Transfer pricing filing deadlines imminent in China 

As the filing deadlines for the first year of China's Corporate Income Tax ("CIT") returns under the new CIT law draw closer, goal posts have been shifted as some of the district tax authorities have changed the filing deadline dates in their jurisdiction.  While the initial filing deadline for 2008 was 31 May 2009, some deadlines have been moved to as early as 20 April 2009 and others as late as 9 June 2009.  This means that for some taxpayers a deadline that was 6 weeks away is now very close.
    
The deadlines for major cities are listed below.  In our discussions with tax bureaus in Beijing, we have been advised that tax officials recommend taxpayers file their returns ahead of the tax filing dates, particularly if the filing date is a weekend.  Tax officials also highlighted that no revisions can be made to returns after the due date.
  
In addition, new deadlines are being continuously released and taxpayers are advised to stay in contact directly with their in-charge tax bureau or with their tax advisers to stay abreast of any changes that may apply to them.
   

1. Related party transactions disclosure forms ("RPT Forms")
2. Voluntary special tax adjustment
3. Thin capitalisation analysis

Issues
  
1. RPT Forms
    
In December 2008 China's State Administration of Taxation ("SAT") released the final version of the RPT forms under Guo Shui Fa [2008] No. 114.  These forms are required to be included with the CIT return under the circular entitled Guo Shui Fa [2009] No. 2, which contains the Implementation Measures of Special Tax Adjustments (Trial) ("The Measures").  Please refer to our earlier China Tax News (Jan 2009, Issue 1) for a summary of China's newly issued transfer pricing and other special tax adjustments.
    
The RPT Forms place a significant information disclosure burden on taxpayers, as there are nine different forms that need to be completed.  The forms are quite cumbersome and require large amounts of information to be provided precisely in the manner prescribed by the SAT.  The forms may require significant amounts of time to comprehend, collate and complete.  In addition, certain sections of the RPT Forms can be confusing with not much clarification provided in the Measures.  In these instances taxpayers are advised to take a reasonable and commercial approach in interpreting the forms in the absence of any guidance from the SAT.  We strongly advise that disclosures made in the RPT Forms should be supported and closely correlated with the taxpayer's CIT return, its contemporaneous transfer pricing documentation ("CTPD"), audited financial statements and information filed by taxpayers' other related parties in China.
   
The due date for filing CTPD has been extended for 2008 to 31 December 2009.  However, some of the analytical work to be included in the CTPD should ideally be at least partially completed by the CIT filing deadline to ensure consistency between the two.  At a recent seminar, the SAT warned that they plan to select transfer pricing audit targets in 2010 based on the 2008 RPT Forms information.
   
Experience to date suggests that while initially many taxpayers were confident in their ability to complete the RPT Forms themselves, we have started fielding an increasing number of questions from taxpayers encountering complexities.  Therefore it may be prudent to seek guidance and have the RPT Forms reviewed by your transfer pricing advisers, particularly in the first year of the Measures being implemented.
     
2. Voluntary special tax adjustment
    
As part of the new CIT law, taxpayers may make a voluntary "special tax adjustment" as part of their CIT return.  This allows enterprises to make upward adjustments (only) to their taxable income.
   
With CIT filing deadlines imminent, taxpayers should carefully consider this opportunity to initiate a voluntary upward taxable income adjustment.  An adjustment may save a taxpayer the "financial" element of the special interest levy (which would be imposed on an under payment of tax arising from a transfer pricing adjustment) and could mitigate their transfer pricing audit risks.  However, taxpayers should consider this adjustment in light of their overall transfer pricing profile.  This relates to the functional and economic analyses performed as part of their CTPD and the extent to which the level of profit (or loss) can be supported and substantiated as being at arm's length.
    
We do not consider that taxpayers should "rush" to make such an adjustment and we do not consider that many will choose this option.  However, if taxpayers would like to make such an adjustment, they need to do this within their CIT return and thus the option must be assessed and a decision made by the filing deadline at the latest.
    
3. Thin capitalisation
   
Please refer to our earlier China Tax News (Oct 2008, Issue 10) on thin capitalisation ratios.
   
In October 2008, the Ministry of Finance and the SAT jointly issued the circular, Cai Shui [2008] No 121("Circular 121"), which set out the prescribed debt to equity ratios as 2:1 for non financial enterprises and 5:1 for financial enterprises.  Circular 121 emphasised that "interest deductions" from related party financing in excess of the prescribed ratios may be deductible if 

1. the taxpayer can provide documentation supporting the higher debt to equity ratio complies with the arms' length principle; or
2. the effective tax rate of the borrowing enterprise is not higher than that of the domestic lending enterprise.

The RPT Forms include a specific form requiring taxpayers to calculate their debt to equity ratios on related party debt.  If a taxpayer has taken interest deductions in excess of the prescribed ratios, the taxpayer must be able to show that the higher debt to equity ratio is arms' length in nature and document this through specific thin capitalisation contemporaneous documentation.  We recommend this documentation be prepared prior to filing the CIT return as the Measures do not provide an extended deadline for thin capitalisation contemporaneous documentation.  Taxpayers could receive a request from their in-charge bureau requesting such documentation soon after the CIT filing deadline.
  
Thin capitalisation is a new concept for many taxpayers in China.  Our long standing overseas and recent China experience in this area shows us that thin capitalisation issues are different in nature and require special techniques to be applied including specific economic analysis.  Taxpayers are advised to seek advice from experts in this field to ensure they are in compliance.
  
Penalties
    
The financial penalties for filing a late CIT return are relatively modest in nature, ranging from RMB2,000 - 50,000.  However, the implication of being a late taxpayer may taint the taxpayer's relationship with its in-charge tax bureau and damage the taxpayer's reputation and standing.  This may then be one of the many elements tax officials consider when determining whether an enterprise should come under audit and have its taxable income deemed.
  
Conclusion
     
In conclusion, taxpayers with related party transactions are strongly advised to

• file their CIT returns on time;
• file their RPT Forms (together with their CIT return) on time;
• ensure the RPT Forms are consistent with their CIT return, CTPD, audited financial statements and the information filed by their related parties in China;
• consider and assess the reasons for relative poor financial performance (including losses) and if considered appropriate make a voluntary special tax adjustment on their CIT return; and
• assuming that the tax rate differential exemption does not apply, ensure any interest deductions in connection with debt which is in excess of one of the prescribed limits are supported by thin capitalisation contemporaneous documentation and that this documentation is prepared prior to filing the CIT return.

As the filing deadlines are almost upon us, if you have not done anything to date in relation to the RPT Forms (and associated issues), you really must assess your position and make necessary arrangements to put yourself in the best position.