May 2009, Issue 13 Observation on China's thin capitalisation rules for banks operating in China The China's new Corporate Income Tax ("CIT") Law has introduced the concept of thin capitalisation. The deduction of interest expenses is not allowed when the ratio of debt to equity from related parties exceeds a certain prescribed debt/equity ratio as stipulated in Caishui [2008] no.121 ("Circular 121").
Most overseas banking groups operating in China are now aware of their obligation to apply transfer pricing principles to their related party transactions, to file the nine related party transaction forms with their annual CIT returns, and to compile transfer pricing documentation unless exempted. However, we note that many of them may not have given enough consideration to the thin capitalisation rules incorporated into the CIT law and the subsequent implementation notices, or to the tax authorities' plans to enforce these rules.
This Issue of News Flash is designed to highlight the key aspects of the thin capitalisation rules and to share the likely approach of Chinese local-level tax bureaus to investigate the thin capitalisation issues of taxpayers.
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