China Tax/Business News Flash 

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Please click on the links below to view more:   Enterprises in China Now Face Greater Risks of Triple Taxation    In order to enhance the PRC tax authorities administration work on the taxation of related party transactions, the State Administration of Taxation ("SAT") has recently issued Guo Shui Han [2006] 901 ("Circular 901") on 28 September 2006.    In accordance with Circular 901, the amount earned by a related party in excess of what would have been earned by an unrelated party is considered to be dividend if the enterprise does not make appropriate accounting adjustments after transfer pricing tax adjustments.  Such "deemed dividend" does not qualify for the exemption from the withholding income tax under Article 19 of the Income Tax Law of the PRC for Enterprises with Foreign Investment and Foreign Enterprises.   Read more...... Expand / Collapse Circular 901 also stipulates that where payment of interest, rental or royalties to related parties was disallowed as a transfer pricing adjustment, no adjustment (refund) of the withholding income tax on the excessive payment should be made.    Actually, the principle cited in Circular 901 echoes previous old circulars such as Guo Shui Fa [1992] 237 and Guo Shui Fa [1998] 59 both of which carry similar wording in this regard.  However, as it was not consistently enforced by local tax authorities and was not restated in a subsequently issued circular - Guo Shui Fa [2004] 143, it was unclear whether such "deemed dividend" treatment remained effective.  Circular 901 may, nevertheless, indicate that SAT intends to monitor and enforce such "deemed dividend" treatment going forward.    We understand that foreign investment enterprises rarely perform post-audit accounting adjustments, PRC transfer pricing risks may become more significant as enterprises now face double or even triple taxation in some cases.   Close China Transfer Pricing - Insiders' Views On 21 and 22 October, Transfer Pricing Service team of PricewaterhouseCoopers was invited by SAT to attend and speak at a transfer pricing conference.  Tax officials from provincial and city level tax bureaux and representatives from some multinational corporations and tax consultants also attended this conference.    During the conference, SAT advised the following developments relating to transfer pricing enforcement in China.    Read more...... Expand / Collapse Transfer pricing documentation requirements - SAT confirmed that the transfer pricing documentation requirements are at the final stage of review and approval.  It will be very likely released within this year.    Centralised enforcement approach - SAT also confirmed that to ensure quality enforcement and consistent approach in transfer pricing audits, establishment and settlement of audit cases must be monitored and approved by SAT.     Transfer pricing audit focus in coming years - SAT suggested that they are strengthening the capability of their tax audit teams and are looking for more substantial transfer pricing adjustments.  The officials also advised that royalties and inter-company service transactions will be their focus in coming years.  They articulated that some companies only earning a net profit of 1-2% of sales could pay royalties of 6-7% on sales.  Moreover, based on their investigations, some companies are paying unreasonable service fees to overseas affiliates.  SAT considers these as unreasonable tax avoidance measures to reduce companies' tax liabilities in China.     Specific penalties and surcharges - The officials are considering imposing specific penalties and surcharges on transfer pricing adjustments.     Advance Pricing Arrangements ("APA") - The tax authorities is open to and welcome APA as a tool to reduce the China transfer pricing risk and international double taxation risk.  However, at the same time, SAT will handle the APA application in a very cautious manner to ensure that the Chinese tax base will not be eroded.    Use of comparables - The tax authorities stressed that China will not give up the use of "secret comparables".  They stressed that a lot of other countries also allow the use of secret comparables.  That said, SAT confirmed that in all bilateral APAs and competent authority cases, public comparable sets are used.  The officials also confirmed that they are considering acquiring another database from Standard & Poor's to improve their benchmarking capability.  Currently, SAT can obtain comparables from (a) internal foreign investment enterprise financial statement database, (b) import and export price database from Customs Office, (c) database from the Statistics Bureau and (d) Bureau van Dijk database.     Proposed tax reform on transfer pricing regulations - SAT is in the process of drafting the regulations on (1) general anti-tax avoidance provision, (2) "thin capitalisation", (3) "controlled foreign company", (4) "deemed profit" provision if in insufficient information is provided, etc.     Close

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