In March 2015, the SAT released Announcement 163 to formalize its position on fees resident enterprises pay to related parties overseas (please see our March 2015 legal flash for detailed information on Announcement 16).
Following the release of Announcement 16, the Zhejiang Province State Tax Authority was the first at provincial level to issue its Working Guidelines on Tax Risk Management of Fees Resident Enterprises Pay to Related Parties Overseas (the “Guidelines”).
Guidelines’ main highlights:
- They point out the main tax risks on which the tax authorities should focus when monitoring crossborder related-party payments from the perspective of resident enterprises, providing examples and key aspects to consider:
- Fees paid to related parties without substantial business activities, especially payments to related parties registered in tax havens and royalties paid for intangible assets with no residual value.
- Fees paid to related parties for services that do not entail a direct or indirect economic benefit for the resident enterprise.
- Fees paid to related parties for incidental interests or fringe benefits, including benefits for belonging to a group, shareholder activities, benefits from financing or listing activities through an overseas holding or financing company.
- Unreasonably priced fees paid to related parties when compared to fees paid to independent third parties, i.e., failing to follow the arm’s length principle.
- They also point out the main tax risks associated to crossborder related-party payments from the perspective of non-resident enterprises:
- Evading taxes in China by claiming services are provided offshore.
- Evading taxes in China by treating royalties as provision of services.
- Evading taxes in China by deliberately avoiding a permanent establishment in China.
- Evading taxes in China by offsetting receivables and payables with related parties.
- The Guidelines specify the use of a six-test approach to evaluate whether a resident enterprise uses related-party payments to shift profits and erode its tax base in China: (i) authenticity test, (ii) necessity test, (iii) benefit test, (iv) value creation test, (v) duplicity test, and (vi) remuneration test.
The Guidelines provide administrative measures that the local tax authorities may adopt, and they especially address what relevant information, divided into five categories, the local tax authorities may request from taxpayers. It is expected that tax authorities in other regions will take similar action to manage crossborder related-party payments. As local tax authorities have strengthened their work in this area and stepped up their assessment of resident enterprises, resident enterprises should prepare themselves to be able to address this type of procedure properly.
Date of issue: June 30, 2015. Effective date: June 30, 2015.