NOTE FROM THE CHAIRMAN

Transcription

1 NOTE FROM THE CHAIRMAN In This Issue Dear Esteemed Clients, Associates & Friends, As 2014 comes to a close, the world economy continues to offer both challenges and opportunities to businesses and investors. Although a few bright spots do exist, economic performance in most countries has not bounced back to pre-crisis levels. Multinational companies and financial institutions are facing increasing pressures as governments seek methods to eliminate tax loopholes to ensure that profits are not parked offshore. The OECD is releasing its Base Erosion and Profit Shifting recommendations for improvement in both tax collection and communication between countries. All of these activities have the effect of increasing the documentation burden on global businesses, and it also increases the frequency at which companies should analyse their tax positions for both compliance and efficiency. This is also true in China as requirements are similar to other countries around the world. China currently remains as one of the better performing and greater potential economies in the world and thus continues to offer opportunities. While the country s economic performance is mixed (as you will read below), there is reasonable stability in most areas, and the government continues to monitor and intervene as needed. Per capita income, and especially disposable income, continues to climb - thus boosting the growth of the consumer market. The numbers joining the middle class in China is expected to double in the next seven years! This fact alone indicates ongoing opportunities for foreign investors, and this year s numbers indicate that more investors are again entering this market. Utilisation of Foreign Direct Investment (FDI) into China is currently on par with last year, and the number of newly registered companies has increased by over 5% in the first nine months. Outbound investment has increased even more dramatically, up more than 30% over last year. And interestingly, more than half of all overseas M&A activities completed by Chinese investors this year has been completed by privately held companies. This trend is expected to continue. In this edition of our newsletter, we provide a brief summary of ongoing China tax developments that will impact foreign entities doing business there. As always, our Nexia China professionals are ready to provide information or advice to help our clients to navigate China s tax and regulatory environment during the execution of investment or business plans. Wishing everyone a Happy Holiday Season and the best of success in business, Henry Tan, Chairman CHINA ECONOMIC NEWS Economic Indicators Imports and Exports Inbound Foreign Direct Investment (FDI) Outbound Foreign Direct Investment CHINA TAX UPDATES Revised Administrative Measures for VAT Exemption on Exported Services China GAAR, Transfer Pricing and BEPS Draft GAAR Measures Stepped Up Investigations on Royalties and Related Party Services Announcement on Special Tax Adjustment Policies China s Responses to BEPS Actions Listening, Thinking, Growing, Asia.

2 CHINA TAX UPDATES Revised Administrative Measures for VAT Exemption on Exported Services In late August this year, China s State Administration of Taxation ( SAT ) released Notice [2014] 49, Revised Administrative Measures for Exemption of VAT on Cross-border Taxable Services, which took effect on October 1 and clarified many issues related to claiming VAT exemption for services provided by China-based service providers to overseas service recipients. While Notice 49 potentially benefits all China service providers that export their services, the clarifications in the notice should be of special interest to global organisations with entities in China. Many of the previous stumbling blocks in claiming and obtaining VAT exemption have been removed. In keeping with continuing VAT reforms that include an ever-widening range of services subjected to VAT, the measures of Notice 49 provide for a commensurate range of exported services that qualify for VAT exemption. Since the VAT reforms began in 2012, the general service categories added to the VAT system include: Modern services (such as consulting, logistics, IT services, cultural and creative services); leasing of tangible movable property; transportation services; and most recently, postal and telecommunication services. Many of the specific services that fall under these general categories are now included as being eligible for VAT exemption when provided by a China-based provider to an overseas recipient. For some services, the only condition for VAT exemption eligibility is that the service recipient be located outside of Mainland China. In other cases, the subject matter of the service must be located outside of China, such as when leasing tangible property that is used offshore, or when warehousing goods in another country. In still other cases, both the service recipient and the subject of the service must be located outside of China. Note that the determination of eligibility is not made automatically if the correct condition is met for a given service transaction, and other conditions apply as well. For example, VAT exemption is not allowed if there is no written service contract between the provider and recipient (except in the case of postal services). Additionally, payment for the service must come from outside of China, except in the case of multinational companies that make use of domestic cash pooling or other centralised account settlement units. Finally, the China-based service provider must perform a record filing process in which (sometimes considerable) documentation must be submitted as evidence to support VAT exemption. Documentation must be written in Chinese language, or if originally in another language, must be translated into Chinese. As is the case with most taxation matters in China, the nature and extent of required documentation during VAT exemption record filing may differ from one location to the next within the country. However, a general listing of commonly required documents includes: A record filing form; The cross border service contract (Original and copy); Proof that the service recipient, service subject matter, or both are located outside of China (whichever is needed to show exemption eligibility); Invoices and bank statements or receipts indicating payment received from overseas; and Other documents that may be required by the in-charge tax authorities. It is also a widely-accepted practice that the party seeking VAT exemption should provide a written summary statement as to why the service qualifies for the exemption. Furthermore, the filing party should be prepared to provide additional supporting documents, clarify any points raised in the documentation, and to discuss/negotiate with the in-charge tax authorities as needed while the claim is being considered. (Continued on page 3) Listening, Thinking, Growing, Asia. 2

3 The Notice 49 measures will likely be of particular benefit to global or multinational companies that utilise domestic cash pooling or centralised banking units. Prior to this revision of the administrative measures, the service provider and service recipient had to be the named parties on both the service contract and invoice, and the payment had to be made directly by the named service recipient to the named service provider. The revisions in Notice 49 now allow for payments to be made from domestic cash pooling units or centralised accounts, regardless of the parties named in other documentation. As mentioned above, the revised administrative measures outlined in Notice 49 bring VAT exemption policies up-to-date with the current state of VAT reforms in China. Additionally, some simplification and flexibility has been brought into the system. However, as local in-charge tax bureaus are left to interpret and apply taxation regulations according to their local practices, inconsistencies will no doubt remain in the system. In some cases, tax officials may broadly interpret VAT exemption eligibility, while in other cases, tax official interpretations may be narrow to point of excluding eligibility where these administrative rules would otherwise allow it. It is therefore imperative that claim filers understand the exemption rules and practices and seek the assistance of tax professionals as needed. China GAAR, Transfer Pricing and BEPS Since the enactment of the 2008 Enterprise Income Tax Law ( EITL ), China s State Administration of Taxation ( SAT ) has increasingly focused attention toward the detection and investigation of global company tax practices that are intended to avoid taxation in the country. In this vain, SAT has continued to upgrade its General Anti-tax Avoidance Regulations ( GAAR ) and other related regulations, such as the infamous Circular 698, which is designed to potentially collect taxes when offshore entities indirectly dispose of an invested entity in China. SAT has also continued to upgrade its Transfer Pricing monitoring practices, including triggers for investigations and tax adjustments. China has also contributed heavily to the OECD Base Erosion and Profit Shifting ( BEPS ) initiative, thereby influencing several of the action plans that have been published since September of this year. Draft GAAR Measures Although a final draft has not yet been implemented, China s SAT has made reasonably clear its intentions with respect to GAAR. On July 3, 2014, SAT released a discussion draft of a new set of GAAR measures, giving interested parties a one-month opportunity to comment before a final version is written and released. Although the GAAR provisions of the EITL indicated no enforcement preference with respect to domestic or cross-border arrangements, the July draft measures illuminate the SAT s focus of GAAR enforcement only on cross-border arrangements. The draft measures instruct tax authorities to examine both the purpose and substance of a given tax arrangement in assessing whether or not to apply GAAR. If determined that a tax avoidance scheme is in place, in which there is a tax benefit but no reasonable commercial purpose for the arrangement, the case would be subject to adjustment under GAAR. A tax avoidance scheme would be any arrangement that has the sole, main or partial purpose to obtain tax benefit, and which is legal in form but has a form that is inconsistent with the commercial substance. In addition to providing detailed GAAR implementation procedures, the draft measures also indicate that other tax administrative avenues, such as transfer pricing and thin capitalisation rules or the provisions of tax treaties, should be exhausted before triggering GAAR procedures. Stepped Up Investigations on Royalties and Related Party Services On the heels of this July draft, the SAT instructed local in-charge tax bureaus throughout China to examine the cross-border royalty payments and service fees that companies within their jurisdictions have made to related parties in the last ten years (within the statute of limitations for transfer pricing related tax adjustments). The local tax bureaus were instructed not only to report the findings to SAT, but also to register formal transfer pricing audits of any companies found to have suspicious service and/or royalty transactions. Presumably, the transfer pricing audits would result in tax adjustments. In keeping with China SAT s practices of the last several years, tax officials are paying particular attention to royalty payments that are made to any entity in a tax haven jurisdiction, or royalties paid to a related party that is perceived to have little or no commercial substance. Furthermore, royalty payments are suspect if the China based payer is perceived to have contributed to the value of the intangible for which payment is made, and in cases where tax authorities deem that the intangible offers little or no value to the payer s business. (Continued on page 4) Listening, Thinking, Growing, Asia. 3

4 With regards to related party services fees, suspect services include any service related to shareholder activities and/or the supervisory functions of the group headquarters. Other suspect transactions include those in which the service appears to be irrelevant to the recipient s business scope or function and risk, or those in which redundant payments appear to be hidden in other transactions. Announcement on Special Tax Adjustment Policies Following these orders from SAT to the local tax bureaus, SAT released Announcement [2014] 54, Issues Related to the Monitoring and Management of Special Tax Adjustments, which took effect on August 29, The announcement covers three administrative principles that shall be used in cases where suspect transaction practices or tax positions are detected in a company s tax declarations, transfer pricing documentation, or other documentation. The first point in the announcement instructs tax bureaus to immediately serve a Notice of Special Tax Adjustment Risk to a taxpayer as soon as tax officials observe through their monitoring that such risk is present. The taxpayer then will have 20 days to submit related data or documentation. During this period, the taxpayer shall also perform a self-evaluation of its transfer pricing practices or other practice that triggered the Notice, and may elect to perform a tax self-adjustment and pay the additional tax for the period in question. In the event that no self-adjustment is made and the taxpayer requests the tax officials to verify or validate the taxpayer s practices, the tax officials shall initiate formal procedures for a special tax investigation. The second point makes it clear that even if the taxpayer elects to make a self-adjustment and tax payment, the tax bureau can still initiate a special tax investigation and make further adjustments if deemed necessary. Of some benefit to the taxpayer, the third clause of the announcement allows that if the taxpayer submits its documentation within the 20 day period and also makes a tax self-adjustment and payment, interest will not be charged on the adjusted amount of tax (which would ordinarily be considered a late payment subject to interest penalties). China s Responses to BEPS Actions In September of this year, the OECD released reports covering seven of the fifteen actions that were identified in the OECD July 2013 Action Plan on Base Erosion and Profit Shifting. The September 2014 reports include recommendations to amend laws and tax treaties as related to: Tax challenges of the digital economy; problems of hybrid mismatches; transparency and substance issues; tax treaty abuse practices; transfer pricing of intangibles; country-by-country reporting and transfer pricing documentation; and modification of bilateral tax treaties. China s SAT offered considerable input in the development of these OECD recommendations. Based on comments the agency posted on its website when posting the Chinese translations of the OECD reports, SAT s position on several of the actions can be inferred. Certainly, the SAT is pleased to see the proposals with respect to transfer pricing of intangibles. China has been pushing for acceptance of its practice of recognising location specific advantages in comparables analysis, a practice featured in the new OECD guidance. Additionally, the OECD s downplay of intangibles ownership and funding in the allocation of group profits in favor of use, function and risks is consistent with the SAT s approach in transfer pricing matters. Finally, the OECD report supports China SAT s increasing preference to utilise profit split pricing methods rather than net margin methods. The support is not only evidenced in the intangibles transfer pricing proposals, but is also seen in the OECD recommendation to utilise country-bycountry reporting in transfer pricing documentation, which China s SAT has also strongly advocated and already put into practice. Take-away Lesson Global companies with invested entities in China, and Chinese entities that invest in companies overseas, both must continually assess their transfer pricing practices and overall tax positions. China s SAT, with increasing support from the OECD, favors a substance and function (over form) approach when evaluating related party transactions and the profits allocated to China entities. Payments made by China entities for services and royalties are increasingly scrutinised and tax deductibility is more frequently denied. This is especially true where the payments are made to offshore entities that lack commercial substance, but also more and more frequently occurs in cases where payments are made for services that are easily performed by (or obtainable by) the China entity, or where the service or intangible are not considered as being relevant to the China entity s business. Global companies can no longer consider a we have always done it this way approach to their tax positions in China. China s SAT is rapidly maturing, as is the overall economy. There are many beneficial reasons for doing business in China, and it is likely that the ever-growing market is chief among them. Avoiding tax is no longer a workable reason. Listening, Thinking, Growing, Asia. 4

5 12) Develop the commodities futures market; allow use of derivatives for hedging against risk, introduce futures varieties for bulk resource products, development commodity options, commodity indexes, carbon emission permits and other trading instruments; CHINA ECONOMY AND FDI UPDATES Economic Indicators So far, 2014 brings mixed performance to China s economy. While a bit below the general target of 7.5%, the 3rd quarter s 7.3% GDP growth rate remains within what policy-makers call an acceptable range to keep the economy moving forward. The drop from Q1 and Q2 is seen as consistent with the 10.8% fall in residential property sales and the 8.9% drop in overall property sales. Government economists expect the property sector to pick up during Q4, and this increase, combined with the current annualised industrial output growth of 8% and a growth trend in emerging industries, should bring Q4 s GDP growth rate back to 7.4% or 7.5%. Worldwide, not all economists agree. Some predict GDP growth as low as 6.9% for the year. Even as industrial output growth increased to 8% in September from August s 6.9%, the manufacturing PMI continues to fall. October s PMI fell to 50.8 from September s 51.1, the lowest value in five months. China is still experiencing an imbalance in the performance of larger manufacturers versus smaller ones. Broken down by size, large manufacturer s PMI posted an expansive 51.9 in October, while medium and small manufacturers respectively posted 49.1 and 48, indicating contraction for these producers. Pro-growth measures taken by the government during Q3 are expected to slow and even reverse any trend of falling manufacturing PMI. Meanwhile, the services sector remains in an expansive mode, even though the non-manufacturing PMI fell from 54.4 in August to 54.0 in September. Service businesses continue to add new order bookings and have also continued to add new jobs for the thirteenth straight month. China s current unemployment rate is 4.1%, but million new jobs have been added in the country in the first nine months of the year, well over the 10 million job target that was in place for the entire year. Officials continue to focus on improving supportive policies, stepping up vocational training and enhancing services in order to ensure that any gap between labor supply and demand does not widen. There is generally good news for both workers and the companies that sell goods and services in China s growing market. The 2014 disposable income is up 7.7% in cities and up 9.8% in rural areas, which translates to consumer spending increases of 12.2% in cities and 13.9% in the countryside. Current estimates indicate China s middle class (those with incomes above USD $9000 / year) is currently about 300 million strong. This number is expected to double in the next seven years. (Continued on page 6 ) Listening, Thinking, Growing, Asia. 5

6 Imports and Exports According to China s Customs Bureau statistics, the total value of imports and exports from January to September 2014 grew by 3.3% over the same period last year to just over USD $3.16 trillion. Import and export by foreign-invested enterprises totaled about USD $1.45 trillion, accounting for 45.8% of the national total. Breaking out the imports, China imported about USD $1.47 trillion worth of goods during the first nine months of the year, up only 1.3% over the same period last year. Foreign-invested enterprises accounted for USD $673 billion, or 45.9%, of the imports into the country, up by 4.6% year on year. During this same period, the value of goods exported from China reached nearly USD $1.7 trillion, a 5.1% increase over last year. Of this, foreign-invested enterprises accounted for US$ 776 billion, or 45.7% of the total, up by 2.2% year on year. Inbound Foreign Direct Investment (FDI) According to the Foreign Investment Department of the Ministry of Commerce, the first nine months of 2014 saw a 5.5% year on year increase in the number of newly registered Foreign-Invested Enterprises, reaching 17,247. The actual use of foreign investment in China during this period from January through September reached about USD $87.4 billion, down 1.4% from the same period last year. This may indicate that this year s relaxation of minimum registered capital requirements for many business types is having some effect on the amount of inbound FDI. The Wholly Foreign Owned Enterprise (WFOE) continues to be the most popular method of FDI into China, accounting for nearly 80% of new registrations and an utilised FDI increase of 2.4% over the first nine months of The number of Equity Joint Ventures (EJVs) has increased by nearly 10% over last year, but FDI utilisation by EJVs has dropped by 13%. Meanwhile, the number of Contractual Joint Ventures (CJVs) has dropped off from last year by just over 20%, with a commensurate drop of 27% in utilised FDI. The overall decrease in foreign capital injected into China, even as the number of new registrations continues to grow, is consistent with the trend that the majority of newly registered foreign invested enterprises are entering the services sector of the economy, where in general, less startup capital is needed. Outbound Foreign Direct investment The period from January through September of 2014 has seen a 21.6% year on year increase in China s outbound investment into other countries and regions, with the value of the investments reaching USD $74.96 billion. During this period, Chinese enterprises have completed a record 176 mergers and acquisitions, up 31% over the same period last year. More than half of the M&A activity has been completed by privately held enterprises, up 120% over last year, while M&A activity by state-owned enterprises is down by 37%. The Chinese government has been relaxing policies in order to promote more M&A activity, and the efforts appear to be paying off. It is expected that China s outbound FDI will continue to grow by at least 10% per year. Certainly at this rate, it will not be long until the Chinese outbound FDI exceeds the inbound. Articles contributed by: Henry Tan; Nexia TS Flora Luo; Nexia TS (Shanghai) Scott Heidecke; Nexia TS (Shanghai) Disclaimer: By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication. Listening, Thinking, Growing, Asia. 6

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