China: The Opportunities And Challenges Of The Simplified Procedure Of Cost Sharing Agreements -- Key Takeaways From Announcement 45

Last Updated: 12 August 2015
Article by Rose Zhou, Richard Bao and Julie Zhang

On June 16, 2015, China State Administration of Taxation ("SAT") promulgated the [2015] No. 45 Announcement on Standardizing the Administration of Cost Sharing Agreement ("CSA") (hereinafter "Announcement 45"). CSA is a framework agreement between different enterprises for determining the costs and risks of collectively developing or acquiring assets, services and rights, and the nature and scope of prospective earnings in terms of assets, services and rights between the parties involved.

Announcement 45 aims to implement the Decision of the State Council on Cancelling Items Requiring Non-administrative Approval (the "Decision"), streamline the administration process, and transform the "reporting to SAT" mechanism to "filing with local in-charge tax authority". Unlike previous application mechanism, the administrative threshold of applying for CSA will be lowered.

Recently, the Organization for Economic Cooperation and Development (OECD) released discussion draft on CSA in relation to the OECD's Base Erosion and Profit Shifting ("BEPS") Action Plan under Action 8 (transfer pricing ("TP") valuation with respect to transfers of intangibles). Announcement 45 is also issued as a proactive response to BEPS.

This alert probes into issues related to CSA under Chinese laws and regulations and reveals the opportunities and challenges for Chinese taxpayers through the introduction of Announcement 45.

Scope of application: following the provision of The Implementation Measures for Special Tax Adjustments (Trial) ("Circular 2")

Announcement 45 does not specifically mention the application scope of CSA, which could be understood that the provisions given in Circular 2 shall be continually adopted, per which, CSA mainly applies to the following two types of transactions:

  • Joint development or transfer of intangible assets; and
  • Joint provision/reception of services, generally concerns group purchasing and group marketing planning.

CSA for joint development and transfer of intangible assets is the commonest CSAs. Each party of the CSA holds a proportionate share of right to the intangible assets arising from the R&D and all parties are granted an independent right to use such assets. Such rights might be in the form of the legal ownership or economic ownership and the participating parties shall not pay royalties for using the aforesaid assets.

CSA service usually applies to group purchasing and group marketing planning. For instance, to enhance efficiency and realize centralized control, a group corporation might arrange a CSA between the headquarter and certain subsidiaries, under which the headquarter shall make and collectively control group marketing decisions and the subsidiaries, based on such decisions, shall carry out marketing planning and implementation activities in their local areas.

One point for attention is that for other types of business, in particular certain routine and supporting services, based on our literal interpretation of the existing laws and regulations, CSA does not apply. Whether CSA could be applicable to these kinds of businesses in practice should be based on the specific situations.

Supervision mechanism: Relax administrative approval while reinforce follow-up administration

Announcement 45 removes the provision of "within 30 days upon conclusion of CSA, an enterprise shall report level by level the CSA to the SAT for record-filing purpose" in Article 69 of Circular 2, and states that tax deduction of costs contributed in a CSA does not require the approval of the tax authorities, provided that within 30 days of conclusion (amendment) of a CSA with related parties, an enterprise shall submit a copy of the CSA to the local tax authorities and also hand in the Enterprise Annual Related Party Transaction Report of People's Republic of China as a appendix while filing the corporate income tax ("CIT") annual return.

Special attention should be given to the fact that Announcement 45 expressly states the focus of tax authority in supervision shall be the follow-up administration of CSA, specifically:

  • Tax authorities shall conduct special tax adjustments for CSA that does not follow the arm's length principle and cost-benefit matching principle; and
  • During the execution of CSA, in case the benefits obtained by a participating party is not equal to the cost contributed and no compensation adjustment is made based on the actual facts, tax authorities shall conduct special tax adjustments.

Focus: Arm's length principle and cost-benefit matching principle

Announcement 45 reiterated the administrative philosophy of CSA given in Circular 2 and stressed the significance of arm's length principle and cost-benefit matching principle in such kind of arrangements.

Under Circular 2, parties of CSA are entitled to the benefits of development and transfer of intangible assets or engagement in services and meanwhile, assume corresponding costs of such activities. Costs borne by related parties shall in general be equal to that undertaken by the non-related parties for the purpose of obtaining the aforesaid benefits under comparable conditions. Thus, the idea of cost match benefit constitutes the cornerstone of CSA. Accordingly, key elements of CSA could be summarized as:

  • Benefits obtained by parties of CSA could be rationally and accurately calculated;
  • Costs assumed by parties of CSA could be rationally and accurately calculated; and
  • Allocation basis of cost contribution of CSA could be rationally determined.

When the anticipated benefits to be obtained by parties of CSA are determined, in case of any inconsistency between the actual benefit received and anticipated benefits, balancing payments should be made to modify the costs contribution of the participating parties.

Balancing payment means a sum of fund used to rectify the cost contribution ratio of parties of CSA. As a cost on the part of the payer, such payment will raise its contribution ratio and correspondingly, on the part of the payee, upon receipt of such payment, its cost contribution ratio in the CSA shall fall down. One thing worthy of note is that in practice, such balancing payment could be two-way, that is, the Chinese party could be a payee to accept such payment, it might also be a payer making such payment. Once compensation adjustment is associated with foreign exchange (foreign exchange settlement and receipt), it might draw the attention of tax authorities and thus requires careful treatment of enterprises.

However, though Circular 2 and Announcement 45 emphasize CSA's compliance with the arm's length principle and cost-benefit matching principle, they give no clear idea concerning methods for calculating the benefits, cost and allocation basis of cost contribution. Discussion on CSA under the BEPS Action Plan of OECD is currently in progress and Circular 2 is also undergoing revision in China, future administrative provisions concerning CSA is still uncertain.

Documents requirements

Per the requirements of Circular 2 and Announcement 45, we list the following documents which might need to be prepared in record-filing and follow-up administration of CSA:

Record-filing phase (not exhaustive):

  • Copy of CSA agreement: Announcement 45 explicitly provides that an enterprise should submit a copy of CSA agreement to tax authorities within 30 days upon conclusion (amendment) of CSA with related parties; and
  • Documents proving CSA's compliance with arm's length principle and cost-benefit matching principle, for instance, method for calculating benefits obtained by participating parties, cost contribution method and forms of contribution made by each party.

Follow-up management phase (not exhaustive)

  • Enterprise Annual Related Party Transaction Report of People's Republic of China: where an enterprise concludes (amends) CSA, it means the occurrence of transaction with related parties and no matter such agreement is carried out or not, this report shall be submitted as an appendix in CIT annual return; and
  • Contemporaneous documentation associated with CSA, for instance, other agreements entered into by parties of CSA for advancing CSA, comparison of anticipated benefits with actual results and corresponding balancing adjustment made etc. One point for notice is that an enterprise implementing CSA shall submit the contemporaneous documentation to the tax authorities before June 20th of the current year.

Practice of outbound payment under CSA

Dealing with the foreign exchange issues under CSA may easily draw the attention from tax authorities, especially cash repatriation to overseas related parties, where:

  • Initial cost contribution of participating parties;
  • On-going cost contribution of participating parties; and
  • Balancing payment.

However, Circular 2 and Announcement 45 do not give detailed provisions regarding the practice of outbound payment in connection with CSA, for instance, as such payment does not fall into the category of service fee or royalties, how shall it be designated and categorized? What documents are required when arranging such payment in addition to those required for general outbound payments? In practice, such issues should be discussed with the in-charge tax authorities and also pending further clarification in future tax regulations and rulings.

Tax implication of CSA

According to Circular 2, the tax treatments for an arm's length CSA are listed as below:

  • Cost contributed by an enterprise shall be deducted before tax in each year specified in CSA; and
  • Where balancing payment is made, the payment shall be included in the taxable income of the year during which such payment is made.

In light of this, cost borne under CSA could be deducted before tax and all the cost contributed shall not constitute royalties or service charge. For the payer of balancing payment, the payment shall be regarded as cost and be deducted before tax; however, for the payee, such payment shall be regarded as income to offset its overpaid cost.

Besides, when implementing CSA, turnover tax, withholding tax or CIT resulted from payment of service fee or royalties by an enterprise shall be exempted.

Key takeaways from Announcement 45

The promulgation of Announcement 45 streamlines the procedure and follow-up administration for CSA, which complies with the "simplified former administration and strengthened follow-up administration" mechanism adopted by tax authorities for tax issues at present:

  • On the one hand, time and administrative costs at early stage can be lowered so that eligible taxpayers could enjoy greater convenience and benefit of tax policy.
  • On the other hand, through strengthened follow-up administration and monitoring, tax authorities will find out historical incompliant tax behavior and carry out retroactive adjustment. Thus, taxpayers will be urged to make greater efforts in managing and mitigating tax risks.

Therefore, Announcement 45 streamlines the procedure while poses opportunities and challenges for taxpayers.

Opportunities

Announcement 45 transforms the "reporting to SAT" mechanism to "filing with local in-charge tax authority" in terms of CSA. Taxpayers can achieve tax optimization and enhance the flexibility of supply chain arrangement through a reasonable CSA in compliance with the arm's length principle. Meanwhile, a compliant CSA not only provides another solution to settle the intractable outbound payment, but also secures stability of tax administration for taxpayers.

Taxpayers are strongly advised to take full advantage of CSA, to seek TP and tax planning opportunities. Chinese taxpayers could actively probe into this opportunity with headquarter or other related parties and reasonably apply CSA to outbound payment model and group supply chain model.

Challenges

Announcement 45 stipulates that tax authorities retain the right to reinforce follow-up investigation and adjustment on contributed costs not in compliance with arm's length principle and cost-benefit matching principle. However, Circular 2 and Announcement 45 lay emphasis on the two principles alone without setting forth detailed implementation and explanations. For instance, what is the pricing of intangible assets in CSA? How to quantify the costs and benefits of the participants? Such problems add to the uncertainty and risks when taxpayers implementing CSA.

How can Grant Thornton help you?

Our seasoned supply chain and TP advisors leverage our in-depth understanding of Chinese tax regulations and over fifteen years' first hand, real world experiences, when tailoring standalone or comprehensive solutions for different businesses under different circumstances.

1. Establishment of CSA

Announcement 45 simplifies former administration of CSA and facilitates enterprises in successfully carrying out their CSA. We can help you with CSA planning, implementation and follow-up management and ensure the smooth establishment and implementation of CSA.

  • Assist taxpayers in establishing proper CSA, including explore its feasibility, identify and strengthen its economic nature, seek a reasonable method and calculation basis for quantifying contribution and benefits;
  • Assist taxpayers in negotiating CSA with tax authorities, participating in technical discussions and negotiations with tax authorities; and
  • Provide guidance and suggestions on implementing CSA and follow-up management for taxpayers.

2. Recommendation and preparation for supporting documents

We can assist you in preparing supporting documents for establishment (or amendment) of CSA, including but not limited to:

  • CSA agreements
  • Other agreements signed by the participating parties for implementing CSA;
  • Documents proving CSA in compliance with the arm's length principle and cost – benefit matching principle; and
  • Contemporaneous documentation of CSA.

3. Assistance in outbound payment procedure under CSA

During the execution of CSA, we anticipate that taxpayers will need to communicate and make explanations with tax authorities when making outbound payments. We are glad to assist you walk through all the outbound payment procedures including preparing supporting documentation per the request of tax authorities, reviewing and submitting CSA, handling the inquiries from the tax authorities /SAFE / banks in terms of outbound payment and other procedures by virtue of our profound understanding of laws and regulations and years of practical experience.

Announcement of the State Administration of Taxation on Standardizing the Administration of Cost Sharing Agreements

Announcement of the State Administration of Taxation [2015] No.45

To implement the Decision of the State Council on Cancelling Items Requiring Non-administrative Approval (Guo Fa [2015] No.27), regulate the administration of cost sharing agreements, according to the Corporate Income Tax Law of the People's Republic of China and the implementation regulations thereof as well as the Law of the People's Republic of China on the Administration of Tax Collection and the implementation rules thereof, the relevant matters are hereby announced as follows:

1. An enterprise shall, within 30 days from the date when a cost sharing agreement among it and its affiliated parties is concluded or amended, submit a copy of the CSA agreement to the local in- charge tax authorities, and also hand in the Enterprise Annual Related Party Transaction Report of People's Republic of China as a appendix while filing the corporate income tax annual return.

2. Tax authorities shall reinforce the follow-up administration of cost sharing agreements and conduct special tax adjustments for cost sharing arrangement that does not follow the arm's length principle and cost-benefit matching principle.

3. During the period when an enterprise implements a cost sharing agreement, the benefit actually shared by a party thereto does not match the cost contributed thereby, the party shall make compensation adjustments in light of facts, otherwise the tax authorities shall conduct special tax adjustments upon investigation.

4. This Announcement comes into force on 16 July 2015, simultaneously repealing Article 69 of the Implementation Measures for Special Tax Adjustments (Trial) (Guo Shui Fa [2009] No.2).

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions