Shanghai office Legal flash April 2017 This issue covers legislation published in March 2017 Index implemented nationwide Administrative provisions on employment of foreigners in china revised Implementing rules on Sino-foreign cooperative joint ventures revised New administrative measures on special tax adjustment investigation and mutual agreement procedure Chinese tax reform: what to expect in 2017 Legal flash Shanghai office 2 Foreign nationwide (全面实施外国人来华工作许可制度) On March 28, 2017, six months after the pilot program was implemented in Anhui, Beijing, Guangdong, Hebei, Ningxia, Shandong, Shanghai, Sichuan, Tianjin and Yunnan, the State Administration of Foreign Experts Affairs, the Ministry of Human Resources and Social Security, the Ministry of Foreign Affairs and the Ministry of Public Security jointly issued The Circular aims to establish a unified system for issuing the work permit notice and the work permit to foreign employees in China from April 1, 2017. As covered in previous issues of our legal flash,1 the former foreign expert work permits and the alien employment licenses for other foreign employees are combined into a new work permit notice for foreign employees, and the former foreign expert certificates and the alien employment permits for other foreign employees are combined into a new work permit. Certificates and permits issued under the former system will continue to be valid until their expiry date. The categorization and scoring system for foreign employees remains the same as during the pilot implementation. However, scoring factors are slightly different: senior-level skilled workers and technicians now qualify for the same points as employees with Chinese language levels are halved, capped at five points, and any of the following four circumstances adds an additional five points (but they cannot be accumulated): (i) patent ownership; (ii) employment in China for more than five consecutive years; (iii) graduation from a renowned university abroad; or (iv) work experience in Fortune 500. The application process for both the new work permit notice and the new work permit is expected to increase from 12 to 22 working days, approximately. Date of issue: March 28, 2017. Effective date: April 1, 2017 1 See http://www.cuatrecasas.com/publications/legal_flash_shanghai_november_2016.html Legal flash Shanghai office 3 Administrative Provisions on employment of foreigners in China revised (修改外国人在中国就业管理规定) On March 13, 2017, the Ministry of Human Resources and Social Security issued its Decision on Revising the Administrative Provisions on Employment of Foreigners in China (Decision No. 32), removing the requirement to submit an invitation letter from the Chinese authorities (usually from commerce departments or foreign affairs offices at municipal or provincial level) together with the application documents for the Z work visa. This means that representatives of representative offices only need to submit the registration certificate for their office, and general foreign employees are only required to submit the new work permit notice mentioned above. This change is expected to shorten the application procedure, as it used to take about 10 days to issue the invitation and sometimes involved different authorities. Date of issue: March 13, 2017. Effective date: March 13, 2017 Implementing rules on Sino-foreign cooperative joint ventures revised (国务院修改中华人民共和国中外合作经 营企业法实施细则等多部行政法规) On March 1, 2017, the State Council announced the revision of several regulations, including the Implementing Rules on Sino-Foreign Cooperative Joint Ventures (Decision No. 676). Further to the revision, the foreign party can no longer apply for approval to recover its investment before the However, the foreign party can still recover its investment in a proportion different to its shareholding, by mutual agreement, as stipulated in the cooperative joint venture contract. Date of issue: March 1, 2017. Effective date: March 1, 2017 Legal flash Shanghai office 4 New Administrative measures on special tax adjustment investigation and mutual agreement procedure (特别纳税 调查调整及相互协调程序管理办法) Profit Shifting  No. 2 on Provisional Administrative Measures on Spec in one regulation, the SAT decided to issue separate announcements focusing on issues that Since then, the SAT has issued Announcement  No. 42, on improving related-party transactions reporting and administra and Announcement  No. 64, on improving the administration of advance pricing With SAT Announcement  No. 6, on improving the administration of special tax effective May 1, 2017, amendments to Circular 2 are now almost complete. Circular 6 will replace chapter 4 (transfer pricing methods), chapter 5 (transfer pricing investigation and adjustment), chapter 11 (adjustment and international agreement procedure) and chapter 12 (legal liability) of Circular 2; Guoshuihan  No. 188, on reinforcing the followGuoshuihan  No. 363, on reinforcing the monitoring and investigation of crossborder relatednouncement  No. 16, on EIT issues relating to crossborder relatedCircular 6 highlights: 1. Overall principle for special tax adjustment administration Circular 6 provides rules for tax authorities on risk management, reinforcing the monitoring Legal flash Shanghai office 5 Circular 6 follows the Draft Regulat profit level when selecting targets for special tax adjustment. However, Circular 6 does not include the specific chapter and measures described in the Draft Regulation, although the tax authorities will probably use them for reference. Specifically, the tax authorities are defining risk levelsfor companies and designing different strategies to: (i) set a risk alert and develop a voluntary adjustment mechanism for companies with medium-to-low risks and high tax compliance, and (ii) launch investigations on companies with high risks and low tax compliance. As the tax authorities will continuously monitor companies before and after the special tax adjustment, Circular 6 removes the previous five-year follow-up monitoring period after tax adjustment under Circular 2 and Circular 188. 2. Risk alert and voluntary adjustment mechanism Circular 6 includes the contents of Circular 54: if the tax authorities implement special tax adjustment monitoring through reviewing related-party reporting, administrating transfer pricing documentation and monitoring profit level, and they identify companies with special tax adjustment risk, they can notify those companies of the tax risk. Companies that receive notice of the tax risk can make voluntary adjustments and pay the tax due based on self-assessment. However, the tax authorities retain the right to investigate the companies if they disagree with the voluntary adjustments. Also, the tax authorities must launch an investigation if a company asksthem to confirm the transfer pricing principles and methods used to self-assess relevant related-party transactions. 3. Special tax adjustment investigation target company Circular 6 lists risk indicatorsthat expose companies to investigation: Significant amounts or types of related-party transactions; Long-term losses, low profit or fluctuating profit. Lower-than-industry level profit. Discrepancy between profit level and functions and risks assumed, or between shared profits and allocated costs under a cost sharing agreement. Transactions with related parties established in low tax jurisdictions. Failure to report related-party transactions or prepare transfer pricing documentation. Legal flash Shanghai office 6 Ratio of related-party debt investment to capital investment exceeding required standards (thin capitalization). Companies established in jurisdictions with income tax rates lower than 12.5% and controlled by Chinese resident companies or Chinese resident individuals that do not distribute profits or reduce the amount of profit distribution without reasonable operation needs (controlled foreign companies). Other tax planning or arrangements implemented without reasonable commercial purposes. This list came from Circular 2, but Circular 6 adds three new targets (cost sharing agreements, thin capitalization and controlled foreign companies) and amends the wording of i) above to comply with the general anti-avoidance rule (Announcement  No. 32). 4. Special tax adjustment investigation procedures Circular 6 provides detailed procedures for launching an investigation, including the format and delivery of tax notices, information required, and methods to obtain evidence. The following companies are not targeted for special tax adjustment investigation: Companies that reached an agreement with the tax authorities in the pre-filing meeting for the APA application, having already submitted the letter of intent and having applied for the APA to apply retroactively to previous years. Companies that have filed the formal application letter for the APA. However, transactions carried out in the years not covered by the APA are still subject to special tax adjustment investigation. Additionally, non-resident companies are also subject to special tax adjustment investigation by the Chinese tax authorities, domestic related parties to deliver the tax notice on investigation to the overseas company. 5. Special tax adjustment investigation comparability analysis and transfer pricing methods During a special tax adjustment investigation, the tax authorities must conduct the comparability analysis from five perspectives: (i) the nature of the transaction assets or Legal flash Shanghai office 7 services, (ii) the functions and risks assumed and assets used by the parties in the transactions, (iii) contractual terms, (iv) economic environment, and (v) business strategy. Compared to Circular 2, Circular 6 improves the detailed analysis content for each perspective, such as adding financial assets, a new type of related-party transaction identified under Circular 42, in (i) and (ii); credibility of the signing related parties in (iii); geographic factors of cost saving and market premium in (iv); and synergy in (v). In addition to the five transfer pricing methods provided under Circular 2 (comparable uncontrolled price method, resale method, cost plus method, transactional net margin method and profit split method), Circular 6 adds three new methods: (a) cost method, (b) market method, and (c) income method. 6. Special tax adjustment rules Circular 6 establishes several special tax adjustment rules for the tax authorities to follow in their investigations: When analyzing and evaluating related-party transactions based on functions and risks assumed by the parties involved, the tax authorities will choose the party with a relatively simple function as the testing object. will be to use public information, but they may also use non-public information. When analyzing and evaluating whether related-party transactions comply with the arm's length principle, the tax authorities can, on a case-by-case basis, choose to apply the arithmetic method, the weighted average method or the quartile method, or resort to other statistical methods to calculate the average or quartile range of the comparable profits or prices on a year-by-year or multiple-year basis. The tax authorities will conduct tests or adjustments on a year-by-year basis, according to the level of comparable profits or prices. profit level, and its profit level is lower than the median value of the comparable profit margin, in principle, the tax authorities will adjust the level to no lower than the median value. When the selected comparables are in different economic environments, the tax authorities will analyze the special geographic factors, such as cost saving and market Legal flash Shanghai office 8 premium, and select a reasonable transfer pricing method to determine the impact of special geographic factors on the profits. As under Circular 363, companies engaging in contract processing or other single production operations, or distribution, contract research and development with overseas related parties should maintain a reasonable profit level. Failing to do so means having to prepare transfer pricing documentation for the years they suffered a loss, regardless of whether the companies reached the threshold for preparing the documentation under Circular 42. As under Circular 2, the tax authorities generally do not make special tax adjustments to transactions between domestic related parties with the same effective tax burden, as long as these transactions do not directly or indirectly result in an overall tax revenue loss at national level. If the tax authorities payment for interest, rentals and royalties, unless otherwise provided, the withholding tax on these payments is not adjusted. 7. Transfer pricing rules on crossborder payments of royalties and service fees Circular 6 includes the transfer pricing rules from Circular 16 on crossborder payments of royalties and service fees by Chinese resident companies, adding more details: a) Circular 6 emphasizes the analysis of value creation for royalty payments related to creation of the intangible assets should match the income allocated to those parties, ation flow and fully maintenance, protection, application and promotion of value creation for the intangible interaction with the functions, risks and assets of other businesses within the group. Circular 6 also emphasizesthat royalties on transferring the right to use intangible assets should match the economic benefits received by the parties that use the intangible assets. The tax authorities may challenge companies that are making a loss and paying significant amounts of royalties, which may need to justify the alignment between the royalties paid and the economic benefits obtained. b) Circular 6 emphasizes the benefit analysis of service fee payments, including those relating to shareholder activities: Legal flash Shanghai office 9 Activities of the board of directors, the shareholders meeting, the board of supervisors, issue of shares and other activities that benefit the shareholders. Activities relating to preparing and analyzing operation and financial reports of the direct or indirect investors, the group headquarters and the regional headquarters of the service recipient. Financial activities relating to the business and capital operations of the direct or indirect investors, the group headquarters and the regional headquarters of the service recipient. Financial, taxation, human resources, legal and other activities needed for group decision-making, supervision, control and compliance. Other similar cases. 8. Legal liability for special tax adjustment Special tax adjustment entails daily interest on payable EIT for transactions conducted since January 1, 2008. Failing to pay the EIT due within the period required by the tax authorities in the notice for special tax investigation adjustment will result in late payment surcharges instead of interest, starting the day after the payment deadline. If a company under investigation appliesto change its business address or for tax deregistration during the investigation, the tax authorities will not process these applications until the investigation is finished. 9. Legal remedies after special tax adjustment If a company objectsto the special tax adjustment after the investigation is finished, Circular 6 providesthree legal remedies: 1. Filing for administrative reconsideration after paying EIT due, interest and any late payment surcharge, or after providing a guarantee for these amounts. 2. Filing an administrative lawsuit if it disagrees with the result of the administrative reconsideration. Legal flash Shanghai office 10 3. Applying to the SAT, under the tax treaties signed between China and other countries, to initiate a mutual agreement procedure to avoid or eliminate international double taxation. The scope of mutual agreement includes: negotiating bilateral or multilateral APAs; and negotiating one party's adjustment as a result of a special tax investigation and adjustment made by the other party to the tax treaties. Circular 6 reflects the insight gained from the eight years Circular 2 was implemented. It follows the principle promoted by G20 that profit should be taxed in the place where the economic activity takes place and value is created, through absorbing the new international tax rules and the results of the BEPS Action Plan, specifying working procedures and methods for domestic special tax adjustment investigation, and normalizing the process and content for international mutual agreement procedure. We expect the tax authorities will be more rigorous with the special tax adjustment monitoring and investigation. Companies should be prepared to face new challenges and conduct self-assessment of their related-party transactions to avoid or reduce the special tax adjustment risk, especially those with low profit levels not matching the functions and risks assumed, and those paying significant royalties and service fees overseas. Date of issue: March 17, 2017. Effective date: May 1, 2017 Chinese tax reform: what to expect in 2017 setting objectives for 2017. He referred to the following tax reforms: Simplifying the current four value added tax rates (17%, 13%, 11% and 6%) into three. Expanding the scope of small-and-low-profit companies that can benefit from a 50% reduction on taxable income for EIT purposes by increasing annual taxable income from RMB 300,000 to RMB 500,000. Increasing from 50% to 75% the R&D expenses super-deduction proportion for small-tomedium technology companies. Legal flash Shanghai office 11 After the session, the Minister of Finance, Mr. Xiao Jie, addressed questions on the individual income tax reform at a press conference, mentioning that the reform program is now in the process of research, design and presentation. One of the main reforms expected is the combined consolidation and categorization tax collection system, which will consolidate part of personal income for annual declaration (e.g., salary, service fee and earnings from publications) and continue to separate collection of other income (e.g., property transfers). More special tax burden are also expected and an increase in the general exempt amount is being considered. Contact Omar Puertas Partner [email protected] Cuatrecasas Shanghai office 20 F Shui On Plaza, 333 Huai Hai Middle Road Shanghai 200021, P.R.C. +86 21 2327 7000 +86 21 2327 7007 [email protected] ©2017 CUATRECASAS. All rights reserved. This document contains legal information produced by Cuatrecasas. This information does not constitute legal advice. Cuatrecasas owns the intellectual property rights to this document. 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