China Tax Monthly Beijing/Hong Kong/Shanghai In this issue of the China Tax Monthly, we will discuss the following tax developments in China: 1. The SAT Issues Supplementary Rules to the Administrative Measures on VAT Zero-rate Regime 2. The SAT Releases 2014 APA Annual Report 3. China Signs the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information 4. Tax Treatment Clarified for Mutual Recognition of Funds between the Mainland and Hong Kong 5. Certain Employer-paid Commercial Health Insurance Premiums Are Exempt from Individual Income Tax 1. The SAT Issues Supplementary Rules to the Administrative Measures on the VAT Zero-rate Regime On 14 December 2015, the State Administration of Taxation (SAT) issued SAT Bulletin  No. 881 (“Bulletin 88”) to supplement and partially repeal SAT Bulletin  No. 112 (“Bulletin 11”), which contains the current administrative measures on the value-added tax (VAT) zero-rate regime. Bulletin 88 was mainly issued to clarify the administration and implementation of Notice 1183 , which extends the VAT zero-rate regime to additional services. 1 Supplementary Announcement of the State Administration of Taxation on the Administrative Measures for Applying the Tax Refund (Exemption) to Taxable Services Eligible for Zero-rated Value-added Tax, SAT Bulletin  No. 88, dated 14 December 2015, retroactively effective from 1 December 2015. 2 Announcement of the State Administration of Taxation on the Issuance of the Administrative Measures for Applying the Tax Refund (Exemption) to Taxable Services Eligible for Zero-rated Value-added Tax, SAT Bulletin  No. 11, dated 8 February 2014, retroactively effective from 1 January 2014. 3 Notice of the Ministry of Finance and the State Administration of Taxation on the Application of VAT Zero-rate to Exported Services Relating to Films, etc., Cai Shui  No. 118, dated 30 October 2015, effective from 1 December 2015. For a detailed discussion of Notice 118, please refer to the October & November 2015 issue of our China Tax Monthly. December / January 2016 China Tax Monthly is a monthly publication of Baker & McKenzie’s China Tax Group. Beijing Suite 3401, China World Office 2 China World Trade Centre 1 Jianguomenwai Dajie Beijing 100004, PRC T: +86 10 6535 3800 F: +86 10 6505 2309 Hong Kong 14/F Hutchison House 10 Harcourt Road Central, Hong Kong T: +852 2846 1888 F: +852 2845 0476 Shanghai Unit 1601, Jin Mao Tower 88 Century Avenue, Pudong Shanghai 200121, PRC T: +86 21 6105 8558 F: +86 21 5047 0020 2 China Tax Monthly | December / January 2016 Failure to claim Under both Bulletin 11 and Bulletin 88, a service provider must claim VAT zero-rate treatment during a VAT declaration period4 before April 30 of the year following the year in which the sales revenue was recorded for accounting purposes. Previously, according to Bulletin 11, in case of late declaration, the relevant service export would be treated as a normal sale subject to VAT. Bulletin 88 now permits the service provider to claim tax exemption5 in case of late declaration. Only if the service provider fails to claim the tax exemption will the service export be treated as a normal sale subject to VAT. Receipts Generally speaking, a service provider must submit a receipt to demonstrate it derived income from a foreign service recipient. In practice, the tax authority normally requires the service fees to be directly paid to the service provider by the service recipient. Bulletin 88 now allows an exception to this rule. A member company of a multinational enterprise (MNE) may submit a receipt issued by a bank to another member company conducting the centralized operation (or receipt and payment) if: (i) the MNE group has been approved to conduct centralized operation of foreign exchange funds or centralized receipt and payment of current-account cross-border renminbi capital; (ii) the payer on the receipt is the service recipient or its foreign affiliates as agreed in the service contract; and (iii) the service provider is stated as the payee or actual payee on the receipt. Certificate issued by the Ministry of Commerce (MOC) Under Bulletin 88, in order for certain taxpayers to enjoy VAT zero-rate treatment, the taxpayer must submit a certificate to show its service contract was registered and approved. For a taxpayer who provides software services, circuit design and testing services, information system services, business process management services or offshore service outsourcing, the certificate is issued by the MOC’s Information Administrative System for Service Outsourcing and Software Export. For a taxpayer who provides radio, film and television distribution and production services, the certificate is issued by the MOC’s Cultural Trade Administrative System. 4 Generally, these VAT declaration periods occur during the first 15 days in each month. 5 Under both the VAT zero-rate regime and the VAT exemption regime, no output VAT is levied on service fees. However, a credit or refund of input VAT incurred in the provision of the relevant services is only available under the zero-rate regime. December / January 2016 | China Tax Monthly 3 Observations In order to benefit from the VAT zero-rate regime, a taxpayer should consider the following: • Timing the recordal of service contract sales revenue to allow sufficient time to submit the VAT zero-rate declaration for the sales revenue; In practice, the tax authorities generally require all supporting documents to be submitted on time for the purpose of VAT zerorate declaration. However, taxpayers may find it difficult to do so depending on when the sales revenue from the service contract is recorded. For example, if the sales revenue is recorded in December, the taxpayer will have no more than four months to prepare and submit the required documents as the taxpayer has to claim zero-VAT treatment in a VAT declaration period before 30 April of the next year. However, if the sales revenue is recorded in January, the taxpayer will have more than one year to prepare the required documents. • Paying service fees directly to branch offices; and Bulletin 88 is unclear on whether each of the service provider’s branch offices needs to receive separate service fee remittances from the offshore service recipient in order to qualify for the zeroVAT treatment on the fees (as each branch office is a separate VAT taxpayer from the head office). Until such time a clarification is made, we highly recommend arrangements where the branch offices directly receive the service fees. • Including a definite service period or a fixed service fee amount in certain service contracts. As mentioned above, for certain services, an MOC certificate is necessary to enjoy VAT zero-rate treatment on certain service contracts. In order to receive the certificate, the taxpayer’s contract must first be approved by the MOC. Practice indicates that the MOC is reluctant to approve service contracts that do not have either a definite service period or a fixed amount of service fees. 2. The SAT Releases 2014 APA Annual Report On 18 December 2015, the SAT released the 2014 China Advance Pricing Arrangement Annual Report (“Annual Report”)6 . The sixth edition of this annual report focuses on China’s advance pricing arrangement (APA) mechanisms, procedures and practices, and provides statistics and analysis for 2005 through 2014. 6 The English version of the 2014 APA Report can be downloaded at http://www. chinatax.gov.cn/n810219/n810724/c1951566/part/1951585.pdf. 4 China Tax Monthly | December / January 2016 Although it generally does not include annual statistics, a side-by-side comparison of the Annual Report with the 2013 and 2012 annual reports reveals taxpayer and SAT activity during 2014. APA requests filed in 2014 Taxpayers filed 15 bilateral and 9 unilateral APA requests in 2014, up from 6 bilateral and 7 unilateral requests in 2013. Both amounts are still significantly lower than in 2012 when 42 bilateral and 3 unilateral requests were filed. This drop highlights the impact of the OECD Base Erosion and Profit Shifting (BEPS) Project on the APA program. On one hand, taxpayers want to reduce the uncertainties created by the BEPS Project via APAs. On the other hand, taxpayers are deterred from filing APA requests because the BEPS project has diverted a lot of SAT resources away from the APA program7 . APAs signed Nine APAs (3 unilateral and 6 bilateral) were signed in 2014 — a 53 percent decrease from the 19 APAs (11 unilateral and 8 bilateral) signed in 2013. This drop probably resulted from the SAT diverting resources from the APA program to the BEPS Project. This lack of resources even caused the SAT to suspend bilateral APA negotiation as of September 2014. Fortunately, in early 2015, the SAT allowed bilateral APA negotiation to resume. Various competent authority meetings have been held, including with the US, Korea, Japan and various European countries. Open requests On 31 December 2014, 136 APA requests (119 bilateral and 17 unilateral) were open. At the end of 2013, 121 APA requests (110 bilateral and 11 unilateral) were open. We expect this year-end trend to continue where open bilateral requests significantly outnumber open unilateral requests. Industries covered The Annual Report lists seven industry categories, in which APAs were signed from 2005 to 2014: • manufacturing (92); • commercial services (5); • wholesale trade and retail (9); • transportation, warehousing, and postal services (2); • scientific and technical services (2); • electricity, heating, gas and water generation and supply (1); and 7 At present, the APA program has only six staff members at the SAT headquarters. December / January 2016 | China Tax Monthly 5 • information transmission, software and information technology services (2). Of the nine APAs signed in 2014, six involve the manufacturing industry and the remaining three involve wholesale trade and retail. Transfer pricing methods The following table lists the transfer pricing methods used in signed APAs from 2005 to 2014 and in 2014 alone: Table one Transfer pricing method 2005 to 2014 2014 Comparable uncontrolled price method 5 0 Resale price method 1 0 Cost plus method 17 0 Transactional net margin method 95 98 Profit split method 3 0 Other methods 4 0 As shown in the table, the transactional net margin method (TNMM) is the most frequently used transfer pricing method, while the comparable uncontrolled price (CUP) method, the resale price method and the profit split method are rarely used. In the Annual Report, the SAT explains that the infrequent use of the CUP method is a result of its high comparability standard. This explanation indicates that the SAT generally thinks it is difficult for the enterprises to meet the high comparability standard required by the CUP method. Thus the SAT may continue to be reluctant to accept the CUP method in future APA negotiations. Meanwhile, the SAT explains that the resale price method and the profit split method were applied less frequently due to enterprises providing insufficient information about transactions and pricing. Thus, the SAT is encouraging enterprises to provide sufficient information so that the resale price method and the profit split method can be used more frequently. 8 Of the nine APAs signed in 2014, four applied the Return on Sales Ratio and five applied the Full-cost Mark-up Ratio. 6 China Tax Monthly | December / January 2016 Term length From 2005 to 2014, most unilateral and bilateral APAs were completed9 within two years. Of the completed bilateral APAs, 56 percent were completed within one year. Among the nine APAs completed in 2014, all three unilateral APAs and three bilateral APAs were completed within two years. Two bilateral APAs took more than three years . Although the SAT aims to complete the review and negotiation process for bilateral APAs within two years, the actual time required varies. Nonetheless, based on the numbers from previous years, taxpayers should remain optimistic the APA process will normally not take more than two years once the APA application has been formally accepted by the SAT. Bilateral APAs Among the six bilateral APAs completed in 2014, three were signed with Asian countries, two were signed with European countries and one was signed with a North American country. These numbers are consistent with previous years in which Asian countries have signed the most APAs with China. What to expect in 2016 In the annual reports, the SAT traditionally includes a preface that describes its general transfer pricing strategy for the following year. The preface in the Annual Report quotes President Xi’s statement at the 9th G20 summit in 2014: “the world should enhance global cooperation in tax matters, crack down on international tax evasion and help developing countries and low-income countries build up tax administration capacity”. According to the Annual Report, this statement has guided China’s tax authorities in their work on international taxation. Therefore, we should expect that the SAT’s strategy will continue to be influenced by the BEPS Project. In addition, the Annual Report once again states that “a submission that presents innovative application of transfer pricing methods or high quality quantitative analysis for intangibles, cost savings or market premiums will merit the SAT’s prioritized consideration”. By once again including this statement in the Annual Report, the SAT is reaffirming its consistent focus on intangibles, cost savings and market premiums. In the post-BEPS world, the SAT will probably turn its attention back to the APA program. Moreover, the SAT is currently evaluating the creation of a separate division to deal with mutual agreement procedures for transfer pricing issues. Once that division is created, more resources will likely be 9 The time starts to run only if the APA request is formally accepted by the SAT. December / January 2016 | China Tax Monthly 7 devoted to the APA program. Those resources should reduce the time to complete an APA. 3. China Signs the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information On 16 December 2015, China signed the Multilateral Competent Authority Agreement (MCAA) on Automatic Exchange of Financial Account Information. In doing so, it became the seventy-seventh jurisdiction to join the OECD MCAA, which is put in place as an international framework that allows the automatic exchange of Common Reporting Standard (CRS) information between jurisdictions. The CRS is an OECD proposal, under which a financial institution in one jurisdiction will be required to identify financial accounts held by tax residents of other jurisdictions and to report that financial information to the local government. The local government will then pass the information to the account holder’s country of tax residence. The CRS information mainly includes: • the name, address, jurisdiction(s) of residence and tax identification number(s) of each reportable person; • the account number; • the name and identifying number (if any) of the reporting financial institution; • the account balance or value as of the end of the relevant calendar year or other appropriate reporting period; and • the total gross amount of interest or dividends received. As of 5 February 2016, 55 jurisdictions have committed to implementing the CRS by 2017, and 41 jurisdictions (including China) have committed to implementing it by 201810. Each country that signs the MCAA is required to notify the OECD Coordinating Body Secretariat of the jurisdictions with which it intends to cooperate with in enforcing the MCAA. The MCAA becomes effective between two jurisdictions when: (i) both jurisdictions have provided such notice of intent; and (ii) the Convention on Mutual Administrative Assistance in Tax Matters (“Convention”) has entered into force and is in effect for both jurisdictions11. 10 The data is sourced from the OECD’s website: http://www.oecd.org/tax/ automatic-exchange/crs-implementation-and-assistance/crs-byjurisdiction/#d.en.345489, visited on 5 February 2016. 11 China signed the Convention on 27 August 2013. The Convention has become effective for China from 1 February 2016, and will become applicable to China from 1 January 2017. 8 China Tax Monthly | December / January 2016 Observations In the first few years of implementation we do not expect that each of the countries that implement the CRS will conduct automatic exchange of CRS information with every other country that implements the CRS. To date, it remains unclear when the MCAA will become effective between the PRC and a specific jurisdiction. However, the PRC has been pushing to implement the automatic exchange of information. According to a meeting held by the SAT on 10 October 2015 in Beijing, the PRC plans to implement the CRS and start automatically exchanging CRS information with more than 45 countries by the end of 2018. Non-PRC residents usually do not hold accounts in PRC financial institutions due to foreign currency control policies. Thus, the PRC’s automatic exchange network for CRS information is unlikely to have an immediate impact on non-PRC residents. However, once the automatic exchange network for CRS information is established, the PRC tax authorities will be able to obtain information about a PRC resident’s account in an offshore financial institution. Therefore, PRC residents must prepare for the forthcoming information exchange. Among other things, each PRC resident should: • Identify what personal and financial information is maintained by his or her financial institutions; • Ensure the information maintained by the financial institutions is accurate (which will help prevent unwarranted tax investigations); • Assess potential exposure and risks from the information exchange; and • Involve tax advisors to develop proper strategies to help maintain PRC tax compliance. 4. Tax Treatment Clarified for Mutual Recognition of Funds between the Mainland and Hong Kong On 14 December 2015, the Ministry of Finance (MOF), the SAT, and the China Securities Regulatory Commission (CSRC) jointly issued Notice 12512 to clarify the PRC tax treatment on income derived under the Mutual Recognition of Funds (MRF) Scheme. As background, on 22 May 2015, the CSRC and Hong Kong Securities and Future Commission (SFC) jointly announced the commencement of the MRF Scheme between the Mainland and Hong Kong starting from 1 July 2015. Under the MRF Scheme, Hong Kong investors can invest in 12 Notice of the Ministry of Finance, the State Administration of Taxation, and the China Securities Regulatory Commission on Relevant Tax Policies on the Mutual Recognition of Funds between the Mainland and Hong Kong, Cai Shui  No. 125, issued on 14 December 2015, effective from 18 December 2015. December / January 2016 | China Tax Monthly 9 a Chinese fund that has been registered with the SFC, or vice versa if registered with the CSRC. On 18 December 2015, the CSRC announced three Hong Kong funds had been officially registered with the CSRC. Meanwhile, the SFC also announced four Mainland funds had been officially registered with the SFC. Income tax treatment for Hong Kong investors According to Notice 125, income derived by a Hong Kong investor (individual or enterprise) from the transfer of fund units in an MRF is exempt from PRC income tax. The PRC-invested company is obligated to withhold 10% of the dividends or 7% of the interest paid to the recognized Mainland fund. Then, no withholding tax will apply when the fund distributes dividends or interest to the Hong Kong investor. Income tax treatment for Mainland investors For income derived from a recognized Hong Kong fund, the tax treatment differs for a Mainland individual investor and a Mainland enterprise investor. Income derived by a Mainland individual investor from the transfer of fund units in a recognized Hong Kong fund is exempt from PRC income tax for the period starting from 18 December 2015 to 17 December 2018, while income derived by a Mainland enterprise investor from the transfer of fund units in a recognized Hong Kong fund is subject to PRC enterprise income tax. Income distributed by a recognized Hong Kong fund to a Mainland individual investor is subject to PRC individual income tax at the rate of 20%, and the fund’s PRC agent is the withholding agent. Income distributed by a recognized Hong Kong fund to a Mainland enterprise investor is subject to PRC enterprise income tax. The fund’s agent does not have a withholding obligation. Business tax treatment and stamp duties Income derived by a Hong Kong investor (individual or enterprise), a Mainland individual investor or a Mainland enterprise investor (other than a financial enterprise) on the transfer of fund units in an MRF is exempt from PRC business tax, while income derived by a Mainland financialenterprise investor is subject to PRC business tax. No PRC stamp duty will be imposed on the transfer, inheritance or gift of fund units in an MRF. 5. Certain Employer-paid Commercial Health Insurance Premiums Are Exempt from Individual Income Tax On 27 November 2015, the MOF, SAT and China Insurance Regulatory Commission (CIRC) jointly issued Notice 126 to initiate the individual 10 China Tax Monthly | December / January 2016 income tax (IIT) pilot program on commercial health insurance. Further, on 25 December 2015, the SAT issued Bulletin 9313 to implement the pilot program. Under the pilot program, starting from 1 January 2016, certain IIT taxpayers can deduct premiums paid for qualified commercial health insurance (limited to RMB200 per month14) from their taxable income in pilot areas15. Qualified commercial health insurance To be a qualified commercial health insurance product under Notice 126, the insurance product: • must provide universal insurance that has security functions and includes a guaranteed minimum benefit account, and shall have both medical insurance and personal account accumulation functions; • must provide direct management and maintenance of the insured’s personal account by the insurance company; • must be offered only to taxpayers over 16 years old who have not reached the statutory retirement age; • may not be refused to an individual based on his or her medical history and must guarantee renewal of the insurance; • may cover medical expenses that are not fully covered by basic medical insurance16; • must meet the minimum insurance amount as set by the CIRC; • must adhere to the “cost compensation and low profit” principle, i.e., if the simple loss ratio for medical insurance is lower than the prescribed ratio, the difference between the actual loss ratio and prescribed ratio shall be returned to the insured’s personal deposit account; and • must be approved by the CIRC. 13 Announcement of the State Administration of Taxation on Collection and Administration Issues Concerning the Implementation of Pilot Individual Income Tax Policies on Commercial Health Insurance, SAT Bulletin  No. 93, dated 25 December 2015, effective from 1 January 2016. 14 For individual business owners, individuals operating businesses contracted or leased from enterprises or public institutions, investors of sole-proprietor enterprises and investors of partnership enterprises, the deduction is limited to RMB2,400 per year. 15 The pilot areas include the four municipalities, i.e., Beijing, Shanghai, Tianjin and Chongqing, and one city from each of China’s 25 provinces or autonomous regions. 16 Basic medical insurance is a mandatory insurance under China’s social security system. December / January 2016 | China Tax Monthly 11 Beijing Suite 3401, China World Office 2 China World Trade Centre 1 Jianguomenwai Dajie Beijing 100004, PRC T: +86 10 6535 3800 F: +86 10 6505 2309 Hong Kong 14/F Hutchison House 10 Harcourt Road Central, Hong Kong T: +852 2846 1888 F: +852 2845 0476 Shanghai Unit 1601, Jin Mao Tower 88 Century Avenue, Pudong Shanghai 200121, PRC T: +86 21 6105 8558 F: +86 21 5047 0020 www.bakermckenzie.com To find out more about how we can add value to your business, please contact: Beijing Jon Eichelberger (Tax) +86 10 6535 3868 firstname.lastname@example.org Jinghua Liu (Tax and Dispute Resolution) +86 10 6535 3816 email@example.com Shanghai Brendan Kelly (Tax) +86 21 6105 5950 firstname.lastname@example.org Glenn DeSouza (Transfer Pricing) +86 21 6105 5966 email@example.com Nancy Lai (Tax) +86 21 6105 5949 firstname.lastname@example.org Hong Kong Amy Ling (Tax) +852 2846 2190 email@example.com New York Shanwu Yuan (Tax and Transfer Pricing) +1 212 626 4212 firstname.lastname@example.org Qualified IIT taxpayers According to Notice 126, IIT taxpayers covered by the pilot program include: • Individuals who derive employment income or consecutive labor remuneration; • Individual business owners; • Individuals operating businesses contracted or leased from enterprises or public institutions; • Investors in individual sole-proprietor enterprises; and • Investors in partnership enterprises. Notably, insurance purchased by an employer for an employee is deemed to be purchased by the employee and can be deducted by the employee accordingly. Tax incentive identification code According to Bulletin 93, the taxpayer’s insurance policy must have a tax incentive identification code stated on it in order for the taxpayer to claim the deduction. The tax incentive identification code is issued by the commercial health insurance information platform. Observations Despite the seemingly complex qualifying requirements, it is usually quite straightforward in practice for the taxpayer to determine whether a specific insurance product is a qualified commercial insurance product under Notice 126. Taxpayers and employers can simply check with the insurance company whether a tax incentive identification code is available for the insurance purchased. This update has been prepared for clients and professional associates at Baker & McKenzie. Whilst every effort has been made to ensure accuracy, no responsibility can be accepted for errors and omissions, however caused. The information contained in this update should not be relied on as legal advice and should not be regarded as a substitute for detailed advice in individual cases. No responsibility for any loss occasioned to any person acting or refraining from action as a result of material in this update is accepted by the editors, contributors or Baker & McKenzie. If advice concerning individual problems or other expert assistance is required, the services of a competent professional adviser should be sought. This update is protected by copyright. Apart from any fair dealing for the purposes of private study or research permitted under applicable copyright legislation, no part of this update may be reproduced or transmitted by any process or means without prior written permission of Baker & McKenzie. 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