In April 2014, State Administration of Taxation of People's Republic of China ("SAT") submitted a letter ("the Letter") to the subcommittee of UN Transfer Pricing Manual for Developing Countries ("UN TP Manual"). In this letter, SAT gives its comments on intra-group services fees and management fees from a China practical point of view. The Letter is expect to have a profound influence on China tax practices for it is the first time that SAT airs its views regarding intra-group service arrangements on the international platform. We share in this article our interpretation and observation of the Letter.
On top of all, SAT agrees with the application of the arm's-length principle for intragroup services outlined in the OECD Transfer Pricing Guidelines ("OECD TP Guidelines"). In this regard, two aspects should be taken into consideration: firstly, to determine whether intra-group services have been rendered by employing the "benefit test"; and secondly, to determine an arm's length price that an independent third party would have been willing to pay for the services rendered under the same circumstances.
Then SAT illustrates the following four circumstances where the parent company should not charge service fees to the subsidiary, which is the core of the Letter.
At last, SAT mentions some practical difficulties regarding intra-group services, such as how to validate the authenticity of the services rendered and the reasonableness of the associated allocation mechanisms, and how to differentiate royalties from technical service fees. For the former, SAT recommends that the UN TP Manual refers the relevant requirements in relation to transfer pricing documentation contained in the OECD Action Plan on Base Erosion and Profit Shifting ("BEPS"), and requires that the parent company discloses in the Master File the transfer pricing policies for global intra-group services, the method and the amount of services fees allocated to each subsidiary. For the latter, SAT recommends that the UN TP Manual provides additional guidance.
II. Our observations
The Letter focuses on the four circumstances where parent company should not charge services fees to the subsidiary. In general, under circumstance 1, 2 and 4, SAT analyses the actual beneficiary based on the benefit test, while under circumstance 3, SAT focuses on whether the charge of service fee is reasonable. The above views of SAT are of great importance to the tax practices in the future. In this regard, we recommend the taxpayers should pay due attention to the four circumstances in the Letter.
Outbound payments especially those involving service fees and management fees are subject to strict administration and scrutiny in China. Although the Announcement  No.40 (Announcement 40) was issued with the purpose to streamline the cross-border remittance procedures for non-trade payments, complex tax practical issues may still occur during the cross-border remittance process.
As mentioned above, this is the first time for SAT to air its views regarding intra-group services from a practical perspective. Previously, only Article 41 in the Corporate Income Tax Law ("CIT") and Article 49 in the Implementation Rules for the CIT Law of the People's Republic of China govern the intra-group service fees and management fees; and the administration of intra-group service fees and management fees mainly depends on the practices. The Letter indicates that, on one hand, SAT has accumulated extensive experience regarding intragroup services administration, and on the other hand, the scrutiny environment on service fees will be even stricter. As such, enterprises may need more assistance in the consulting and negotiation with tax authorities on cross-border service fee remittance issue.
At last, we will pay close attention to the two practical difficulties mentioned in the Letter and promptly update the reply from the subcommittee of UN TP Manual in our future alerts.
III. How Grant Thornton can help you?
At present, although our SAT streamlines the cross-border remittance procedures, complex tax practical issues may still occur during the cross-border remittance process. With the increasingly strict scrutiny of SAT, our tax professionals have accumulated extensive experience during the communication and negotiation with local tax bureaus and are ready to provide the following services to assist you in the following areas:
- Contract Review: conduct contract review to ensure the tax compliance and tax efficiency, as well as to reflect the related responsibilities and liabilities of both parties regarding additional taxes that may incur under the remittance procedures;
- TP Policy Review: conduct TP review to assess whether the intercompany charges is arm's length and the allocation method is appropriate;
- TP Study: conduct a "benefit test" to support the business substance of the intercompany transactions and prepare a TP study to establish arm's length charges for intercompany transactions;
- Document Review: review the submitted documents and the inhouse supporting documents to ensure the consistency and also to support the tax deduction, as well as provide comments on additional documentation possibly needed;
- Application and Negotiation: assist in the contract registration and tax assessment process through discussing and negotiating with and seek confirmation from the in-charge tax authorities regarding the taxable income.
Originally published April, 2014.
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.