During a short period of 30 days, China State Administration of Taxation ("SAT") had released two notices regarding anti-avoidance measures, measures that would impact directly the daily operation of taxpayers. This frequency of codification is so rare as to stir public speculation on China's determination to further step up its antiavoidance efforts.
- On July 30, 2014, SAT released the Notice of Anti-Avoidance Examination on Outbound Payments of Significant Amount (Notice No. 146 , hereinafter Notice 146) to strengthen the tax administration on outbound intercompany payments for the purpose of profit shifting.
- On August 29, 2014, SAT released the Announcement on Issues Relating to Monitoring and Management of Special Taxation Adjustment (Announcement No.54 , hereinafter Announcement 54) to further standardize and clarify the risk identification procedures carried out by tax authorities for special taxation adjustment, as well as the legal rights and obligations of taxpayers for this matter, including the option of self adjustment.
The current spot check targets any Chinese entity who remitted, during the period of 2004 to 2013, significant amount of service fee or royalty fee to overseas affiliates. Notice 146 requests local tax authorities to evaluate the business substance and economic sense of such payments, and in particular those bound for tax havens or other low tax jurisdictions. Also, Notice 146 specifies the following types of transactions as more prone to receive further questioning:
- Any service fee paid for –
－ Shareholder activities (including planning, management and supervision activities with respect to the operation, finance and human resource function of the local Chinese entity);
－ Centralized group management function;
－ Services received from an overseas party that duplicate the activities being performed by the local Chinese entity itself or any third party contracted by the Chinese entity;
－ Services received from an overseas party that are not relevant to the function and risk profile, or compatible to the current operation, of the local Chinese entity.
－ Circumstance where the service is provided in conjunction with other transaction, and that the pricing of the other transaction has already compensated the overseas party adequately for the service.
- Any royalty fee paid to –
－ Entity in tax haven;
－ Overseas affiliate that does not assume, or only assumes very limited business function;
－ Overseas affiliate albeit the fact that the local Chinese entity has added unique contribution to the licensed intangible property, or that the value of the licensed intangible has depreciated significantly.
Notice 146 empowers local tax authorities to launch formal investigation on any Chinese entity with obvious trace of tax avoidance.
Announcement 54 sets forth the main procedures for tax authority to assess the tax risk and inform the taxpayer of such. It also outlines the followingup measures that tax authorities and taxpayers shall adopt respectively to clear such risk:
- Tax authority shall identify tax risk based on the transfer pricing filing and documentation of taxpayer, and inform the taxpayer of any;
- Once being informed of such risk, the taxpayer can choose to conduct self adjustment and pay up the tax, or request the tax authority to provide formal opinion on the matter of special taxation adjustment. In the latter case, the tax authority shall launch the formal investigation procedure;
- Tax authority reserve the right to launch formal investigation and assess tax, in the event that taxpayer has made self adjustment, but to the level still falling short of the arm's length principle;
- Contemporaneous interest and a 5% surcharge are technically chargeable on top of the tax adjustment. Nevertheless, Announcement 54 stipulates that the 5% can be waived if the taxpayer chooses to perform self adjustment, and duly provides any relevant document requested by the tax authority along the process.
Grant Thornton observations
As we interpreted earlier in this alert, the unprecedented frequency of recent codification is no doubt signaling the determination of SAT to tackle tax avoidance under a full scale basis.
Notice 146 can be viewed, to certain extent, as a sequel to Announcement No. 40 that was co-issued in 2013 by SAT and State Administration of Foreign Exchange ("SAFE") to change the outbound remittance game rule of non trading items from "pre-approval" to "post-monitoring". As the view we shared in the tax alert dated August 2013, such a conversion does not in essence ease the control of Chinese authorities on outbound remittance of non-trade payments; rather, taxpayers could encounter with higher level of uncertainty under this new mode. The release of Notice 146 seems to echo our speculation, and poses practical challenges to entities with such needs for remittance.
As to Announcement 54, the advocated self adjustment mechanism may not function as a true relief for taxpayers, since completing a self adjustment does not bring immunity to formal investigation and assessment of the in-charge tax authority.
All in all, both Notice 146 and Announcement 54 are strengthening which is already a quite stringent antiavoidance legislation of China. The tax authorities are therefore expected to pursue tax avoidance leads under a more standardized approach, yet more aggressively.
Grant Thornton suggestions Raise your alertness to tax risks
In the context of the recent legislative development, taxpayers need to raise their alertness to tax risks. Consideration shall be given both to the planning of future transactions and risk review of the historical as well as ongoing transactions.
- For contemplated future transactions, the taxpayer is advised to formulate a reasonable transfer pricing policy so as to mitigate preemptively any significant exposure;
- For historical and ongoing transactions, a comprehensive risk review shall be performed right away. Taxpayers can prepare appropriate documents and explanations for any potential inquiry from the local tax authority. They shall also consider rectifying the risk identified during the review so as to contain the exposure.
Raise the frequency of routine Monitoring
In China, special taxation adjustment has 10 years as the statutory limitation. Take Notice 146 for instance, the period of investigation spans from 2004 to 2013. In view of this, routine monitoring of transfer pricing mechanism is crucial for taxpayer to identify and correct any significant deviation in time. Naturally, it is already too late when the tax authority has launched formal investigation.
Tips for Next Step upon being notified of tax risk
Upon being informed by the in-charge tax authority of any tax risk, effective communication is essential as it enables the taxpayer to better understand the specific requirement of the tax authority on the self adjustment procedures, including but not limited to the approach of supplementary filing and the booking of such adjustment from an accounting perspective. More importantly, taxpayers shall try to better guesstimate the real expectation of tax authorities during the communication, so as to conduct self adjustment more effectively and avoid being further investigated.
Self adjustment is under most circumstances more effective and less time consuming for taxpayers compared to the formal investigation launched by tax authorities. This being said, taxpayers will lose the opportunity to seek tax relief from mutual agreement procedure during a self adjustment initiative. As such, serious deliberation shall be given from a global perspective of whether to perform a self adjustment, especially when the potential quantum of adjustment is significant.
How can Grant Thornton help you?
Facing the ever-stringent environment of anti-avoidance in China, taxpayers need to substantiate their intercompany arrangement so as to mitigate their overall transfer pricing exposure. Our seasoned professionals can lend support in the following aspects –
- Planning of supply chain and intercompany transactions, as well as the documentation of such planning;
- Risk and opportunity review for the current transactions;
- Regular (monthly or quarterly) monitoring and analysis of the preset transfer pricing arrangement and advices on correcting the deviations;
- Key technical assistance and intervention during the communication between the taxpayer and the tax authority.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.