Profit monitoring and management system of multinational corporations launched in Jiangsu

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1 EY China TP Alert Profit monitoring and management system of multinational corporations launched in Jiangsu Executive summary On 17 March 2017, the State Administration of Taxation (SAT) issued the Administrative Measures for Special Tax Adjustment and Investigation and Mutual Consultation Procedures (Announcement of the State Administration of Taxation [2017] No.6, hereinafter as Bulletin 6 ), requiring that local tax authorities, oriented by risk management, should establish a profit monitoring system targeting at related-party transactions of multinational companies (MNCs), strengthen the monitoring of profitability, and encourage tax compliance through special tax adjustments via monitoring and management and special tax investigation. In this connection, Jiangsu Provincial State Tax Bureau (JSSTB) developed a set of profit monitoring indicators, based on which it established a profit level monitoring and management system of MNCs. 150 MNCs located in Jiangsu that undertake large-scale, complex, and typical relatedparty transactions were selected as the pilot companies in the system. On 16 April 2018, JSSTB invited the 150 MNCs to attend a meeting, introducing the rationale, mechanism and measurements of the profit monitoring system, aiming to encourage taxpayer cooperation and voluntary compliance. Detailed discussion The specific profit monitoring measures introduced by JSSTB include the following: Extensive collection of tax-related information Assessment of tax risk Evaluation of tax compliance status Categorization of risk level; and Implementation of risk management. Extensive collection of tax-related information The main sources of information may include: regular corporate tax fillings, transfer pricing contemporaneous documentations, information exchange among governmental authorities, corporation websites, news, industry reports, commercial database and tax information exchange, etc. 1

2 Such information would lay the foundation for the in-charge tax authorities to establish a Global One Stop database for each company under the monitoring system. Analysis of tax risks Through a set of comprehensive qualitative and quantitative indicators, the risk level is analyzed and assessed from the following three dimensions, i.e. global group as a whole, the all Chinese affiliates, and the individual local Chinese entity. For example, local tax authorities may calculate the hypothetical corporate income tax liabilities according to the following methods in the sequence of priority: 1. Benchmarking against the profit level negotiated in anti-tax avoidance investigations or advance pricing arrangements (APA) 2. Reasonable profit split results based on value chain analysis 3. Reasonable profit split results based on the group segmental report 4. Reasonable profit split results based on the consolidation profit of the group 5. Use of the profit level of comparable companies selected through preliminary analysis Then tax authorities would calculate the potential tax deviation amount and the degree of deviation based on the hypothetical tax payable of the company, where: Potential tax deviation amount = Hypothetical tax payable Actual tax paid Degree of tax deviation = Potential tax deviation amount / Hypothetical tax payable The syndicated risk ranking is then determined by qualitative and quantitative risk levels, based on which the companies would be divided into different categories such as high-risk, medium-risk, or low-risk. Qualitative Risk High Medium-risk Medium-risk High-risk Medium Medium-risk Medium-risk Medium-risk Low Low-risk Medium-risk Medium-risk Evaluation of tax compliance status Quantitative Risk The level of tax compliance is evaluated quantitatively from the following six dimensions, i.e. the aggressiveness of the group s global tax planning, the quality of the related-party transactions filing, the quality of transfer pricing contemporaneous documentations, the internal tax control policy with regard to related-party transaction, reactions to transfer pricing risk identified, as well as the willingness of the management to cooperate and communicate (1 to 5 points from low to high). Categorization of risk level The risk level would then be defined into different categories based on the syndicated risk assessment and the willingness of compliance. Risk Level High Medium Low Implementation of risk management JSSTB would release the Guidance of International Taxation Compliance Management regularly to all taxpayers, which covers the stand of the tax authorities, main cross-border tax risks identified, and various initiatives of tax authorities on cross-border tax management. Tax Risk Reminder Letter will be delivered to taxpayers with high and medium risk levels, in order to communicate the potential risk level, alert the existence of specific tax adjustment risks, and encourage taxpayers to communicate with the tax authorities on how to mitigate relevant tax risks. For those taxpayers who are categorized as high risk but refuse to communicate with tax authorities after risk alert, or those who do not take effective actions to reduce tax risks after communication, JSSTB will initiate anti-tax avoidance investigations. Observation and recommendation It is noted that the MNC profit level monitoring system was launched in the context of the continuous promotion and implementation of Base Erosion and Profit Shifting (BEPS) initiated by Organization for Economic Cooperation and Development (OECD), tax reform in the United States, the Belt and Road Initiative, as well as the mandate of state council to improve the business environment. The MNC profit level monitoring system aims to transform tax administrative approach from the prior investigation-oriented into a new system of management, service, and investigation. It is our understanding that this initiate of JSSTB was under the guidance of the SAT, which means that the experience accumulated in trial run of such system in Jiangsu could be promoted and rolled over nationwide. Therefore, JSSTB s MNC profit level monitoring system could serve as an important reference for MNCs operating outside of Jiangsu province Low Medium High Syndicated Risk (1 to 5 representing the willingness of compliance from low to high) 2

3 JSSTB s new system is based on the extensive collection of big data, which imposes high requirements on taxpayers compliance level, completeness, accuracy, and consistency of regular tax filings. Management needs to pay special attention to the information consistency between local statutory audit reports and tax returns, the consistency between the related-party transaction forms and transfer pricing contemporaneous documentations, the consistency between the contents disclosed in the master file and local file, as well as the consistency of information disclosure at the group level and local entity level, etc. We have noticed that JSSTB put the taxpayer s willingness to comply with tax laws as important as, or even more important than, the specific tax risks. Previously, high-risk taxpayers may be directly listed as the audit target; however, under the current system, to the extent the company demonstrate its willingness to comply with tax regulations and cooperate with tax authorities, the taxpayer may not be audited after proactive communications with the tax authorities and taking action to reduce tax risks. Such change also reflects certain add-on flexibility of local tax authorities under this new management model. It is worth to mention that similar to the principles set by BEPS action plan and the SAT, JSSTB emphasizes the importance of value chain analysis in the MNC profit level monitoring and transfer pricing management. Compared with the common approach used by tax authorities which requires MNCs to maintain a certain markup on cost (even if the MNCs are making a loss overall), the analysis based on value chain contribution seem to be more reasonable, such as the analysis of the functions actually performed and risks actually assumed by each participant, the profit of the entire value chain, and the profit level of local entities. At the same time, such method also imposes higher requirements on the value chain analysis in master file and local file prepared by taxpayers. In addition, MNCs need to pay attention to that unlike antitax avoidance investigations where the companies can receive a concrete assessment and subsequently apply for mutual agreement procedure to mitigate double taxation, under the new monitoring system, companies may not be able to obtain certainty and eliminate the impact of double taxation as it would likely be conducted via self-taxadjustment. Therefore, after the taxpayer receives a tax risk warning letter from the tax authorities, it is highly recommended that local management should timely report and discuss with the headquarters, and actively consult with tax advisors for suggestions, in order to determine appropriate strategies to cope with tax risks. Nevertheless, for companies located in countries or regions that have no effective tax treaties with China (such as Taiwan region), it might be an effective way for them to use the monitoring system and communicate with tax authorities to eliminate tax risks. In addition, if the results of these communications can be converted as APAs, high tax certainty could still be achieved and double taxation be effectively eliminated. 3

4 Transfer pricing contacts of EY in China Greater China Transfer Pricing Leader Travis Qiu North China Transfer Pricing Partner Joanne Su Leonard Zhang Carter Li Simon Liu Hong Kong Transfer Pricing Partner Martin Richter Kenny Wei Central China Transfer Pricing Partner Julian Hong Kana Sakaide Mark Ma Janice Ng Taiwan Transfer Pricing Partner George Chou Ext george.chou@tw.ey.com Suzhou Transfer Pricing Director Ananda Jiang ananda.jiang@cn.ey.com South China Transfer Pricing Partner Jean N Li jean-n.li@cn.ey.com 4

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