China's SAT issues regulations on outbound service payments as part of crackdown on tax evasion

This article first appeared in Transfer Pricing Week, a sister publication of China Law & Practice


On March 18, the SAT issued a notice, in accordance with China's Enterprise Income Tax law, which is intended to further regulate and strengthen the transfer pricing management of fees paid by companies to offshore related parties.

The details

The notice said:

• Any company paying fees to offshore related parties, should follow the arm's-length principle. If the payment of fees to offshore related parties does not follow the arm's-length principle, the tax authority may make an adjustment accordingly;
• When a company pays fees to offshore related parties, the tax authority in charge may request that the enterprise provide the contract or agreement between the company and the aforementioned related party, and record all documents proving that the transaction occurred and followed the arm's-length principle;
• When a company makes a payment for services provided by an offshore related party, such services should allow the company to directly or indirectly receive economic benefit; and
• When a company needs to pay royalties for the use of intangible property (IP) rom an offshore related party, the company should consider the degree of contribution in value creation towards the IP by all related parties, and determine the economic benefit for all parties.

Transactions no longer eligible for tax deductions

(a) Services that are unrelated to the functions performed and risks assumed by a company or services that are unrelated to the operations of a company;

(b) Services provided by a related party that exercises control, management and supervision over a company in order to safeguard the investment interests of the investors who have directly or indirectly invested in that company;

(c) Services provided by a related party to a company who have already purchased the services from a third party or have already performed the services itself;

(d) Services that have already been compensated as part of other related transactions; and

(e) Any other services that are unable to directly or indirectly bring economic benefit to a company.

“The definitions [for non-deductible charges] provided in the announcement, in some instances, could be subject to interpretation,” said Joanne Su of EY. “This puts more responsibility on taxpayers to document the facts and circumstances of each case, and provide relevant evidence when possible.”

For companies who make offshore payments to related parties that do not follow the arm's-length principle, the tax authorities may make special tax adjustments within 10 years from the assessable year in which the service was provided.

“With more stringent provisions under the new announcement, it becomes more important to ensure that the local Chinese subsidiaries of MNCs have ready documentation in hand, on a transactional level, to support the economic substance behind affected related party transactions,” said Su.

Aggressive tax climate

The new regulations come as no surprise following a string of announcements by the SAT regarding profit shifting and tax evasion.

In July 2014, SAT issued Circular 146 on assessing cross-border transactions. The circular challenged the impact of OECD guidelines and called for local authorities to begin reviewing and assessing taxpayers' positions on cross-border service fees and royalties paid to overseas related parties.

In February 2015, SAT introduced more aggressive and extensive general anti avoidance rule (GAAR) measures.

China's first major tax evasion case, involving a US based multinational, is also likely to have intensified the SAT's focus on transfer pricing. Xinhua News Agency reported that the multinational was ordered to hand over almost 840 million yuan ($137 million) in back taxes.

The SAT has been aggressive from the get go and is unlikely to change its approach anytime soon.

Taxpayer fears

While China's hostile tax environment is already a worry for taxpayers, there are also fears that China lacks the personnel and expertise to deal with such complex cases.

Transfer pricing issues are complicated at the best of times and challenge many an expert.

With the potential for bias on behalf of the SAT, as well as a lack of expertise, transfer pricing in China is becoming less and less desirable for multinationals.


By Sophie Harding, Transfer Pricing Week