China: Asia Tax Bulletin Summer 2017

Last Updated: 25 July 2017
Article by Pieter de Ridder

OECD Multilateral Convention (MLI)

China signed the MLI on 7 June 2017. It has opted out of the MLI's permanent establishment (PE) provisions concerning (i) artificial avoidance of PE status through commissionaire arrangements and similar strategies; (ii) artificial avoidance of PE status through the specific activity exemptions to their Covered Tax Agreements; and (iii) splitting-up of contracts.

China made the following reservations:

  • Article 3 (Transparent Entities): The PRC reserves the right for the entirety of Article 3 not to apply to its Covered Tax Agreements.
  • Article 9 (Capital Gains from Alienation of Shares or Interests of Entities Deriving their Value Principally from Immovable Property): The PRC reserves the right for Article 9(1)(a) not to apply to its Covered Tax Agreements.
  • Article 10 (Anti-abuse Rule for Permanent Establishments Situated in Third Jurisdictions): The PRC reserves the right for the entirety of Article 10 not to apply to its Covered Tax Agreements.
  • Article 12 (Artificial Avoidance of Permanent Establishment Status through Commissionaire Arrangements and Similar Strategies): The PRC reserves the right for the entirety of Article 12 not to apply to its Covered Tax Agreements.
  • Article 13 (Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemptions): The PRC reserves the right for the entirety of Article 13 not to apply to its Covered Tax Agreements.
  • Article 14 (Splitting-up of Contracts): The PRC reserves the right for the entirety of Article 14 not to apply to its Covered Tax Agreements.
  • Article 15 (Definition ofa Person Closely Related toan Enterprise): The PRC reserves the right for the entirety of Article 15 not to apply to the Covered Tax Agreement to which the reservations described in Article 12(4), Article 13(6)(a) or (c), and Article 14(3)(a) apply.
  • Article 16 (Mutual Agreement Procedure): The PRC reserves therightforthefirstsentence of Article 16(1) not to apply to its Covered Tax Agreements on the basis that it intends to meet the minimum standard for improving dispute resolution under the OECD/G20 BEPS Package.

China made the following notifications:

  • Article 2 (Interpretation of Terms): The PRC lists 102 agreements that it wishes to be covered by the Convention.
  • Article 4 (Dual Resident Entities): The PRC lists the agreements that it considers contain a provision described in Article 4(2) that is not subject to a reservation under Article 4(3)(b) through (d).
  • Article 6 (Purpose of a Covered Tax Agreement): The PRC chooses to apply Article 6(3). Furthermore, the PRC lists the agreements that it considers are not within the scope of a reservation under Article 6(4) and contain preamble language described in Article 6(2). The PRC also lists the agreements it considers do not contain preamble language referring to a desire to develop an economic relationship or to enhance co- operation in tax matters.
  • Article 7 (Prevention of Treaty Abuse): The PRC lists the agreements that it considers are not subject to a reservation under Article 7(15)(b) and contain a provision described in Article 7(2).
  • Article (8) (Dividend Transfer Transactions): The PRC lists the agreements that it considers contain a
  • provision described in Article 8(1) that is not subject to a reservation under Article 8(3)(b).
  • Article 9 (Capital Gains from Alienation of Shares or Interests of Entities Deriving their Value Principally from Immovable Property): The PRC lists the agreements that it considers contain a provision described in Article 9(1).
  • Article 11 (Application of Tax Agreements to Restrict a Party's Right to Tax its Own Residents): The PRC lists
  • the agreements which contain a provision described in Article 11 (2).
  • Article 16 (Mutual Agreement Procedure): The PRC lists the following agreements:
  1. 3 agreements, together with the article and paragraph number, containing a provision that provides thata case referred tointhefirstsentence of Article 16(1) mustbe presented withina specific time period that is shorter than 3 years from the first notification oftheactionresulting in taxation not in accordance with the provisions of the Covered Tax Agreement;
  2. 97 agreements, together with the article and paragraph number, containing a provision that provides thata case referred tointhefirstsentence of Article 16(1) mustbe presented withina specific timeperiodthatis at least 3 years fromthefirst notification oftheactionresulting in taxation notin accordance with the provisions of the Covered Tax Agreement;
  3. 1 agreement that does not contain a provision described in Article 16(4)(b)(i);
  4. 11 agreements that do not contain a provision described in Article 16(4)(b)(ii);
  5. 1 agreement that does not contain a provision described in Article 16(4)(c)(i); and
  6. 4 agreements that do not contain a provision described in Article 16(4)(c)(ii).
  • Article 17 (Corresponding Adjustments): The PRC lists the agreements that it considers contain a provision described in Article 17(2).

Deductibility of provisions for securities industry

On 21 March 2017, the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) jointly issued a notice (Cai Shui [2017] No.23) clarifying the deductibility of provisions for the securities industry. The notice applies from 1 January 2016 to 31 December 2020, and the former notice (Cai Shui [2012] No.11) is annulled.

The Shanghai and Shenzhen Stock Exchanges may form provisions for risks up to 20% of the total handling charges on stock exchange transactions, or 10% of the annual membership fee for enterprise income tax purposes, provided that the net asset value of total funds does not exceed CNY 10 billion.

The Shanghai and Shenzhen branches of the China Securities Depository and Clearing Company may form provisions for security settlement risks for enterprise income tax purposes up to a maximum of 20% of the company's business income, provided that the net asset value of total funds does not exceed CNY 30 billion. Contributions made by securities companies to the same funds are also deductible in accordance with the different ratios and percentages.

Contributions to security investors' protection funds made by the Shanghai and Shenzhen Stock Exchanges are deductible for enterprise income tax purposes up to 20% of stock exchange transaction handling charges, provided that the maximum amount of the provision has not been reached. Securities companies may deduct their contributions to security investors' protection funds within the limit of 0.5% to 5% of business revenue.

The Dalian Commodity Exchange, Zhengzhou Commodity Exchange, China Financial Futures Exchange and Shanghai Futures Exchange may form provisions for risks for enterprise income tax purposes up to 20% of handling charges collected from the members.

In accordance with relevant regulations, futures companies are allowed to make provisions for risks up to 5% of net income, being the balance of transaction handling charges less handling fees payable to futures exchanges.

Payments to guarantee funds made by the Dalian Commodity Exchange, Zhengzhou Commodity Exchange, China Financial Futures Exchange and Shanghai Futures Exchange are deductible for enterprise income tax purposes up to 2% of transaction handling charges (3% if paid before 8 December 2016), provided that the maximum amount of the provision has not been reached. The same applies to contributions to the same funds made by futures companies, the percentages being between 50 and 100 billionth of the transaction amount (between 500 and 1000 billionth if paid before 8 December 2016).

In cases where provisions are liquidated or withdrawn, the amounts which have become available will be subject to enterprise income tax.

Advertisement and business promotion expenses

The Ministry of Finance and the State Administration of Taxation jointly issued a notice on 27 May 2017 (Cai Shui [2017] No. 41) clarifying the deductibility of expenses on advertisement and business promotion. The Notice applies from 1 January 2016 to 31 December 2020.

According to the Notice, advertisement and business promotion expenses incurred by the cosmetic industry (including manufacturing and sales), pharmacy or beverage manufacturing industries are deductible for enterprise income tax purposes, for up to 30% of the revenue of the current year. Any excess may be carried forward and similarly deducted.

In addition, an enterprise that has entered into a cost- sharing agreement on sharing such expenses may choose to claim the deduction (up to 30% of its revenue) for itself or may allocate the expenses, either wholly or partly, over to another associated enterprise which is included in the agreement. The allocated expenses may then be deducted by the associated enterprise on top of its own incurred expenses (up to 30% of its revenue).

The Notice emphasises that the expenses on advertisement and business promotion incurred by the tobacco industry are not deductible in determining taxable income.

Venture capital enterprises

Further to the tax reduction measures announced on 19 April 2017, the Ministry of Finance (MOF) and the State Administration of Taxation (SAT) have jointly issued a notice (Cai Shui [2017] No. 38), dated 28 April 2017, announcing the pilot tax incentives for venture capital enterprises and individual investors investing in technology start-ups or venture investment enterprises. The notice applies from 1 January 2017 in respect of enterprise income tax and from 1 July 2017 in respect of individual income tax.

A venture capital company or cooperative joint venture investment limited company that invests and holds a direct equity investment in qualifying technology start- ups for at least two years will be allowed a tax deduction of 70% of the investment amount from its taxable income once a holding period of two years has expired. If the allowable deduction cannot be fully utilised in a tax year, the balance amount may be carried forward to the following tax years.

The same tax policy applies to individual investors for the purposes of individual income tax.

Qualifying conditions

Technology start-ups:

  • Must be resident enterprises located in China which are assessed on the basis of actual profit (as opposed to deemed profit);
  • Must have fewer than 200 employees (at least 30% of whom must have a university degree). In addition, their assets and annual revenue may not exceed CNY30 million at the time of investment;
  • Must have been in business for more than five years (i.e. 60 months);
  • Are not listed in the year in which the investment is made or in the following two years; and
  • must have incurred at least 20% of total costs and expenses on research and development (R&D).

Venture investment enterprises:

  • Must be resident enterprises located in China which are assessed on the basis of actual profit and may not have set up technology start-ups (as described above);
  • Must register and operate in compliance with the provisions stipulated in the Administrative Measures on Venture Investment Enterprises (Order No. 39 of the Development and Reform Committee);
  • Their associated enterprises may only hold equity interests in technology start-ups which are less than 50% of the share capital of the technology start-ups; and
  • Must be registered in one of the designated areas (see below).

Individual investors:

  • Cannot be founders or employees of technology start- ups as described above. The same restriction applies to family members of individual investors; and
  • Cannot hold more than 50% of the share capital in such start-ups. Also, the technology start-up enterprises must be located in one of the designated areas.

Designated areas

The eight pilot innovation (designated) areas include the Beijing-Tianjin-Hebei region, Shanghai, Guangdong, Sichuan, Wuhan, Xi'an, Shenyang and Suzhou Industrial Park.

Transfer of residential property by individuals

On 17 March 2017, the State Administration of Taxation (SAT) issued a new announcement (SAT Gong Gao [2017] No. 8) clarifying the timing of the transfer of a residential property of an individual in determining the entitlement to the preferential tax policy. The announcementtookeffectas from 1 April 2017.

According to the announcement, if an individual transfers a residential property and fails to obtain a home ownership certificate due topropertyrights disputes orforotherreasons, the effective date ofthe legal documents issued by the People's Court or the Arbitration Commission may be considered the date oftransfer tobe stated intheownership certificate for such property.

Transfer pricing

Courtesy Bloomberg BNA, it was reported on 20 April that China's newtransfer pricing rules, effective May 1, omit a controversial value contribution allocation method (VCM) proposed by the State Administration of Taxation in 2015. China's Bulletin 6, Administration Measures of Special Tax Investigation Adjustments and Mutual Agreement Procedures, issued March 17, retains the five traditional OECD transfer pricingmethods – the comparable uncontrolled price method (CUP), resale- minus method, cost plus method, transactional net margin method(TNMM), and profit-split method.

New VAT rules published

The State Administration of Taxation (SAT) issued an announcement on 20 April 2017 (SAT Gong Gao [2017] No. 11) providing new administrative rules with regard to VAT. All articles of the announcement (except articles 9 and 10) apply from 1 May 2017. Article 9 applies from 1 June 2017, and article 10 applies from 1 July 2017.

According to article 1 of the announcement, a taxpayer's business activities comprising the sale of self-produced goods, machinery and equipment, steel structures and the provision of construction and installation services are not considered mixed sales in the sense of Cai Shui [2016] No. 36; for VAT purposes, sales of goods and the provision of construction services should be calculated separately and taxed at different rates.

According to article 3 of the announcement, SAT Gong Gao [2016] No. 17 will not apply if taxpayers provide construction services across counties (municipalities and districts) belonging to the same tax administrative district.

From 1 June 2017, small taxpayers engaged in the construction industry will be able to issue their own VAT invoices.

From 1 July 2017, general taxpayers are required to register or confirm VATinvoices and motor vehicle sales invoices received on or after 1 July 2017 on the VAT invoice confirmation system within 360 days of issuance.

International Tax Developments

Spain

On 19 May 2017, China and Spain signed a social security agreement.

Netherlands

On 1 September 2017, the China (People's Rep.) - Netherlands Social Security Agreement (2016) will enter into force. The agreement generally applies from 1 September 2017.

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This article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein. Please also read the JSM legal publications Disclaimer.

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