treatise on Buddha Nature and Ratnagotravibhāga-mahāyānōttaratantra-śāstra all likewise explain [the rebirth of arhats and pratyekabuddhas] outside the three realms. Śrāvaka, pratyekabuddhas and bodhisattvas of great power receive three kinds of transformation bodies. Furthermore, the Mahāprājñā-pāramitôpadeśa, quoting the third scroll of the Lotus Sūtra, explains that there is an excellent pure land beyond the three realms. Arhats are born within it. It is thus that we know for certain that the cessation of the two vehicles is the cessation of the coarse delimited saṃsāra which they call entering nirvāṇa. In truth they will possess a transformation body in the pure land, receive the Buddha's teachings and practice the bodhisattva path. If this were not so, then at the time they had not turned their minds [to the Mahāyāna] they would have no transformation [body], but upon turning their minds [to the Mahāyāna] they would be gradually realized bodhisattvas. They would not be called 'two vehicles'. Thus we know that it is outside the three realms that they receive the transformation [body]. The Hīnayāna thinks this is nirvāṇa. The Mahāyāna [has] a deeper explanation. In truth it is a transformation [body they receive]. Fundamentally there is no nirvāṇa [as the Hīnayāna would understand it]. The Śrīmālā-sūtra states that śrāvakas and pratyekabuddhas in truth have no nirvāṇa. It is only the tathāgata who has nirvāṇa.(1) This treatise [the Dasheng Fajie Wuchabie Lun 大乘法界無差別論] states below, “It should be understood that there is only the single vehicle path. If this were not so, it would be different from this as there would be another nirvāṇa. The same dharma-dhātu – how could there be an inferior nirvāṇa and a most excellent nirvāṇa?”(2) It is through these [citations] that we should understand that since those of the two vehicles [arhats and pratyekabuddhas] have no nirvāṇa, they will all attain bodhi, and thus all sentient beings are the object [of the aforementioned teaching].
These are potentially shocking statements – saying that there is no nirvāṇa. However, we need to keep in mind in this context 'nirvāṇa' refers to the absolute cessation of rebirth and existence, which is the goal of Śrāvakayāna teachings. The idea here is that there really is no absolute escape from our common reality, which for the unenlightened being is experienced as saṃsāra. This is not to deny the truth of the cessation of suffering. In Mahāyāna thought it is asserted that one can operate within common reality – even being reborn time and time again – without suffering, even experiencing it as bliss, provided wisdom and compassion are manifest.
The statement from the Mahāprājñā-pāramitôpadeśa he is citing is as follows.
(CBETA, T25, no. 1509, p. 714, a9-15)
Question -- Arhats in their past lives must have extinguished all the conditions and conditions to receive a new body. Where do they abide and perfect the Buddha's path?
Answer -- When one attains arhatship all contaminated causes and conditions of the three realms are extinguished and one is no longer reborn in the three realms. There is a pure Buddha-land beyond the three realms, even being without the word 'defilements'. In this realm, the place of the Buddha, they hear the Lotus Sūtra, and perfect the Buddha's path. As the Lotus Sūtra says, "There are arhats who, if they have not heard the Lotus Sūtra, think of themselves as having attained cessation. In another realm I explain this - you all will become buddhas."
One will notice that the text does not explicitly say arhats are reborn in this pure buddha-realm outside the three realms. However, it seems logical to read it as such given that the question is where arhats reside after they pass away and how do they achieve buddhahood. Other writers like Jizang (549–623) 吉藏 interpret this passage in the same way.(3) I think this is the logical way to understand this passage as well. The other thing to note is that there is no mention here of a 'transformation body' (變易身), which is actually an idea obtained from other texts.
As to his metaphysical reasoning for absolute cessation of all existence being untenable he explains in greater detail why there is no 'end of ashes and eternal cessation' (無灰斷永滅) for the two vehicles in his work entitled the Commentary on the Undiscriminated Mahāyāna Dharmadhātu Śāstra 《大乘法界無差別論疏》 by citing a passage from the Ghana-vyūha-sūtra 《密嚴經》 and elaborating the metaphysical reasons why such a permanent cessation is untenable.
《大乘法界無差別論疏》卷1：「密嚴第一頌云。涅槃若滅壞。眾生有終盡。眾生若有終。是亦有初際。應有非生法。而始作眾生。解云。此亦是聖教。亦是正理。若入寂二乘灰斷永滅。則是眾生作非眾生。若令眾生作非眾生。則應有非眾生而始作眾生。」(CBETA, T44, no. 1838, p. 62, a18-23)
A verse in the Ghana-vyūha-sūtra states, “If nirvāṇa were cessation, then a sentient being will have a complete end. If a sentient being has an end, then there should also be a beginning time. There should be a non-sentient dharma that starts being a sentient being.” Interpretation – This is the holy teaching and is also the right principle. If one were to enter into extinction, the two vehicles' 'end of ashes and eternal cessation', then this sentient being would become a non-sentient being. If a sentient being is made into a non-sentient being, then there should be non-sentient beings beginning to be sentient beings.
Fazang is arguing here that arhats and pratyekabuddhas cannot achieve an absolute cessation – that is to say, using his vocabulary, becoming a non-sentient entity – because it would follow that since a sentient entity could become a non-sentient entity, then a non-sentient entity should be able to become a sentient entity. If a sentient being has an ultimate absolute end, then it should also have a beginning according to him. For Fazang this would be equal to saying that an uncontaminated dharma could give rise to a contaminated dharma. He references the Vijñaptimātratāsiddhi-śāstra to demonstrate this point.
《大乘法界無差別論疏》卷1：「唯識論中。說有漏生於無漏。則難勿無漏法還生有漏。今亦例同。既眾生入滅同非眾生。勿非眾生法而還作眾生。」(CBETA, T44, no. 1838, p. 62, a23-26)
In the Vijñaptimātratāsiddhi-śāstra it is explained that [if it is suggested that] the contaminated is produced in the uncontaminated, then the criticism is that there are no uncontaminated phenomena still producing the contaminated. Now the precedent is the same since sentient beings would enter cessation and be the same as a 'non-sentient being', [but] there are no 'non-sentient being' phenomena that still produce sentient beings.
One could respond by asking if a sentient being is doomed to exist as such without any possibility of transcending the state of being a sentient being. Moreover, how is it a sentient being becomes a buddha which is not a sentient being? Again, one must take into consideration the context in which this argument is being put forth. Fazang is arguing that sentient beings by virtue of being sentient entities cannot become non-sentient entities completely detached from reality, isolated in a nirvāṇa apart from all other beings. Sentient beings can, however, attain buddhahood where while not being a 'sentient being' they still actively interact with reality and all the sentient beings within it. This is an emotionally charged idea that one can still work within saṃsāra without being adversely affected by it.
Fazang's own sentiments are clear in the following statement by him:
《修華嚴奧旨妄盡還源觀》卷1：「觀色即空成大智而不住生死。觀空即色成大悲而不住涅槃。以色空無二。悲智不殊。」(CBETA, T45, no. 1876, p. 638, b1-3)
Seeing that form is emptiness manifests great wisdom and one does not abide in saṃsāra. Seeing that emptiness is form manifests great compassion and one does not abide in nirvāṇa. When form and emptiness are non-dual, compassion and wisdom are not different.
Still, I think his arguments would not satisfy a lot of people and raise many more questions. For example, from a Śrāvakayāna perspective one could argue that sentient beings do not become 'non-sentient beings', but rather just that upon attaining arhatship and passing away the causes and conditions for a sentient being to arise simply cease like a candle light being snuffed out. However, the Mahāyāna proponent could defer to canonical scriptures which indeed state arhats are reborn outside the three realms and eventually achieve buddhahood, though the Śrāvakayāna proponent would not accept this.
As I said above there are multiple theories on this matter. Fazang's ideas outlined above represent the views of just one thinker. He was a prolific writer and over the centuries many others read his works not only in China, but also in Korea and Japan. He no doubt influenced his posterity and so his ideas are worth special consideration.
1 See the following. 《勝鬘師子吼一乘大方便方廣經》卷1：「阿羅漢辟支佛有怖畏。是故阿羅漢辟支佛。有餘生法不盡故。有生有餘梵行不成故。不純事不究竟故。當有所作。不度彼故。當有所斷。以不斷故。去涅槃界遠。何以故。唯有如來應正等覺得般涅槃。成就一切功德故。阿羅漢辟支佛。不成就一切功德。言得涅槃者。是佛方便。唯有如來得般涅槃。成就無量功德故。阿羅漢辟支佛。成就有量功德。」(CBETA, T12, no. 353, p. 219, c1-9)
3 See the following. 《勝鬘寶窟》卷2：「問。無漏云何是業。...答。即此無漏作意之義。故名為業。生羅漢業。是變易果。生相云何。如智度論云。有妙淨土。出過三界。是阿羅漢當生彼中。」(CBETA, T37, no. 1744, p. 54, a18-21)