Improving the Administration of Bilateral Advance Pricing. Arrangements in China

Transcription

1 Improving the Administration of Bilateral Advance Pricing Arrangements in China Hui Zhang 1 Abstract- This paper examines the prospects for using bilateral advance pricing arrangements (bilateral APA) as a tool of preventing double taxation in China. Comparing international experience and reviewing the development of bilateral APAs in China, the paper finds that the reason China has fewer than other countries, and what can be done to improve the administration of bilateral APAs so bilateral APAs can be promoted. Keywords: administration, bilateral advance pricing arrangements, China Hui Zhang Graduate School of Business and Commerce, Keio University huizizhanghui@gmail.com 1 I am grateful to Akihide Maeda and Rick Krever for very helpful comments. 1

2 1. Introduction There are an increasing number of multinational enterprises participating in the booming economy in China (Figure 1). Accordingly, the amount and complexity of intercompany transactions with Chinese affiliates has increased. These companies seek a level of certainty for the tax consequences of these cross-border transactions. Figure 1 Registration Status of Foreign Funded Enterprises ( ) Unit Year million USD Number of enterprises(unit) Total investment(100 million USD) Source: National Bureau of Statistics of China There are two reasons for this. First, they want to avoid long and costly tax disputes over tax years that prevent them from finalizing their accounts and determining available profits. Second, they need to know in advance of a large transaction what the tax cost will be so they can plan their investments with certainty about the after-tax rate of return. If this is not possible, there may be less quality investment and both the companies suffer and China misses some possible valuable investments. Tax authorities also have an interest in avoiding long disputes and knowing with certainty how much tax they should collect from a taxpayer. 2

3 Two possible problems arise with a cross-border transaction with a related company. The first is this problem of uncertainty of the tax that is payable in each country. The second is the risk that the two tax authorities will choose different transfer prices for the sale of goods or services and the related taxpayers will face double taxation. This could happen if one country says the sale price is lower than the one chosen by the taxpayer and the other country uses a higher price. To achieve certainty of tax treatment and to resolve real or potential transfer pricing disputes before they arise, companies may seek an advance pricing agreement (APA) with their host tax authority. However, to achieve the highest level of certainty, they will want to enter into a bilateral APA. This is the most desirable result from the company s viewpoint because it provides the certainty of an APA and it prevents double taxation by ensuring the same agreed prices will be used in both countries for a cross-border transaction. It is desirable from the view of the two tax authorities because the companies will be forced to provide direct to the tax authorities all the information needed to determine the correct transfer price. In last two decades, unilateral APAs and increasingly bilateral APAs have been used worldwide to give businesses an opportunity to reach an agreement with the tax administrations on either side of a cross-border transaction about a fair principle to allocate income and expenses between related parties. Bilateral APAs were introduced in China in 1998 after the Chinese tax office, known as the State Administration of Taxation (SAT), issued a series of irregular circulars. These are rulings created by the tax authority that have force like a law. Because they were issued as an inconsistent series of separate rulings, the circulars did not provide a full guide for bilateral APA procedures. In 2004, they were largely replaced with a much more detailed set of rules. 3

4 The rules explaining how unilateral APAs and bilateral APAs operate have been improved again and now have their own chapter in a new issued tax law Implementation Measures of Special Tax Adjustment (which was issued in January 2009). The theory and experience of the last decades practice in other countries has shown that a concluded bilateral APA may resolve uncertainty of business dealings and benefit both tax payers and tax authorities. It is clear that more use of bilateral APAs is important to the development of international transactions and cross-border investment. It is in China s interest to make it easier for companies to have bilateral APAs with Chinese and foreign tax authorities and to encourage more use of these agreements. But as is explained further below, China lags well behind other countries in the number of bilateral APAs it has and much work is needed to catch up. China has far fewer bilateral APAs than other countries with large economies and many cross-border transactions. This paper looks at the development of bilateral APAs in China, the reason China has fewer than other countries, and what can be done to improve the administration of bilateral APAs so bilateral APAs can be promoted. The paper is arranged as following. Second part, overview of Advance pricing arrangement, which follows this Introduction, provides an overview of the APA system and describes the introduction of the bilateral APA system in China as well as the legal basis in China for bilateral APAs. The third part, comparison of administration in China and other countries, will compare the administration practices in China and other countries. Recommendations in part four for improvement of the Chinese bilateral APA administration based on the previous elaboration will be given in the fourth part to improve bilateral APAs in China. 4

5 2. Overview of Advance pricing arrangement (APAs) 2.1 Brief Introduction to APAs An APA is intended to resolve transfer pricing issues before they arise. An APA is an agreement between a taxpayer and the competent authorities in advance of the taxpayer transactions, in which the parties set forth the best transfer pricing method to use for purposes of calculating and allocating the taxable income which arises as a result of the specified transactions. An APA helps ensure that the taxpayer satisfies the requirements of the competent authority. Meanwhile, an APA formalizes an agreement to the facts surrounding the transactions to which it will apply, the transfer pricing method, the taxable years to which the APA will apply, and an arm s-length range of results. There are two types of APA: a unilateral APA and a bilateral or multilateral APA. A unilateral APA involves an agreement only between the tax administration of one country and a tax payer. In a bilateral or multilateral APA, an agreement is reached between related taxpayers in two or more countries and the tax administrations of those countries. APAs, especially bilateral APAs, were introduced and have been welcomed worldwide since 1980s with the booming of multinational companies because of the business integration and economic globalization. The bilateral approach creates efficiency by involving both competent authorities in the negotiation from the outset. By working simultaneously with both tax authorities, it is expected to reach an appropriate solution to taxpayer s transfer pricing issue. 2.2 The Legal Basis for Bilateral APA The legal basis for a bilateral APA is the Mutual Agreement Procedure (MAP) 5

6 Article of tax treaties (Article 25 of the OECD model treaty). Article 25 entitles taxpayers to ask the competent authority (CA) of each country (the authority in the tax office that is responsible for making decisions under a tax treaty) to reach an agreement to prevent double taxation. The treaty allows the two authorities to meet and reach an agreement on any issue affecting a taxpayer. In a bilateral APA, a taxpayer in one country and a related taxpayer another country will ask the competent authorities of the two countries to reach an agreement on the transfer price for a transaction between the two taxpayers. The taxpayers provide the competent authorities with the information to support the transfer price they believe is appropriate and the two authorities will choose a price and agree to apply that price when determining the tax liability of the two related taxpayers. 2.3 Development of Bilateral APAs in China The APA concept was first introduced in formal transfer pricing regulations (Guoshuifa [1998] No 59) in 1998 in China. The first unilateral APA was concluded in that year between a Chinese taxpayer and the tax authority. Since then, more than 100 APAs have been concluded, most of which are unilateral. The first bilateral APA was concluded between China and Japan in China's State Administration of Taxation (SAT) processed 12 bilateral APAs by the end of 2009, involving APAs with tax authorities in Japan, South Korea, the United States and Denmark. Around 40 bilateral APA applications are in the process of examination and evaluation. Compared with the case number in United States (Table 1), the position and experience of APA team is still in the beginning level. 6

7 Table 1 APA Applications, Executed APAs ( United States) APA applications filed during 2008 Unilateral Bilateral Multilateral Year Total All APAs executedâ Year Source: IRS Announcement and Report Concerning Advance Pricing Agreement (March 27th, 2009) In September 2004, the SAT issued a set of formal APA rules in Guoshuifa (national tax circular or ruling) [2004] No. 118 (the APA rules). In January 2009, new provisions on APAs were issued in Chapter 6 of Implementation Measures of Special Tax Adjustments (Guoshuifa [2009] No. 2). The new provisions establish a new regime for transfer pricing with extensive regulations. The new APA provisions provide comprehensive guidance on the procedures for concluding an APA, from pre-filing, to the signing of the APA, and the responsibilities of the taxpayer and tax authorities during the term of the APA. It covers a wide variety of transactions such as the sale and use of tangible assets, the transfer and use of intangible assets, the provision of services, and loan transactions. According to the new APA provisions, the term of an APA may range from three years to five years starting from the year after the filing of the formal APA application. APAs are limited to enterprises whose annual related-party transactions exceed RMB 40 million. The original APA guidelines did not specify how long APAs could last or set a minimum turnover for qualifying taxpayers. Another change in the new procedure is a rule that allows a taxpayer to remain anonymous during the pre-filling stage (by asking 7

8 a third party to make the initial contact with the tax authority). Under the new rules, the tax authority may agree to apply the transfer price set in an APA to transaction in years prior to the years covered in the APA. This is sometimes called a roll back of the APA. Unless the taxpayer specifically asks for the roll back treatment and the tax authority agrees, the APA will apply to future years only. In the case of a bilateral APA, of course the two competent authorities would have to agree to the retroactive application of the APA transfer price. 3. Comparison of Administration in China and Other Countries 3.1 Time schedule for concluding a bilateral APA It is difficult to say exactly how long it takes to conclude a bilateral APA because there are different views as to when the process starts and when it is completed. Some observers would say the process starts when the taxpayer begins collecting the information to submit to the tax authority and others measure the start from when the tax authority receives the information and the formal process begins. Similarly, some say the process ends when the agreement is signed between the two competent authorities and others say it is finished when the taxpayer receives notice of the prices that will be used. While it is therefore difficult to measure exactly how long a bilateral APA takes to be concluded, reports by tax authorities in China and in other countries suggest that Chinese authorities process these agreements more quickly than many other authorities. The processing of bilateral APAs in 2009 was quite quick based on the cases which were concluded that year between the SAT and foreign competent authorities. The original filing for a bilateral APA between China and Denmark was made in August 2008 and the agreement was signed in October 2009 a little over one year later. (Tseng, 8

9 Steven. July 2009) Another three bilateral APAs between China and Korea were concluded within one year, with the original filing at the end of 2008 and the arrangements signed in November 2009(SAT, 2009). In contrast to these times, statistics from a recent report of the U.S. APA program indicate that the average length of time for a new bilateral/multilateral APA with the U.S. competent authority is 42.4 months (which includes multilateral APAs that can involve more than two countries) (IRS, 2009). (Table 2) The time to develop the U.S. competent authority negotiating position for a bilateral APA was 18.7 months in 2008 (IRS, 2009). The Australian processing time for bilateral APA applications increased over the past six years beginning in from 13 months to 23 months in and then decreased to 16 months in (Robert Feinschreiber, 2009). Table 2 Months to Complete Bilateral APAs ( United States) Bilateral/Multilateral New Bilater/Multilateral Renewals Average 42.4 Average 30.2 Median 38.4 Median 26 Source: IRS Announcement and Report Concerning Advance Pricing Agreement (March 27th, 2009) 3.2 APA team The competent authority is in the SAT, the national tax authority. However, there is no unit dedicated to APAs and there is no plan to set up an APA office (Spencer Chong, 2009). There are very few experts in transfer pricing in the SAT who could calculate the correct transfer price for an APA. One report from one of the major accounting firms says there are only five or six persons in the SAT who are experts in transfer pricing.(david Oak, 2009) The APA process is carried out by local tax office experts in 9

10 transfer pricing. These officers are in the local government tax offices that sit above the municipal or autonomous prefecture level (the levels immediately beneath the province level). There were 91 of these offices by the end of (LIU Zuo, 2008) The local tax officials determine the APA price and communicate this to the SAT officials who are responsible for the mutual agreement procedure. The number of foreign funded enterprises in 2007 was 286,232, which included manufacturing 189,030 (66%), wholesale and retail trades 19,968 (6.7%), real estate, leasing and business services 14,741 (5.2%) and 14,437 (5%) respectively. The most of foreign funded enterprises are located in eastern and coastal regions (Figure 2), which have experienced officials, but there are still many enterprises in other regions with comparatively few transfer pricing experts. Figure2 Registration Status of Foreign Funded Enterprises by Region (2007) Unit Beijing Hebei Inner Mongolia Jilin Shanghai Zhejiang Fujian Shandong Hubei Region Guangdong Hainan Sichuan Yunnan Shaanxi Qinghai Xinjiang Million USD Number of Enterprise(Unit) Total Investment(100million USD) Source: National Bureau of Statistics of China It is a big challenge for regional tax authorities in professional staff and experience because the APA process involves many legal, tax, accounting and economic issues. The APA team members should be qualified for functional and risk analysis, the selection of 10

11 the transfer pricing method, the selection of the comparables, and the adjustments to the comparables. The Large Enterprise Administration Department was recently created during a restructure of the SAT, starting from The restructure is supposed to work to coordinate tax efforts between government and business entities across different jurisdictions within China where the interpretation and implementation can be different at times. The restructure is supposed to work together with the 2009 APA regulation mentioned earlier, Implementation Measures of Special Tax Adjustment. It may be possible to see at the end of this year if the new administration practices improve the bilateral APA processes. In Japan, the APA is processed mainly by NTA headquarter and regional taxation bureaus mainly in Tokyo, Osaka and Nagoya. The office of Mutual Agreement Procedures was established in July There are two position of the Director responsible for MAP now, one of which was created in July 2008 and is mainly responsible for APAs. According to 2008 statistics, the APA office in IRS is organized in 4 branches, each having a lead negotiator, tax professionals, economists and factual experts who are responsible for educating the IRS APA team regarding the taxpayer s industry, organization, and transaction. The economic professional s responsibility is to develop and defend the functional and risk analysis, the selection of the transfer pricing method, the selection of the comparables, and the adjustments to the comparables. 3.3 APA statement China has not yet issued any public report on the APA program, though it has been suggested that the SAT is considering issuing an annual APA report (Wang Xiaoyue, deputy director of the SAT s anti-tax avoidance division, quoted in Chong, 2009). The 11

12 compilation and publication of a series of books based on APA in China and transfer pricing audit experiences are also in contemplation. Japan s APA Program Report 2008 shows a clear picture of mutual agreement procedures and advance pricing arrangements, especially number of bilateral APA by industry, transaction type, transfer pricing method and region. As for IRS, the annual statutory report is issued since 2000 after the first report about APAs, which includes information with respect to calendar years 1991 through Recommendations Bilateral APAs are important for modern tax administration of multinational companies and it is in the interest of the Chinese tax authority and investors in China for China to have a bilateral APA system that is of high quality. Three recommendations for improvement can be made based on this study of China s bilateral APA system and the systems in developed countries such as Japan, Australia and the United States, First, speedy processing of bilateral APAs has to be balanced with prudence including more examination and evaluation of cases to produce reliable results. The processing time to compete bilateral APAs in China is claimed to be much less than the processing time in the United States and Australia. However, the tax administrations in these countries are very experienced in the field and can access comprehensive databases and comparable data. The different times in China and these other countries suggests that Chinese authorities may be processing APAs without enough review. Perhaps, more time should be spent using more tools to obtain information about taxpayers. While the APA process is specifically designed to achieve a faster resolution than the successive examination, appeals and tax administration processes, some compromise with time may be needed to guarantee the best result. 12

13 Second, the SAT should increase its APA human resources. It should establish an office dedicated to APAs to deal with an expansion of the bilateral APA system for more APAs with more countries. Now there are a group of experienced transfer pricing officials around the country but they are spread across different offices. This means the APA process has two steps. First, the local tax office has to review the taxpayer and recommend a transfer price for the bilateral APA and then the competent authority in the SAT has to negotiate with the competent authority of the other country. A central office that has special authority for APAs could work with local officials to improve efficiency, quality, and consistency. At the same time, it is useful to clarify specific responsibilities and authority for the local officials and national APA team. Regular update training is necessary for the staffs who are involved in the APA program. Third, the SAT should issue a full annual APA report with details of the bilateral APA program. This will also improve the APA program with transparency and may lead to better administration. There is no fixed method to fit all cases, but an annual report definitely would give taxpayers and foreign tax authorities with a description of the experience, structure and activities of APA program in China. Importantly, the annual report can be used to give formal and uniform guidance to the APA program across all of China in the national and and local tax authority offices. This will ensure there is consistent administration in all 23 provinces, 5 autonomous regions and 4 municipalities directly under the central government. Similar treatment for all taxpayers seeking APAs is important for fairness to taxpayers and to help taxpayers have trust in the APA system and use it more often. The last but not the least, it is necessary to improve the level of using modern technology, such as database and online information, to achieve more proper result 13

14 during the review and evaluation. Some of online databases provide extended and detailed information of corporations all over the world. If the information can be used in the process of Bilateral APA review and evaluation, the quality and the efficiency would be improved undoubtedly. 14

15 References: David J. Canale, Steven C. Wrappe. (2008) Advance Pricing Agreements- A Strategic Tool in Global Transfer Pricing Management The Tax Executive, May- June, pp David Oak, Spencer Chong. (2009) State Administration of Taxation of Taxation promoting advance pricing arrangements in China May, Internal Revenue Service (IRS). Announcement and Report Concerning Advance Pricing Agreements March 27, LIU Zuo(2008). Tax System of the People s Republic of China Beijing: China Taxation Press. National Bureau of Statistics of China China Statistical Yearbook 2008 China Statistics Press Registration Status of Foreign Funded Enterprises by Region at Year-end Registration Status of Foreign Funded Enterprises by Sector at Year-end (2007) National Tax Agency. APA Program Report 2008 Robert Feinschreiber, Margaret Kent. (2009) Advance Pricing Agreement Process in Japan Corporate Business Taxation, July, p (2009) Australia s Advance Pricing Arrangement Program Corporate Business Taxation, May, p39 Spencer Chong.(2009) Chinese Official Discusses Advance Pricing Arrangement Program July, State Administration of Taxation of People s Republic of China (SAT).(2009) Bilateral Advance Pricing Arrangement between China and Korea November 15

16 Tseng, Steven. (June, 2009) Interpretation of the New Regulations. International Tax Review, June Tseng, Steven.(July, 2009) China and Denmark: First Bilateral Advance Pricing Arrangement. 16