29 August 2013 Global Tax Alert News from Transfer Pricing China s SAT issues fourth Advance Pricing Arrangement Annual Report Executive summary On 13 August 2013, China s State Administration of Taxation (SAT) published the China Advance Pricing Arrangement Annual Report (2012) (the 2012 Report). 1 The publication of the 2012 Report is in line with the SAT s commitment to achieve systematic administration of APAs and increase the transparency of the APA process. Further, the 2012 Report illustrates certain new concepts and information which the Chinese tax officials are actively advocating in the APA negotiation process. The 2012 Report, covering statistical data and analysis for the 2005-2012 period, follows the previous year s report (the 2011 Report) in terms of content and framework. The 2012 Report describes the mechanism, procedures, implementation procedures and practical development of China s APAs. Standardized forms for APA application and communication purposes are presented in appendices to the 2012 Report. In comparison to the 2011 Report, the 2012 Report specifically describes the staffing and the teaming of SAT s APA program, and reiterates the principles adopted by Chinese tax authorities to determine the acceptance of an APA request. Background of APA in China Transfer pricing administration is one of the most important anti-tax-avoidance tasks throughout China s tax administration system. In the manner of cooperation, APA settles transfer pricing issues and potential transfer pricing disputes, reduces tax authorities managerial cost and efforts, and assists enterprises to mitigate transfer pricing risks. From China s tax administration perspective, the SAT recognizes that cooperative approaches such as APAs create significant efficiency in tax collection, provide effective solutions for international taxation disputes, and avoid double taxation. Furthermore, the SAT recognizes that a bilateral or multi-lateral APA is an effective tool to achieve increased certainty on overall tax revenue allocation in the spirit of international cooperation.
Thus, the SAT has shifted its focus from passively reacting towards proactively transforming, and has set course for a standardized working mechanism which integrates administration, service and auditing instead of relying primarily on transfer pricing audits and adjustments. The SAT strives to monitor taxpayers profitability and improve internal working and administration mechanisms through transfer pricing management and APAs. APA statistics Cases signed as of 31 December 2012 The 2012 Report focuses on cases negotiated under Guoshuifa [2004] No. 118 and Chapter 6 of Guoshuifa [2009] No. 2 during the 2005-2012 period 2 in which China signed 85 APA agreements (56 unilateral and 29 bilateral). The SAT signed three unilateral APAs and nine bilateral APAs during 2012, which compares to 12 signed APAs in 2011. However, currently there are still 15 unilateral and 112 bilateral APA requests (and submission intentions) pending in the process. The number of applications accepted, increased from 89 in 2011 to 121 in 2012, with the same number of unilateral APAs and an incremental 32 bilateral APAs in comparison to 2011. Overall, there is an increase of 21 APAs in the Pre-Acceptance phase and of 11 APAs in the Accepted Application phase. This trend reflects that the SAT attached more importance to the pre-evaluation work and the quality of the APA applications. Year 2012 Types Signed Bilateral 9 75% Unilateral 3 25% Total 12 Year 2005 Year 2011 Types Total Signed Concluded but not yet signed Pending cases in the process Total Pre- Acceptance Accepted Applications Bilateral 31 29 34% 2 110 73 37 Unilateral 60 56 66% 4 11 6 5 Total 91 85 6 121 79 42 APA statistics Bilateral APAs negotiated by region The report shows that among the 29 bilateral APAs signed during the past eight years, the majority of the APAs, i.e., 20 of them, were signed with Asian countries; five with European countries; and four with a North American country. Of the bilateral APAs signed in 2012, five out of nine were signed with Asian countries; one with a European country and three with a North American country. Time required for concluding cases The SAT s goal is to sign unilateral APAs and bilateral APAs within 12 and 24 months, respectively, after the submission of the formal APA application. 2 Global Tax Alert Transfer pricing
In 2012, six bilateral APAs were signed within 12 months; one within 24 months and two within 36 months. As for unilateral APAs, two cases were signed within 12 months; and one case was signed within 24 months. Year 2012 Types From Application to Signing <1 year 1-2 years 2-3 years >3 years Total Unilateral 2 1 0 0 3 Bilateral 6 0 1 2 9 Year 2005 Year 2012 Types From Application to Signing <1 year 1-2 years 2-3 years >3 years Total Unilateral 30 25 1 0 56 Bilateral 17 4 5 3 29 The average time to complete APAs highly depends on the covered transactions complexity, the quality of the application package submitted along with the taxpayer s cooperation, the in-charge bureau s review resources, and the attitude of competent authorities (in the case of a bilateral APA). Industries covered by signed APAs According to the statistics of signed APAs in different industries published by SAT, from 2005 to 2012, 85% of the APAs signed are related to manufacturing while only 15% cover other industries. In numbers, there are 72 signed APAs related to manufacturing, three related to commercial services, four related to wholesale and retail trade, two related to transportation, warehousing and postal services, one related to scientific and technical services, one related to electricity, thermo, gas and water generation and supply, and two related to information transmission, software and information technology services. Year 2005 Year 2012 Industry Involved (among signed APA cases) Number Manufacturing 72 Commercial Services 3 Wholesale trade and retail 4 Transportation, warehousing and postal services 2 Scientific and technical services 1 Electricity, thermo, gas and water generation and supply 1 Information transmission, software and information technology services 2 Total 85 Transfer pricing methods During the 2005-2012 period, the ( TNMM ) using Return on Sales ratio or Full Cost Mark-up ratio as the profit level indicator ( PLI ) was by far the method most frequently used to conclude APAs. Among the 15 cases signed in 2012, 12 cases relied on the TNMM; of which seven cases used the Full Cost Mark-up ratio as PLI, four cases the Return on Sales ratio and one case the Return on Capital Employed; additionally one case relied on the Cost Plus Method, one case relied on the Profit Split Method; and one case relied on another method not disclosed. 3 Global Tax Alert Transfer pricing 3
Year 2012 Type Number Cost Plus Method 1 Full Cost Mark-up 7 Return on Capital Employed 1 Return on Sales 4 Profit Split 1 Other methods(not disclosed) 1 Total 15 Year 2005 Year 2012 Type Number Comparable Uncontrolled Price Method 4 Resale Price Method 1 Cost Plus Method 17 Full Cost Mark-up 31 Return on Capital Employed 1 Return on Sales 32 Berry Ratio 0 Profit Split 3 Other methods(not disclosed) 4 Total 93 New concepts in the 2012 Report Future focus and principle in the APA program In the preface of the 2012 Report, the SAT highlights its shifting of focus from passively reacting to taxpayers non-compliance activities towards proactively transforming taxpayers compliance behaviors. The rapid development of the APA program also reflects this trend. Furthermore, the 2012 Report highlights that the SAT is strengthening cooperation with international organizations, such as the United Nations, Organization for Economic Cooperation and Development (OECD), among others. In October 2012, the SAT participated in the preparation of a Chapter in the United Nations Practical Manual on Transfer Pricing for Developing Countries, addressing the principles and methods regarding cost saving, market premium, marketing intangibles to safeguard developing countries taxation benefits, emphasizing the merits of buying power, land and labor costs in the emerging markets, and effectively expressing and advocating China s practical experiences in anti-avoidance administration. Finally, with an aim to maintain China s overall economic benefits in the international taxation, the SAT constantly improves implementation procedures and administrative work, proactively participates in international conversations and communications, and is actively involved in the process of formulating international tax regulations and transforming of global tax system. Resource allocation and team organization From 1 January 2005 through 31 December 2012, the Chinese tax authority has received 141 submitted intentions or formal applications for bilateral APAs in total, and the future workload is anticipated to increase dramatically. In the 2012 Report, the APA program managed to increase the number of persons at the SAT Headquarters to eight. According to staff expertise and the requirements of bilateral negotiations, the staff is organized into three teams responsible for: Asia Pacific Team 1: Japan and Korea Asia Pacific Team 2: the US, Canada, Australia, Singapore, HK SAR European Team: the UK, Germany, the Netherlands, Italy, Belgium, Luxemburg, Denmark, Sweden, Switzerland 4 Global Tax Alert Transfer pricing
Prioritization in the APA application process Confronting numerous APA applications and limited human resources, Chinese tax authorities will adopt the following principles in order to determine the acceptance of an APA request: Overall principle: first come, first served. The quality of the request submission, e.g., whether all required documents have been submitted, whether the transfer pricing method applied is appropriate, and whether the calculation is correct. Applicants will be required to make additions or revisions to the submission when necessary. Whether the applying taxpayer is in a particular industry or located in a particular region that merits prioritized attention. For a bilateral APA (BAPA) request, whether the BAPA partner country has the intention to accept the case and pursue such BAPA, will also be an important factor for consideration. Implications The 2012 Report reflects that the SAT constantly improves resources allocation and team organization, and iterates the significant principles to determine the acceptance of an APA request. This reflects SAT s focus on the strengthening of the concrete implementation procedures on anti-avoidance administration and monitoring, and enhancing the requirement of information quality in the APA program. While companies may want to use an APA mainly to get tax certainty, it is recommended that multinational companies seek professional advice to evaluate companies operations and formulate appropriate work plans and application materials to achieve prioritized acceptance in the APA application. According to the 2012 Report, Chinese tax authorities are adopting new concepts such as location saving advantages, cost savings, market premiums and marketing intangibles in the APA program and bilateral negotiation, which is also evidenced by the principle published in Chapter 10 in the United Nations Practical Manual on Transfer Pricing for Developing Countries. Therefore, it is necessary for multinationals to analyze and consider these new concepts going forward. Therefore, the total package is crucial for proper planning to consider the analytical methods and data employed in the APA and to profoundly study the risky areas including intangibles, market premium, supply chain, cost saving, excessive profit split. Moreover, the SAT also transmits its intention in the 2012 Report that an APA may also serve Go Global Chinese entities which have overseas operations. Chinese entities shall pay close attention to the development and trend regarding OECD, the country of investment and Chinese transfer pricing regulations. On the basis of risk management, the Go Global Chinese entities should also attempt to communicate and cooperate with Chinese and overseas tax authorities employing APA program as a tool to increase tax certainty. Endnotes 1. English version: http://www.chinatax.gov.cn/n8136506/n8136608/n9947993/n9948014/n12360820. files/n12360827.pdf Chinese version: http://www.chinatax.gov.cn/n8136506/n8136608/n9947993/n9948014/n12360820. files/n12360826.pdf 2. Refers to the period from 1 January 2005 to 31 December 2012, same as below. 3. Some APAs involved two or more kinds of transactions and multiple transfer pricing methods may have been used. Global Tax Alert Transfer pricing 5
For additional information with respect to this Alert, please contact the following: Ernst & Young (China) Advisory Limited, Shanghai Jessica Tien +86 21 2228 2115 jessica.tien@cn.ey.com Kana Sakaide +86 21 2228 2289 kana.sakaide@cn.ey.com Travis Qiu +86 21 2228 2941 travis.qiu@cn.ey.com Zhi Bin Yao +86 21 2228 3429 zhibin.yao@cn.ey.com Il Kook Chung +86 21 2228 2697 Il-kook.chung@cn.ey.com Ernst & Young (China) Advisory Limited, Suzhou Julian Hong +86 512 6763 3269 julian.hong@cn.ey.com Ernst & Young (China) Advisory Limited, Beijing Joanne Su +86 10 5815 3380 joanne.su@cn.ey.com Henrik Hansen +86 10 5815 3000 henrik.hansen@cn.ey.com Takahama Manabu +86 10 5815 2834 takahama.manabu@cn.ey.com Lillian Du +86 10 5815 2606 lilian.du@cn.ey.com Ernst & Young (China) Advisory Limited, Shenzhen Enoch Hsu +86 755 2502 8287 enoch.hsu@cn.ey.com Ernst & Young Tax Services Limited, Hong Kong Martin Richter +852 2629 3938 martin.richter@hk.ey.com Ernst & Young (Taiwan), Taipei George Chou +886 2 2720 4000 ext. 2735 george.chou@tw.ey.com EY Transfer Pricing Global Transfer Pricing, Germany Thomas Borstell, +49 211 9352 10601 Americas, United States Purvez Captain, +1 713 750 8341 EMEIA, Germany Oliver Wehnert, +49 211 9352 10627 Japan, Tokyo Kai Hielscher, +81 3 3506 1356 Global Markets, United Kingdom John Hobster, +44 207 951 6438 TESCM, Amsterdam Victor Bartels, +31 88 4071378 Asia Pacific, Singapore Luis Coronado, +65 6309 8826 6 Global Tax Alert Transfer pricing
EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. 2013 EYGM Limited. All Rights Reserved. SCORE No. CM3768 This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com