In 2015, the continued increase in crossborder transactions led to greater control supported by an intensive development of tax laws and regulations on anti- avoidance and transfer pricing. At the same time, China continued to develop a more solid taxation system, simplifying procedures and encouraging certain activities through special tax policies. This update highlights the most significant tax updates of the year. Please see our monthly legal flash for more comprehensive information.
Regarding anti-avoidance measures, the State Administration of Taxation (“SAT”) Announcement  No.7 was a crucial milestone, replacing the rules on offshore indirect equity transfers with a more comprehensive regulation covering indirect transfers of all types of Chinese properties that do not have reasonable commercial purposes and are carried out merely to avoid taxes in China.
Announcement  No.7 sets out (i) a blacklist of transactions considered not to have a reasonable commercial purpose without requiring further analysis, (ii) safe harbor rules that exempt certain indirect transfers of Chinese taxable properties, and (iii) the criteria to assess whether a transaction that does not fall in either category has reasonable commercial purposes. This is a welcomed improvement that should reduce the local authorities’ discretion and provide stronger grounds to defend non-taxation when a transaction is not tax-driven.
While it encourages voluntary reporting of indirect transfers by reducing or waiving penalties and interest if a reassessment takes places, reporting is no longer compulsory unless the tax authorities request it during an investigation.
In an effort to combat tax avoidance and evasion, on July 1, 2015, the National People's Congress ratified the Council of Europe and the OECD’s Multilateral Convention on Mutual Administrative Assistance in Tax Matters, to further integrate and open up China’s taxation system to the international community by committing to share information with other members of the convention on all types of Chinese taxes, except customs duties.
Regarding transfer pricing practices, the SAT has been paying closer attention to fees resident enterprises pay their overseas related parties, concerned that multinational groups have used aggressive tax planning and unreasonable service fees and royalties to shift profits away from China.
In this context, following China’s active participation in the OECD’s Base Erosion and Profit Shifting (“BEPS”) Action Plan (despite not being a member of this organization), the SAT has identified and specified the following overseas related- party payments as not meeting the arm’s length principle and, therefore, not being deductible for enterprise income tax (”EIT”) purposes:
Fee payments to related parties that do not perform functions or bear risks, and do not engage in any substantive business activities.
Fee payments for services that do not imply a direct or indirect economic benefit for the service recipient (such as irrelevant services, shareholding monitoring activities, duplicated services, services already paid for through other related-party transactions and benefits resulting from merely belonging to a group).
Royalty payments for using intangible assets that are not consistent with the specific risks and functions performed and the value created, but instead rely on their formal ownership.
Royalty payments for incidental interest or fringe benefits earned from financing or listing activities through an overseas holding or financing company.
Rules on administration of cost sharing agreements were also revised by mid- 2015: they no longer require the tax authorities’ examination and pre-approval before being implemented, although filing and post-monitoring is strengthened. However, this area still needs more development to overcome the lack of experience of both the tax authorities and the enterprises.
On December 21, 2015, the SAT issued the China Advance Pricing Agreement Annual Report for 2014, which covers the statistics on China’s advance pricing agreements (“APA”) from January 1, 2005, to December 31, 2014. This is the sixth year that the SAT has issued the APA Annual Report to introduce the China APA system, procedures and implementation. Although the number of signed APAs in 2014 dropped compared to 2013, an analysis of the statistics confirms taxpayers’ increasing inclination to use APA as a way to gain future certainty and to reduce double taxation risks in the case of tax reassessment.
Regarding the international framework, the most significant change relates to non-resident taxpayers’ access to the treatments and benefits established under China’s network of tax treaties.
Pre-approval procedures for tax treaty treatments and benefits relating to dividends, interest, royalties and capital gains are replaced with self-declaration filing procedures, or through giving their withholding agents complete documents proving eligibility. However, tax authorities are called to strengthen verification to avoid tax treaty abuse and underpayment of Chinese taxes.
China signed double taxation agreements with Chile, Taiwan and Zimbabwe on May 25, 2015, August 25, 2015, and December 1, 2015, respectively.
Further to the EU’s and China’s commitment to strengthen customs cooperation and mutually recognize the Authorized Economic Operator (“AEO”) status in the EU and in China, which certifies that business operators are compliant and meet certain standards, specific implementing guidelines were issued on October 30, 2015. As already implemented with Hong Kong, Korea and Singapore, this implies several mutual customs-clearance advantages for these AEOs in their import and export transactions.
China has also adopted several measures relating to EIT, affecting resident and non-resident enterprises.
Following the general trend to reduce approvals, the administration of EIT preferential policies of Chinese resident companies has gradually shifted from a system combining approval and filing procedures to one based mainly on filing procedures, including preliminary and post-filing obligations. In exchange, the tax authorities are called to implement monitoring and risk management procedures, and increase the frequency of regular reviews and audits.
Preferential enterprise income tax policies for small and low-profit enterprises were extended from January 1, 2015, to December 31, 2017 (first by increasing the taxable income threshold to benefit from the effective 10% tax rate to RMB 200,000; later, by eliminating the threshold), as were the accelerated depreciation of fixed assets policies (to cover new key industries).
The SAT has also relaxed the pre-tax deduction requirements for salary expenses, making accrued salary expenses for the past year deductible as long as they are paid to the employees before the EIT annual declaration for that year is completed. It also allows salaries and welfare benefits paid to dispatched employees to be included in the total salary amount of the enterprises accepting the dispatched employees, increasing the calculation basis for deduction limitations.
In addition, to promote innovation in China, the super-deduction policy for R&D expenses was revised and improved before the year-end, broadening its scope, simplifying accounting and management issues, and replacing the previous record filing procedure with a post-monitoring procedure.
Further to promoting innovation, starting October 1, 2015, when a resident enterprise obtains income from a non-exclusive licensing of technology for over five years, the enterprise will be entitled to an EIT exemption of up to RMB 5 million and a 50% reduction on the excess (before this was limited to exclusive licensing for five years or transfer of ownership of qualified technology).
In 2014, the State Council made a general call to improve institutional mechanisms and policies that encourage corporate mergers and restructuring, advocating for a review of the special treatments relating to EIT, land value-added tax (“land VAT”), value-added tax (“VAT”) and business tax.
In response, several circulars have been issued since December 25, 2014, (i) expanding the scope of the EIT tax deferral treatment by relaxing some of the conditions to access it and introducing new eligible types of transactions, such as transfer of equity or assets within a group and non-monetary asset investments, and (ii) temporarily exempting land VAT and deed tax triggered on restructuring transactions until December 31, 2017.
Finally, migration from business tax to VAT was further implemented in 2015 under the VAT pilot reform by expanding the scope of the zero-rated policy to include more types of exported services and by recognizing taxpayers’ right to offset input VAT paid before being recognized as a general VAT taxpayer (i.e., while setting up the business, including purchasing office and manufacturing equipment, paying utilities and contracting services) if certain conditions are met.