China’s State Administration of Taxation (SAT), on June 3, released English-language descriptions of SAT transfer pricing guidance, a circular reporting on the SAT’s efforts to curtail tax avoidance, and a paper outlining the changes required to transform China’s taxation system into one more truly governed by the rule of law.
The SAT explained that its decision to release transfer pricing guidance, “Announcement on Corporate Income Tax on Making Payments by Domestic Enterprises to Overseas Associated Enterprises,” last March was prompted by investigations into related party cross-border payments.
The “investigations [showed] that, as economic globalization and integration go deeper, it is often the case in China that [multinational corporations] make irrational payments to their overseas associated enterprises, leading to base erosion and loss of tax revenue,” the SAT said.
The guidance states that payments made by a Chinese enterprise to an overseas related party for services that do not provide economic benefits to the Chinese enterprise can not be deducted, the SAT said.
The guidance sets forth the following four circumstances where payments are considered to be in violation of the arm’s length principle:
[1] making payments to the overseas associated enterprises that fail to perform their functions and take risks, and have no substantial operational activities;
[2] paying the associated enterprises the service fees for the labor services that cannot deliver direct or indirect economic benefits;
[3] paying royalties to the associated enterprises that only have the legal ownership of the intangible assets but make no contribution to the value creation;
[4] paying royalties to the overseas associated enterprises for the fringe benefits created by the financing-oriented listing activities.
Moreover, the guidance requires MNEs to show contracts and agreements to tax authorities that establish that payments to overseas associated enterprises are arm’s length, the SAT explained.
Li Wanfu, director of the SAT Taxation Science Research Institute, predicted that the announcement “will play a positive role in strengthening tax administration, closing taxation loopholes, promoting standardized operations, and enhancing tax compliance.”
Combating tax avoidance
In a separate English-language document, the SAT discussed a recently released circular outlining the SAT’s successes in cracking down on tax avoidance.
According to the SAT, efforts to combat tax avoidance produced additional tax of RMB 52.3 billion (USD 8.4 billion) in 2014. Of that, the SAT attributed 39.6 billion (USD 6.4 billion) to investigations into the tax affairs of of 1,526 enterprises that resulted in changes to pricing and tax planning models that increased profits attributed to China.
The SAT also said that in 2014 it filed 272 anti-tax avoidance cases, settling 257 cases for RMB 7.9 billion (USD 1.3 billion) in additional tax revenue.
The agency also reported that in 2014, bilateral negotiations with eight countries involving 33 cases increased tax revenue by RMB 1.023 billion (USD 165 million) and helped reduce international double taxation by RMB 1.48 billion (USD 238.7 million).
The SAT said that it took a “multifaceted” approach to combating tax avoidance in 2014, including developing a system to monitor MNE profits and to identify risks of noncompliance; increasing scrutiny of related party transactions; improving internal processes; taking an active role in OECD, G20, and UN tax reform efforts; and developing new tax guidance.
Taxation by Law
The SAT also provided an English language summary of its recently released publication “Guiding Opinions on Fully Promoting Taxation by Law.”
The guidance has the stated purpose of “pointing the way for boosting the rule of law in taxation at higher standards and levels and achieving the modernization of tax governance system and capability.”
According to the SAT, while China’s tax system has improved in recent years, still has many flaws that must be addressed, including, “low awareness of the rule of law in taxation, weak authority of the tax law, poor operation of the regime and mechanism of taxation by law, insufficient standardization of law enforcement and unfavorable environment for the rule of law in taxation, damaging the legal rights and interests of taxpayers, and impeding the scientific development of tax work.”
The SAT identified multiple areas where tax authorities should strive to improve practices, broken down into nine “key tasks.” Suggested action includes taking further steps to ensure that tax is collected strictly according to the law; improving tax guidance and dispute resolution; ensuring the equal treatment of taxpayers; increasing public disclosure of government actions; increasing the idea of the rule of law in taxation across society; and improving the functioning of the tax department.
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