Since 2009, the Chinese tax authorities have strengthened their tax administration on transfer pricing and income derived by non-TREs. The STA has released a number of tax circulars addressing the tax administration of transfer pricing, foreign contractors and service providers, WHT on passive income, etc.
Under the CIT Law, non-TREs are subject to CIT on the capital gain derived from the disposal of equity investment in Chinese companies. In addition, the transfer has to be effected at fair value so that any gain shall be recognised for tax purpose at the time when the transaction takes places (unless the transaction qualifies for deferral tax treatment provided under the tax regulations).
The Chinese tax authorities have, in recent years, challenged and clawed back CIT on several equity transfer cases whereby non-TREs disposed of their equity investment in China to related parties at cost or below 'fair value'. In addition, they have become more knowledgeable on valuation theories and methodologies and are applying them in reviewing valuation reports in order to ascertain the fair value of equity transfer transactions for tax purposes.
In addition, the Chinese tax authorities have geared up their efforts in recent years to scrutinise investment structures involving intermediate holding companies incorporated in low-tax jurisdictions. One of their focuses is on the indirect equity transfer of Chinese companies by non-TREs. The income derived by a non-TRE from the disposal of a non-Chinese company is not taxable under China’s domestic income tax law.
However, if the Chinese tax authorities are of the view that the non-TRE transferor has used an abusive arrangement to indirectly transfer the equity of the Chinese company (i.e. interposing and disposing of the special purpose vehicle for no reasonable commercial purpose, but just for avoidance of China withholding income tax), it may re-characterise the equity transfer based on the 'substance over form' principle and disregard the existence of the special purpose vehicle. Once the special purpose vehicle is disregarded, the transfer would be effectively a transfer of the underlying Chinese company’s equity, and the transfer gain would be China source and subject to China withholding income tax.
In early 2015, the STA issued a circular that sets out new guidance on the assessment of indirect transfer of China taxable properties by non-TREs. This guidance extends the scope to capture all ‘China taxable properties’, including not only equity investment in Chinese companies but also immovable properties located in China and assets of an establishment or place of a foreign company in China. It also provides clearer criteria on how to assess ‘reasonable commercial purpose’ and introduces ‘safe harbour’ scenarios.
The STA has also released circulars relating to the claiming of treaty benefits by non-TREs and interpretation of certain articles and terms in the tax treaties, such as dividends, royalties, beneficial ownership, etc. Aggressive tax planning (including, but not limited to, tax-avoidance and treaty-abusive arrangements) not supported by reasonable commercial purposes and substance will be subject to scrutiny by the Chinese tax authorities. Non-residents and their withholding agents are required to file certain prescribed forms and other supporting documents when performing tax filing to justify their claims for the tax treaty benefits. The tax position taken by the non-residents or withholding agents are subject to examination by the Chinese tax authorities after the tax filing.
The STA issued a Departmental Interpretation Note (DIN) in 2010 for the tax treaty concluded between China and Singapore. It is the first time the SAT has introduced a set of technical views, interpretation, and practice guidelines for the implementation of a tax treaty in such a comprehensive manner. More importantly, this set of interpretation is also applicable to other tax treaties concluded by China if the provisions of the relevant articles in those tax treaties are the same as those in the China/Singapore tax treaty. Thus, it is likely to have a wide impact to tax residents of other countries/regions that have entered into tax treaties with China.
For transfer pricing investigation, increasing scrutiny has been imposed on outbound related-party remittance, such as service fees and royalty payments. Specifically, in addition to the arm’s-length nature of the service fees and royalty transactions, the Chinese tax authorities may also require taxpayers to demonstrate the commercial substance of the overseas service provider or intangible property owner.
The Chinese tax authorities are also stringent on activities for the decision-making, monitoring, control, and compliance purposes of the group, and may challenge the service remittance for group finance, tax, human resources, and legal activities, which is different from common positions taken by Organisation for Economic Co-operation and Development (OECD) countries. Another focus of the Chinese tax authorities in transfer pricing investigation is location-specific advantages (e.g. location saving of Chinese low-cost resources, market premium of Chinese market). As such, the Chinese tax authorities often expect a different transfer pricing policy in China, which will pose difficulties on multinational groups who implement a consistent transfer pricing policy around the world.
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