China's New Tax Form Zeroes in on Low-Tax Jurisdictions

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing. 

By Kevin A. Bell

July 20 — New rules requiring Chinese entities of multinational groups to report the effective tax rates of their overseas related parties might cause considerable risk to multinationals operating in China through principals in jurisdictions that offer favorable tax deals, a Shanghai economist said.

Glenn DeSouza, managing director of Transfer Pricing Management Consulting, said some jurisdictions with high headline tax rates offer breaks to major companies in exchange for commitments to provide jobs or other economic benefits. Form 14, included in the tax authority's “Public Notice 42 Regarding Refining the Reporting of Related Party Transactions and Administration of Transfer Pricing Documentation,” will highlight these instances by requiring Chinese companies to report new information on their top five overseas related parties by value of transactions.

China's State Administration of Taxation posted the new guidance—Bulletin [2016] No. 42—on its website July 12. The documentation guidance, an unofficial translation of which appears in the Text section, finalizes one aspect of a discussion draft issued in September 2015 that also covered transfer pricing methods and thin capitalization rules—areas that are expected to be covered in future guidance (25 Transfer Pricing Report 304, 7/14/16).

The SAT for many years has wanted to obtain more information about U.S. group entities in low-tax jurisdictions, such as Singapore, because it believes U.S. multinationals are using transfer pricing rules to shift their profits to these jurisdictions, when in the SAT's view such profits belong in China.

Cheng Chi of KPMG in Shanghai described the information required by Form 14 as including the names of the related parties, their registered and operational addresses, and business activities including industry sector, registered and paid-up capital, effective tax rate, tax incentives received and entity-level financial availability of the related parties in question.

“The availability of this information will facilitate review of material cross-border transactions and make future cross-border exchange of information between national tax authorities more convenient and expedient,” he told Bloomberg BNA July 18.

Jeff Yuan of PricewaterhouseCoopers in Shanghai said it is expected that tax authorities will rely on the new related-party transaction forms “to select the investigation targets by using their big data analytical technology and systems.”

Tax Incentives

DeSouza, whose firm is allied with Baker & McKenzie LLP, said the new overseas related-party information “could cause considerable risk to multinationals who have been using principals located in tax-flexible nations to invest and operate into China.”

He told Bloomberg BNA July 18 that “there are certain jurisdictions which despite their high headline tax rate are willing to cut deals with major companies in the form of tax incentives for commitments to provide a minimum number of jobs or other economic benefits.”

The Shanghai economist said high headline rates have provided cover to multinational corporations, who present them to the Chinese tax authorities when asked about the tax rates where their related parties operate. Form 14 enables the SAT to obtain the relevant information by asking for “eligible tax incentives” and “actual taxes paid,” DeSouza said. Now the SAT will be able to “easily figure out just what effective tax is actually being paid by the related party,” he added.

Raising the Bar

DeSouza also said that while Form 14 will expose low-tax jurisdictions, “this is by no means a reason to avoid investing and using these places.” Rather, “it raises the bar in that the taxpayer now has the onus to demonstrate that the location has compelling commercial benefits that go beyond low taxes such as an excellent treaty network, IP protection, a good legal system, world-class labor supply, central location, port facilities and so forth.”

Operating through a low-tax jurisdiction “is only a problem if tax is the one and only reason the multinational is in that place,” the economist said.

Targeted Review

Mimi Wang of KPMG in Shanghai said the new disclosure forms require taxpayers to disclose the exact subject of the transaction from a specified list prescribed by the SAT.

For example, she said, in reporting transactions involving the transfer of the right to use intangible assets, taxpayers must identify the exact nature of the subject intangible from the following list: patent, unpatented technology, trade secrets, trademark, brand, customer list, sales channels, market research results, franchise, government licences, land use rights, goodwill, copyright and other intangible assets.

This information will assist tax authorities in conducting a more targeted review and investigation of different types of related-party transactions, she said.

To contact the reporter on this story: Kevin A. Bell in Washington at kbell@bna.com

To contact the editor responsible for this story: Molly Moses at mmoses@bna.com

Copyright © 2016 Tax Management Inc. All Rights Reserved.