The general anti-avoidance rule ("GAAR") has been high on the radar screen of the State Administration of Taxation ("SAT") since the Enterprise Income Tax Laws became effective on January 1, 2008. The enforcement of the GAAR appeared to work quite well and generated a tax revenue of 46.8 billion RMB in 2013. On July 29, 2014, the SAT struck again by adopting Shuizongbanfa [2014] No. 146 ("Circular 146"), which was intended for internal circulation within the Chinese tax authorities.

Circular 146 essentially mandates a nationwide crackdown on outbound services fees and royalties paid to related parties, especially those located in low tax jurisdictions, over a period of 10 years from 2004 until 2013. Given the importance of services fees and royalties in outbound repatriations, Circular 146 once again highlights the vague standards of reasonable business purpose and economic substance. Clearly, certain outbound services fees and royalties are subject to elevated scrutiny pursuant to Circular 146.

Outbound Services Fees

The suspect outbound services fees by a domestic enterprise include the following:

  • Services fees paid to shareholders in connection with planning, management, and monitoring activities of the domestic enterprise' operation, accounting, and human resources etc.;
  • Group management fees paid for uniform management among the group;
  • Services fees paid for services the domestic enterprise is capable of performing or a third party has already performed;
  • Services fees paid for services irrelevant to the domestic enterprise' functions and risks, or incompatible to the domestic enterprise's operation despite relevance to its functions and risks; and
  • Services fees paid twice for the single package of services.

Outbound Royalties

The suspect outbound royalties by a domestic enterprise include the following:

  • Royalties paid to tax haven jurisdictions;
  • Royalties paid to foreign related parties serving no or simple functions; and
  • Royalties overpaid in excess of the due value or without recognition of the domestic enterprise's special contributions.

Our Observations

Circular 146 is a part of the GAAR enforcement trend. The SAT requires the local tax authorities to complete the initial enforcement survey by September 15, 2014. Suspicious taxpayers will be targeted in special tax adjustment proceedings. Right after the issuance of Circular 146, the SAT released Announcement [2014] No. 54 to provide further guidance of special tax adjustment proceedings on August 29, 2014. More are likely on the way.