On 20 March 2015, the PRC State Administration of Taxation (“SAT”) issued Public Notice Regarding Corporate Income Tax Relating to Payment of Expenses to Related Foreign Parties by PRC Companies (关于企业向境外关联方支付费用有关企业所得税问 题的公告) (“Notice 16”), providing stricter transfer pricing rules for the control of service fees and other payments made by PRC companies to related foreign parties. ThisUpdate gives a short summary of the key points of Notice 16.
Notice 16 reiterates the principle found in article 41 of the PRC Corporate Income Tax Law (“CIT Law”) and provides that companies must comply with the arm’s length transaction principle for payments made to related foreign parties. If the payments are not at arm’s length, the tax authority may intervene and make the appropriate adjustments to the company’s tax assessment. The tax authority has up to 10 years from the year in which the relevant transaction occurred to act.
Copies of contracts and other documents
In line with article 43 of the CIT Law, Notice 16 provides that a PRC company making payments to a related foreign party may be required by the competent tax authority to provide copies of the contracts with the related foreign party pursuant to which those payments were made and such other transaction documents as may be needed to prove that the transaction is true and genuine and complies with the arm’s length principle.
Types of service fees that are not deductible
Notice 16 provides that any payments made by a PRC company to a related foreign party will not be deductible for PRC corporate income tax purposes if, in relation to the purported services provided for those payments, the foreign party bears no risk, carries no functions, and does not have any substantive business operations. Specifically, Notice 16 requires that any service fees paid by a PRC company must directly or indirectly benefit the PRC company (as the payer). For example, service fees are not deductible for the purposes of assessing liability for PRC corporate income tax if:
- the services are irrelevant to the functions, risks, or business activities undertaken by the PRC company;
- the services are for the purpose of controlling, managing, and monitoring of the PRC company to ensure that the PRC company’s direct or indirect shareholder will obtain the benefits from the investment;
- the services have been purchased by the PRC company from a third party or carried out by the PRC company itself;
- the PRC company does not receive the particular services from the related foreign parties although it does benefit as a result of being within the same corporate group;
- the services have been paid for in other related-party transactions; or
- the PRC company does not receive direct or indirect economic benefits from such services.
Payments for the Use of Intangible Property
When payments are not deductible
Under Notice 16, a PRC company making payments to a related foreign party for the use of intangible property (i.e., intellectual property, land use rights, and concessionary rights) must take into account of how much contribution each party has made to the creation of the value of the intangible property for the purpose of determining the economic benefits that each party is entitled to enjoy. If a PRC company makes payments to a related foreign party that owns the intangible property but does not contribute to the creation of the value of the intangible property, and this transaction is not in line with the arm’s length principle, those payments will not be deductible for the purposes of assessing liability for PRC corporate income tax.
Initial Public Offerings
If a PRC company incorporates a foreign holding company or a financing vehicle for the main purpose of an initial public offering, all payments made by the PRC company to the related foreign parties as a result of ancillary benefits resulting from the IPO will not be deductible for the purposes of assessing liability for PRC corporate income tax.