China & Hong Kong Latest Transfer Pricing Developments

Transcription

1 China & Hong Kong Latest Transfer Pricing Developments Navigating through the complexity June 2015

2 Disclaimer The materials of this seminar/workshop/conference are intended to provide general information and guidance on the subject concerned. Examples and other materials in this seminar/workshop/conference are only for illustrative purposes and should not be relied upon for technical answers. The Hong Kong Institute of Certified Public Accountants (The Institute), the speaker(s) and the firm(s) that the speaker(s) is representing take no responsibility for any errors or omissions in, or for the loss incurred by individuals or companies due to the use of, the materials of this seminar/workshop/conference. No claims, action or legal proceedings in connection with this seminar/workshop/conference brought by any individuals or companies having reference to the materials on this seminar/workshop/conference will be entertained by the Institute, the speaker(s) and the firm(s) that the speaker(s) is representing.

3 Agenda Introduction and recent developments of Base Erosion and Profit Shifting (BEPS) Recent developments in transfer pricing regulations and enforcement in China Advance Pricing Arrangement regime in China and Hong Kong In a nutshell 3

4 Introduction and recent developments of Base Erosion and Profit Shifting ( BEPS )

5 Overview Recent BEPS update Current updates BEPS SAT s response OECD s Actions and Deliverables in 2014 The Impact 5

6 In the headlines 6

7 Who is driving the BEPS project? BEPS: Base erosion and profit shifting What is BEPS? Commissioned by G20 and devised by the OECD Shifting profits in ways that erode the taxable base to locations with favourable tax treatment No or unduly low tax Consensus driven approach involving alignment of domestic rules, changes to Model DTAs and Commentary and Transfer Pricing Guidelines Domestic and international tax rules fail to keep pace with changing business models. Lack of coherence of tax rules between countries. TP rules permit separation of profits from economic substance. Why does BEPS arise? How to address BEPS?

8 Overview Recent BEPS update Current updates BEPS SAT s response OECD s Actions and Deliverables in 2014 The Impact 8

9 Addressing Base erosion and profit shifting Current update G20 summit <Addressing Base Erosion and Profit Shifting> (12 February 2013) <Action Plan on Base Erosion and Profit Shifting> (19 July 2013) Any new update? Addressing Base Erosion and Profit Shifting Action Plan on base Erosion and Profit shifting 9

10 Overview Recent BEPS update Current updates BEPS SAT s response OECD s Actions and Deliverables in 2014 The Impact 10

11 OECD 15 Actions and 7 Deliverables for Addressing the tax challenges of the digital economy 2 Neutralising the effects of hybrid mismatch arrangements 3 Strengthening CFC rules 4 Limiting base erosion via interest deductions and other financial payments 5 Countering harmful tax practices more effectively, taking into account transparency and substance 6 Prevent treaty abuse 7 Artificial avoidance of PE status 11

12 OECD 15 Actions and 7 Deliverables for Align TP outcomes with value creation: intangibles 9 Align TP outcomes with value creation: risks and capital 10 Align TP outcomes with value creation: other high risk transactions 11 Establish methodologies to collect and analyse data on BEPS and the actions to address it 12 Require taxpayers to disclose their aggressive tax planning arrangements 13 Re-examine TP documentation 14 Make dispute resolution mechanisms more effective 15 Develop a multilateral instrument 12

13 Overview Recent BEPS update Current updates BEPS SAT s response OECD s Actions and Deliverables in 2014 The Impact 13

14 Impact of BEPS Nexus Review of the taxation principles applicable to the digital business Widening the definition of PE Transfer pricing Substance. Attribution of profit to the PE Intangibles: Legal ownership vs economic ownership Further documentation obligations Financing Hybrids Further attention to financial transactions with related parties. Limitations to deduct interest expenses Anti-abuse Additional anti-abuse legislation is expected. Tax inspection could focus more in the review of anti-abuse legislation. 14

15 Overview Recent BEPS update Current updates BEPS SAT s response OECD s Actions and Deliverables in 2014 The impact 15

16 China SAT s Responses and Opinions Showing strong supportive gesture to the OECD s BEPS project Establishing a BEPS task force within the SAT Taking this opportunity to improve China's domestic tax rules and international tax administration capabilities SAT Propaganda Conference on BEPS Project on 25 September 2014 Identifying 15 unacceptable tax practices Emphasizing SAT s view of the OECD recommendations Providing the SAT s observations on specific BEPS Action Plans Sharing the SAT s action plans on an international level and domestic level to address BEPS timetable SAT Announcement on 17 September

17 15 Unacceptable Tax Practices (1/2) SAT s official identified 15 unacceptable tax practices, which reflect the SAT s determination to tackle BEPS issues in China: Base Erosion and Profit Shifting Double / Multiple Non-taxation Aggressive Tax Planning Tax Regimes that are not Transparent Holding Structures or Transactional Arrangements without Economic Substance Deduction of Inappropriate Costs Loss incurred by Chinese Subsidiaries with Single / Simple Functions Treaty Abuse 17

18 15 Unacceptable Tax Practices (2/2) SAT s official identified 15 unacceptable tax practices, which reflect the SAT s determination to tackle BEPS issues in China: Unreasonable Overpricing of Intangibles Remuneration Inconsistent with Function and Contribution to Value Creation High-Tech Company with Low Profit Margins China's Location Specific Advantages not Observed Losses Transferred from Foreign Entities to the Chinese Subsidiaries Refusal to Provide Data / Information / Documentation to Chinese Tax Bureaux upon Request Hybrid Mismatch Arrangements for the Purpose of Tax Avoidance 18

19 SAT s increased focus on Anti-avoidance In a recent public seminar, an SAT official has reiterated the SAT s increased focus on anti-avoidance. The following trend shown during the seminar shows the increase in tax revenue from SAT s continuous and relentless effort in combating and cracking down the cross border tax avoidance and evasion: 2014 年中国反避税贡献税款 523 亿元 Published by SAT during a public seminar in April

20 Jiangsu State Tax Bureau s Recent Development on International Taxation Administration Jiangsu State Tax Bureau ( Jiangsu STB ) is well known for its sophistication and aggressiveness in transfer pricing investigation. In June 2014, Jiangsu STB issued a paper entitled <Administrative Plan on international tax compliance for >, summarizing their current stance towards the BEPS Action Plan and highlighting the most important tax risks in an international context for MNEs. Jiangsu STB is the first and only provincial tax bureau, which had established a specific branch to centralise the transfer pricing investigation and APA administration. 20

21 Jiangsu STB s Administrative Plan on international tax compliance for Tax risks of cross-border taxation Establish off-shore structure to avoid tax jurisdiction Base erosion by cross-border investment or financing Erosion of the profit of domestic enterprise by overseas output of intangible assets No report or under-report of overseas income by overseas investing enterprises Functional restructure and mismatch of economic substance and profit level Profit transfer by means of associated outbound payment Lowering the tax burden of the whole group by off-setting intercompany transactions Profit transfer by means of purchasing overseas associated enterprise with unreasonable price Provide associated R&D service without responding gains or returns Benefit the whole group by assuming implicit cost without corresponding compensation Tax avoiding transactions by means of shell company in tax heaven or offshore account Not report capital gains obtained by taking advantage of start-up period Avoid non-resident tax obligation thorough three-party contract 21

22 Overview Recent BEPS update Current updates BEPS SAT s response OECD s Actions and Deliverables in 2014 The impact 22

23 OECD 15 Actions and 7 Deliverables for 2014 Recent Updates 1 Addressing the tax challenges of the digital economy 2 Neutralising the effects of hybrid mismatch arrangements 3 Strengthening CFC rules 4 Limiting base erosion via interest deductions and other financial payments 5 Countering harmful tax practices more effectively, taking into account transparency and substance 6 Prevent treaty abuse 7 Artificial avoidance of PE status 23

24 OECD 15 Actions and 7 Deliverables for 2014 Recent Updates 8 Align TP outcomes with value creation: intangibles 9 Align TP outcomes with value creation: risks and capital 10 Align TP outcomes with value creation: other high risk transactions 11 Establish methodologies to collect and analyse data on BEPS and the actions to address it 12 Require taxpayers to disclose their aggressive tax planning arrangements 13 Re-examine TP documentation 14 Make dispute resolution mechanisms more effective 15 Develop a multilateral instrument 24

25 Recent BEPS updates - At a glance Issue date Action Plans Key message 31 March 15 Action 12 Require taxpayers to disclose their aggressive tax planning arrangements Sets out a standard framework for a mandatory disclosure regime that ensures consistency while providing sufficient flexibility to deal with country specific risks and to allow tax administrations to control the quantity and type of disclosure 3 April 15 Action 3 Strengthen CFC Rules Focuses on developing recommendations for the design of CFC rules to combat BEPS 16 April 15 Action 11 Establish methodologies to collect and analyse data on BEPS and the actions to address it 29 April 15 Action 8 Assuring that TP outcomes are in line with value creation Intangibles Improve availability and analysis of data on BEPS, including to: monitor the implementation of the Action Plan and; evaluate effectiveness and economic impact of actions to address BEPS on an ongoing basis To ensure contributions are tantamount to the benefits received under a CCA 15 May 15 Action 7 Prevent the artificial avoidance of PE status Expansion of scope of existing PE rules 22 May 15 Action 6 Prevent Treaty Abuse Includes a simplified Limitation on Benefits (LOB) Article for inclusion in the OECD Model Income Tax Convention and provides conclusions and proposals on 20 targeted issues 25

26 Discussion Draft on Revisions to Chapter VIII of the Transfer Pricing Guidelines on Cost Contribution Arrangements ( CCAs ) On 29 April 2015, the OECD released a discussion draft proposals under Action 8 of the BEPS Action Plan BEPS Update Proposed fundamental modifications to Chapter VIII of the OECD Transfer Pricing Guidelines with respect to measuring the value of contributions to CCAs and the tax characterisation of contributions, balancing payments and buy-in/ buy-out payments; and to make it consistent with other BEPS amendments including those addressing the fundamental issues on risk, capital, recharacterisation and intangibles Consistent with the underlying concept of BEPS initiative, the primary goal of the proposed revision to ensure contributions are tantamount to the benefits received under a CCA The OECD invited targeted comments on these proposals by 29 May 2015 The input will be discussed during a public consultation on 6/7 July

27 OECD releases revised BEPS proposals on Permanent Establishments On 15 May 2015, the OECD released revised proposals on the Permanent Establishments (PE) rules in Article 5 of the OECD Model Tax Treaty BEPS Update On 15 May 2015, the OECD released revised proposals on the Permanent Establishments (PE) rules in Article 5 of the OECD Model Tax Treaty Scope of dependent agent rule is expanded (including narrowing the scope of independent agent rule) Scope of specific activity PE exemptions is narrowed Proposed anti-fragmentation rule to prevent abuse of the PE rules by segregating activities across associated entities Expansion of the scope of existing PE rules 27

28 Recent developments in transfer pricing regulations and enforcement in China

29 China TP regulations Location Specific Advantages TP in China Intangibles Investments in/ out of China Intragroup services 29

30 Briefly, SAT s recent focus area of international tax development in China: To take part in international tax rules formulation along the principle of profits should be taxed in the location where economic activities take place and values are created To improve domestic tax laws and systems Revision of Tax Collection and Administration Law and Individual Income Tax Law (in 2 or 3 years) Tax regulations recently issued: SAT Order No.31, SAT Public Notice [2015] No.7, SAT Public Notice [2015] No.16 To formulate detailed tax rules regarding controlled foreign corporation and hybrid mismatch To strengthen anti-avoidance measures and Exchange of Information 30

31 Briefly, SAT s recent focus area of international tax development in China: To help taxpayers by: Making tax regulations more transparent and clarify about taxpayers rights and obligations; Soliciting feedback from different stakeholders in respect of tax reform in China To help developing countries to upgrade their tax administration and collection capabilities, consistent with China s One Belt One Road strategy Following issuance of OECD discussion draft on CCAs, SAT issued State Council Circular [2015] No. 27 effecting the below: Remove approval requirement on a series of tax matters, including Cost Sharing Agreement; Cancelling the non-administrative approval of 49 items and adjusting the approval authority of 84 items that requires government internal approval 31

32 China TP regulations Location Specific Advantages TP in China Intangibles Investments in/out of China Intragroup services 32

33 Definition of Intangibles OECD Perspective Commercial intangibles Either used for the production of a good or the provision of a service. Or business assets transferred to customers or used in the operation of business (e.g. software) Trade intangibles Often created through risky and costly R&D activities. E.g. patents, know-how, designs, and models Marketing intangibles Product of market research or sales activities and aids in commercial exploitation or have an important promotional value. E.g. trade names, trademarks, customer lists, distribution channels and unique packaging (OECD Transfer Pricing Guidelines, paragraph 6.2) 33

34 China s perspective: Jiangsu State Tax Bureau s official opinions on High/New Tech Enterprise (HNTE) and royalty HNTE Are the contract manufacturing companies allowed to be entitled to HNTE status or to enjoy super deduction of R&D expense? Higher return is expected if R&D related activities are performed? Royalty Can the rate of royalty sustain after China s contribution to the value of IP becomes more notable? 34

35 China TP regulations Location Specific Advantages TP in China Intangibles Investments in/out of China Intragroup services 35

36 Background of Public Notice 16 ( PN16 ) Mar 2014 Apr 2014 Jun 2014 Services fee for shareholder activities not deductible SAT submitted official Response to the United Nations regarding intra-group services and management fees, reaffirming the importance of arm s length principle on intra-group services payment Profit shifting via outbound payments The State Tax Bureau of the Jiangsu Province issued the Administrative Plan on international tax compliance for , highlighted the most important tax risks in an international context for MNEs were related to BEPS Six-point tests Outlined a six-point test to determine whether transfer pricing adjustment is required Aug 2014 Mar 2015 Scrutiny on outbound service fee and royalty fee With the released of Circular 146, The SAT requested local-level bureaus to launch a comprehensive tax examination on the significant service fee and royalty fee payments made by Chinese enterprises to their overseas related parties Four types of non-deductible payments The SAT issued Public Notice 16: Certain Corporate Income Tax Matters on Outbound Payments to Overseas Related Parties provided guidance on outbound payments to foreign related parties 36

37 Key focus of Public Notice 16 Arm s Length Principle and Authenticity test 4 types of non-deductible payments 37

38 Arm s Length Principle and Authenticity test Public Notice 16 Enterprises must comply with the arm s length principle when making outbound payments to avoid special tax adjustments by the tax authority; the tax authority is empowered to request for relevant related party documentations to proof the authenticity and arm s length nature of the transaction Official interpretation No approval is required in advance of any overseas related party payments The tax authority is empowered to request for contracts or agreements concluded with its overseas related party, and relevant documentation within a specified period, to test the arm s length nature of the related party payment The tax authority is empowered to make special tax adjustments in cases of non-compliance with the arm s length principle Adjustment period: 10 Years (commencing from year of transaction) 38

39 4 Types of non-deductible payments Unqualified overseas related parties Non-deductible Royalties paid to related parties without contribution to value creation of underlying intangible assets Unqualified service fee Royalties paid for incidental benefits from financing or listing activities 39

40 China TP regulations Location Specific Advantages TP in China Intangibles Investments in/out of China Intragroup services 40

41 Implications on MNC operations in China Global value chain vs. Profit split method Historical trend: setting up of certain simple functions entities in China by MNCs Examples: Contract manufacturers involved in R&D process; High and New Technologies Enterprises (HTNEs) enjoying preferential tax rates but pay outbound royalty to parent company Key question: Which party to secure profits deriving from an integrated value chain? China perspective: assess the importance of the entities, to justify a higher return of the single function performed Indicative changes towards Profit Split concept in China s tax landscape Potential usage of the profit split method will increase in China bringing additional income to the country Flip side: whether Chinese tax authority is willing to accept the losses from the implementation of the profit split method? 41

42 Implications on outbound investments from China Principal structure model vs. Profit split method Historical trend: setting up of headquarters in lower tax jurisdictions by Chinese entities, economic activities remain in China Chinese operating company pays management fee/ royalty to offshore headquarters, which have no economic substance China perspective: challenge the substance of offshore headquarters and assess the importance of the economic activities of China operating company Key question: whether profit split method is appropriate to capture the contribution of Chinese operating companies? In a recent public seminar, the Deputy Director of SAT International Taxation Department (Ms. Wang Xiaoyue) has shared her the SAT s agenda to enhance administration for outbound investments: formulating CFC implementation rules, Foreign Tax Credit management, Information Sharing System, expansion of knowledge database of more countries tax systems. 42

43 China TP regulations Location Specific Advantages TP in China Intangibles Investments in/out of China Intragroup services 43

44 The attribution of location savings and market premium OECD: location savings do not belong automatically to one party but must be allocated in line with the bargaining situation - Need to determine the appropriate allocation of location savings: the arm s length principle (based on bargaining positions) - Due to lack of sufficient comparable data, need to conduct a vertical analysis of entities along the value chain Location savings and market premium are new transfer pricing ( TP ) challenges often seen in BRICS* economies with low cost, but booming economy and huge market, such as China and India Market premium: pull of sales volume and price Location savings: reducing prices of factors of production *BRICS: Brazil, Russia, India and China 44

45 Quantification and allocation of location specific advantages Unique features in China limiting relevance of non-chinese companies as comparables Fast economic growth, rising income and a huge consumer base with great purchasing power creating imbalance of supply and demand Impact of government regulations and policies on production and consumption Consumer general preference to foreign brands Location savings and market premium China authorities apply LSAs in transfer pricing investigations and APA negotiations 45

46 Advance Pricing Arrangement ( APA ) regime in China and Hong Kong

47 SAT Reports China completed Eight Bilateral APAs, 11 Unilateral APAs, in 2013 Key development: China s SAT releases its annual APA report for 2013 Key takeaway: China signs 8 BAPA and 11 Unilateral Agreements in 2013 What s next: Demand for BAPAs continues to outstrip the SAT s limited staff resources 47

48 China APAs From 2005 to 2013, 147 intentions of formal applications for bilateral APAs (of which 37 were concluded) were received. The number of APA applications will continue to increase. By 31 December 2013, cumulative total of APAs signed is 104, 67 unilateral and 37 bilateral. In 2013, total of 11 unilateral APAs and 8 bilateral APAs, representing an all year high, among which 5 were signed with Asian countries, 2 were with European countries, 1 was with North American country. 4 Due to lack of resources in SAT, significant requests for APA are waiting for acceptance. 5 For new APA application, different type of related party transactions (e.g. services, intangibles), an innovative application of TP method (e.g. profit split method), or a high-quality analysis for intangibles and market premium will get SAT s attention and priority consideration. 48

49 Hong Kong DTA Network In Progress Belgium Thailand Mainland China Luxembourg Brunei Netherlands Indonesia Hungary Kuwait Austria United Kingdom Portugal Spain Czech Republic Jersey Malaysia Mexico Canada Italy Guernsey Qatar Korea South Africa United Arab Emirates Bahrain Bangladesh Finland Germany India Israel Latvia Macao SAR Ireland Switzerland Mauritius Liechtenstein Vietnam France Japan Malta Pakistan Romania Russia New Zealand Saudi Arabia 49

50 Hong Kong APA program s development HK APA is still progressing APA program was introduced in 2012 with cautious optimism in Hong Kong Associated practical challenges were fully apprehended APA is accepted as an effective dispute resolution mechanism HK APA experience IRD is open to fair negotiations with enterprises Shift in bilateral relationship between IRD and enterprise Reduce TP audits and consequential adjustments and penalties Snapshot of APA filings Trade: distribution, wholesaling, service, manufacturing, research and development BAPA partners: Mainland, Netherlands, Japan, Korea TP methodology: TNMM-FCMU, TNMM-operating margin, cost plus, profit split Processing time of BAPA concluded: 15 to 24 months Period of BAPA concluded: 5 years 50

51 Hong Kong APAs HK IRD very encouraging of APA applications Five APA applications accepted by the HK IRD to date Two concluded negotiations with Netherlands and Japan Open and transparent approach is one of the key success factors Source: Information as at 31 October 2014 per IRD comments at a public seminar 51

52 A Recent Bilateral APA Case (Scope) Key components Parent company in Country A Finished products Manufacturing company in Country A Semi-finished products Third party assemblers in Country A Manufactured parts W Manufactured parts X Finished products with unique characteristics Country A: Major assembly Hong Kong: Procurement Monitoring third party manufacturers Exchange and inventory risks No R&D and marketing Materials Third party suppliers in Country B Hong Kong company Key components & materials Manufactured parts W & X Third party manufacturers in Country B 52

53 A Recent Bilateral APA Case (Technical Issues) Business nature: wholesaler or contract manufacturer Review of possible internal comparables TNMM Full Cost Mark-Up Exclusion of extraordinary loss from FCMU for a particular year Determining the arm s length range Weighted average approach Pooled approach Compensating adjustment Term adjustment Year-by-year adjustment 53

54 In a nutshell

55 Managing TP risks (a) Review the current risk profile, identify high risk areas and take immediate actions (b) Review the economic substance along the value chain and whether the tax arrangement is consistent with the economic substance Proper TP documentation in place to get ready for a potential transfer pricing investigation Effective & efficient communication maintained with local level tax bureaus (a) Sound ongoing internal tax risk control and improve charges mechanism (b) Sustainable intra-group charges structure 55

56 Tax function in China Being aware of the reality Be pro-active! What are the high risk areas? Be flexible! SAT views are also development, be open-minded and adapt to the changes Be prepared! Be aware and get ready to address unique challenges in China Be sustainable! Tax arrangement follows economic substance, build sound tax internal control system 56

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