Substantial increases in tax disclosures will provide a road map for China’s SAT
China’s State Administration of Taxation (“SAT”) recently announced a major initiative to collect global tax information from multinationals to challenge 15 “unacceptable tax practices.” The new General Anti-Avoidance Rule (GAAR) Circular No. 32 published on December 12, 2014 signals an accelerated timetable to crackdown on profit shifting through transfer pricing.
Multinational companies of all sizes need to be aware of the SAT’s plans for increased scrutiny, as the SAT has a particular focus on capturing more corporate income tax in China. To facilitate this initiative, China plans to institute requirements for country-by-country reporting where Chinese and foreign multinationals will need to disclose income taxes paid in every country where they operate to the SAT.
Multinational Tax Matters High on China Leaders’ Agenda
“Efforts should be made to reinforce the international collaboration on tax matters, to crack down on cross-border tax avoidance and evasion.”
– China President Xi Jinping at the 9th G20 Leaders’ Summit, November 2014
According to the SAT, President Xi’s comments were the first time tax matters have been included in a high-profile international speech by a Chinese president. China’s SAT has responded by issuing a detailed set of coordinated guidelines for challenging tax avoidance arrangements.
What Issues Are Under Scrutiny?
The GAAR Circular finalizes certain procedural guidelines for taxpayers and enforcement priorities for tax authorities. Specifically, the Circular aims to contest transactions (a) where the main benefit is to realize a tax benefit or (b) do not have economic substance.
China’s 15 ‘Unacceptable Tax Practices’
- Base erosion and profit shifting
- Failure to respect specific qualities of Chinese market (expectations for higher profits based upon access to Chinese customers)
- Aggressive tax planning
- Low return of high-technology enterprises (companies benefitting from the preferential high technology tax rate are expected to earn higher profits)
- Hybrids for tax avoidance
- Unreasonable expense deductions (e.g., excessive service charges)
- Return unmatched with the functions and value contributions (lower than expected profits for functions performed in China)
- Abusive use of tax treaties
- Arrangements without substantive economic activities
- Non-cooperation in submitting documentation
- Foreign losses shifted to China (e.g., Chinese subsidiaries that regularly incur losses)
- Double or multiple non-taxation
- Losses incurred by single-function enterprises (distributors or contact manufacturers)
- Non-transparent tax system
- Unreasonably high pricing of intangibles (royalties)
What Can Companies Do?
For many multinationals, many of the 15 Unacceptable Tax Practices relate to profit margins earned by Chinese subsidiaries of foreign-parent companies. The SAT is convinced that multinationals are utilizing the intercompany prices of goods, services, royalties and other transactions to undercompensate their Chinese affiliates.
In our experience, many multinationals rely on a transfer pricing policy without necessarily revisiting the end results for reasonableness. Other companies rely on outdated transfer pricing reports or analyses. In both cases, the SAT is now better positioned to challenge the standard way of doing things.
Since Chinese tax authorities will have new tools to audit companies, now is an ideal time to revisit a company’s transfer pricing approach from both a Chinese and overseas tax authority perspective. Bottom line, China is introducing more aggressive tax audit processes to claim a greater share from companies with operations in China.