China Tax Monthly Beijing/Hong Kong/Shanghai In this issue of the China Tax Monthly, we will discuss the following tax developments in China: 1. Land VAT Imposed on Share Transfers 2. China Issues New Rules on Super Deduction of R&D Expenses 3. VAT Zero-rate Regime Extended to More Services 4. Tax Incentives for National Independent Innovation Demonstration Zones Expand Nationwide 5. The SAT Issues Internal Guidance on Non-residents Claiming Tax Treaty Benefits 6. Referral Letter no Longer Required to Apply for a HK Tax Residency Certificate 7. Recordal Procedure Applies to All EIT Incentives 8. New HNTE Recognition Rules Expected for January 2016 9. Consolidation of Three Certificates Rolls out Nationally 10. Xianyang Case: Tax Authorities Highly Sensitive to Indirect Transfers 1. Land VAT Imposed on Share Transfers At the end of October 2015, an informal letter1 (Bian Han  No. 3) issued by the Hunan Provincial Local Tax Bureau became available to the public. This informal letter states that land value-added tax (“Land VAT”) should be levied on share transfers conducted by a controlling shareholder that actually transfers real estate via a share transfer and derives economic interest from the transfer. The legal position in the letter is controversial because Land VAT normally only taxes gains realised from the transfer of land, buildings and associated structures. It does not normally apply to share transfers. The 1 Notice of the Asset and Behavior Taxation Office of Hunan Provincial Local Tax Bureau to Clarify the Land VAT Imposition on Transfer of Real Estate in the Form of Share Transfer, Xiang Di Shui Cai Xing Bian Han  No. 3, dated 27 January 2015. October & November 2015 China Tax Monthly is a monthly publication of Baker & McKenzie’s China Tax Group. Beijing Suite 3401, China World Office 2 China World Trade Centre 1 Jianguomenwai Dajie Beijing 100004, PRC T: +86 10 6535 3800 F: +86 10 6505 2309 Hong Kong 14/F Hutchison House 10 Harcourt Road Central, Hong Kong T: +852 2846 1888 F: +852 2845 0476 Shanghai Unit 1601, Jin Mao Tower 88 Century Avenue, Pudong Shanghai 200121, PRC T: +86 21 6105 8558 F: +86 21 5047 0020 2 China Tax Monthly | October & November 2015 position in the letter is based on three State Administration of Taxation (SAT) notices, i.e., Notice 6872 , Notice 3873 and Notice 4154 . The three SAT notices Notice 687 responded to a Guangxi case in which two shareholders jointly transferred 100 percent of the shares held in a company. The company’s main assets were land use rights and buildings. The SAT decided the share transfer was subject to Land VAT. Notice 387 responded to a Guangxi case in which a company contributed real estate to another company and then transferred the received shares less than two months later. The SAT decided the substance of the transfer was a real estate transfer and was therefore subject to Land VAT. Notice 415 responded to a Tianjin case. The notice provided no details about the case. Instead, it simply stated that a shareholder transferred land use rights via a share transfer and that transfer was therefore a real estate transaction subject to Land VAT. Observations The three SAT notices demonstrate that Chinese tax authorities have been increasingly aggressive to counter tax avoidance. In such circumstances, the share transfer in a special purpose vehicle (SPV) is subject to an increasing risk of being subject to Land VAT if the SPV has little to no substance and merely holds real estate. For example, if a shareholder makes a tax-free contribution of land into an SPV and then immediately transfers the received shares, the share transfer faces significant risk of Land VAT exposure. That said, it is questionable whether the tax authorities have any legal basis to impose Land VAT on share transfers given that the Interim Regulations on Land VAT does not include a share transfer as a taxable event. Further, for Land VAT, there is no anti-avoidance rule at legislation level that authorizes tax authorities to re-characterize the share transfer as a real estate transaction. However, we should bear in mind that China may include a general anti-avoidance rule (GAAR) that can be applied to various taxes in the future. If introduced, the GAAR will provide the tax authorities with the legal basis to justify the land VAT imposition on share transfers. 2 Reply of the SAT to Questions relating to the Land VAT Imposition on Transfer of Real Estate in the Form of Share Transfer, Guo Shui Han  No. 687, dated 5 September 2000. 3 Reply of the SAT to Questions concerning Relevant Land VAT Policies, Guo Shui Han  No. 387, dated 17 July 2009. 4 Reply of the SAT to Questions concerning the Land VAT Imposition on the Transfer of Land Use Rights by Tianjin Taidahengsheng, Guo Shui Han  No. 415, dated 29 July 2011. October & November 2015 | China Tax Monthly 3 2. China Issues New Rules on Super Deduction of R&D Expenses On 2 November 2015, the Ministry of Finance (MOF), the SAT and the Ministry of Science and Technology (MOST) jointly issued Notice 1195 , addressing the new rules on super deduction of R&D expenses. Notice 119 will take effect from 1 January 2016 and replace the current rules, i.e., Guo Shui Fa  No. 116 and Cai Shui  No. 70. Super deduction refers to the tax incentive available to enterprises engaged in R&D. An enterprise can either (i) take a one-time enterprise income tax (EIT) deduction in the current year equal to 150 percent of the actual R&D expenses if no intangible asset results from the R&D, or (ii) amortize the resulting intangible asset at 150 percent of the actual R&D expenses that are calculated into the cost of the relevant intangible asset. Super Deduction expanded to new industries Currently, the super deduction is only available to enterprises engaged in listed high-tech industries. Notice 119 will expand the super deduction to cover all industries except for those on a “negative list”. The negative list includes the following industries: • tobacco manufacturing; • hotel and catering; • wholesale and retail; • real estate; • leasing and business services; • entertainment; and • other industries specified by the MOF and the SAT. Qualified activities expanded Under the current rules and Notice 119, R&D activities refer to systematic activities conducted by an enterprise to obtain and creatively apply new scientific and technological knowledge or to materially improve technologies, products (services) and techniques.6 Notably, Notice 119 extends the super deduction to creative design activities. Qualified expenses expanded Notice 119 categorizes qualified R&D expenses into the following seven broad categories: 5 Notice on Improving the Super Deduction Policy of R&D Expenses, Cai Shui  No. 119, dated 2 November 2015, effective from 1 January 2016. 6 Notice 119 specifically names seven activities to be excluded from the super deduction because the activities do not meet the definition of R&D activities. 4 China Tax Monthly | October & November 2015 • labor costs; • direct investment expenses; • depreciation expenses; • amortization of intangible assets; • design fees for new products, formulating fees for new technique procedures, clinical test expenses for new drug development and field trial expenses for the exploration and development of technology; • other related expenses; and • other expenses specified by the MOF and SAT. “Other related expenses” should not exceed 10 percent of the total qualified R&D expenses. The new qualified expenses under Notice 119 are labor costs for external R&D personnel, inspection fees for trial products, expert consulting fees, insurance premiums for high-tech R&D, and travel and conference expenses directly related to the R&D. The last three items are classified as other related expenses and thus subject to the 10 percent limitation. Contract R&D For contract R&D, Notice 119 leaves unchanged the current rule that permits the principal rather than the entrusted party to take the super deduction. But Notice 119 limits the qualified R&D expenses to 80 percent of the actual expenses. Further, under Notice 119, expenses incurred by a foreign entrusted party are not eligible for the super deduction. Notice 119 makes a welcome change in only requiring the breakdown of contract R&D expenses between related parties instead of between unrelated parties as the current rules require. Simplified procedures In addition to its expanded scope, Notice 119 has simplified procedures. First, Notice 119 changes the accounting requirement from the current special account to subsidiary account. Compared to the complicated standards for special accounts, the simpler standards for subsidiary accounts will lower compliance burdens. Second, Notice 119 reduces the burden on an enterprise during a dispute with the tax authority over eligibility for the super deduction. Currently, a tax authority may require an enterprise to submit an appraisal opinion issued by a government science and technology department if the tax authority disputes the enterprise’s eligibility for the super deduction. Notice 119 will instead require the tax authority to directly solicit that appraisal opinion from the competent science and technology department. Therefore, the enterprise will no longer bear the cost of obtaining the appraisal opinion. October & November 2015 | China Tax Monthly 5 Retroactive super deduction According to Notice 119, starting from 1 January 2016, an enterprise, which is eligible for but fails to enjoy the super deduction, can retroactively enjoy the super deduction after completing a recordal procedure within three years. Notice 119 does not clarify how this retroactive super deduction will be implemented: e.g., cash refund or decrease in the tax due in the year the enterprise claims to enjoy the super deduction. Article 51 of the PRC Tax Collection and Administration Law (TCAL) should provide the tax authorities with guidance in handling the retroactive super deduction. This general provision states that a taxpayer can claim a refund of overpaid tax within three years from the date of the tax payment. Therefore, after applying the retroactive super deduction, the tax authorities should refund any overpaid tax in cash. However, it remains to be seen how the tax authorities will implement the retroactive super deduction in practice. Observations With its expanded scope and simplified procedure, Notice 119 will benefit resident enterprises directly conducting R&D activities or outsourcing R&D activities to other resident enterprises. As the entrusted party under a contract R&D arrangement is not entitled to the super deduction, a Chinese subsidiary conducting R&D activities on behalf of a foreign principal will not be able to enjoy the super deduction. To enjoy the super deduction, the Chinese subsidiary needs to conduct the R&D activities on its own behalf. The foreign principal could transfer the intellectual property (IP) ownership to the Chinese subsidiary so that it could enjoy the super deduction. But, in practice, as IP protection concerns in China remain paramount for most foreign companies, the super deduction incentive will likely not induce many foreign companies to move R&D activities and IP ownership to China. Notice 119 makes one more significant change. It expressly excludes expenses for R&D outsourced to foreign companies from the super deduction incentive. This exclusion will likely discourage enterprises from purchasing foreign R&D services. 3. VAT Zero-rate Regime Extended to More Services On 30 October 2015, the MOF and the SAT jointly issued Notice 1187 , which extends the zero-rate regime to cover the following exported services provided by general value-added tax (VAT) taxpayers (which are presently VAT exempt): 7 Notice of the MOF and the SAT on the Application of VAT Zero-rate to Exported Services Relating to Films, etc., Cai Shui  No. 118, dated 30 October 2015, effective from 1 December 2015. 6 China Tax Monthly | October & November 2015 • radio, film and television program distribution and production services; • technology transfer services, software services, circuit design and testing services, information system services, business process management services and contract energy management services with offshore subjects; and • information technology outsourcing (ITO), business process outsourcing (BPO) and knowledge process outsourcing (KPO) services as prescribed in the applicable catalogue in Notice 1068 . As background, VATable exported services, i.e., VATable services provided by Chinese service providers to foreign service recipients, are zero-rated or exempt for VAT purposes. Regardless of whether zero-rated or exempt, no output VAT is levied on service fees. However, a credit or refund of input VAT incurred in the provision of the relevant services is only available under the zero-rate regime. In other words, compared to the exemption regime, the zero-rate regime grants the general VAT taxpayer more favourable tax treatment. Observations Notice 118 fixes an inconsistency in VAT treatment of exported R&D services. Before Notice 118, exported software R&D services were considered “software services” that only enjoyed VAT exemption, and exported hardware R&D9 were considered “R&D services” that enjoyed 0 percent VAT on export. Now, by extending the zero-rate regime to software services, Notice 118 will harmonize the treatment of software R&D and hardware R&D. In addition, the expansion of the zero-rate regime to ITO, BPO and KPO will benefit all technologically advanced service enterprises (TASE)10 because export of these services is a TASE’s sole or main business activity. 8 Notice of the MOF and the SAT on the Inclusion of the Railway Transport Industry and Postal Service Industry in the Pilot Collection of VAT in Lieu of Business Tax, Cai Shui  No. 106, dated 12 December 2013, effective from 1 January 2014. 9 The research and development of new technology, new products, new techniques or new materials or their systems. 10 A Chinese TASE will be able to enjoy a reduction in its enterprise income tax rate from 25 percent to 15 percent. October & November 2015 | China Tax Monthly 7 4. Tax Incentives for National Independent Innovation Demonstration Zones Expand Nationwide On 23 October 2015, the MOF and the SAT jointly issued Notice 11611 to expand the coverage of four tax incentives from the national independent innovation demonstration zones to the whole nation. On 16 November 2015, the SAT issued three bulletins, i.e., Bulletin 8012, Bulletin 8113 and Bulletin 8214, to further clarify and supplement Notice 116. EIT treatment of corporate partners in a venture capital LLP According to Notice 116, starting from 1 October 2015, where a limited liability partnership (LLP) established specifically for the purpose of venture capital makes an equity investment in a non-listed small- or medium-sized high-tech company for at least 24 months, its resident corporate partners may deduct 70 percent of the invested amount in the non-listed small- or medium-sized high-tech company from the profits distributed by the LLP for EIT purposes. Bulletin 81 further clarifies that in order for a corporate partner to enjoy the 70 percent deduction, the corporate partner should also have paid the capital to the LLP for not less than 24 months. Before Notice 116, EIT treatment differed for direct and indirect investment in a non-listed small- or medium-sized high-tech company. According to the EIT law and its implementing regulations, an enterprise could deduct 70 percent of the direct equity investment in the high-tech company from its taxable income when investment was held for two years. Whereas, for indirect investment, the 70 percent deduction only becomes available after the entry into force of Notice 116 except in some pilot zones. By expanding the 70 percent deduction to indirect investment, Notice 116 partially changed this inconsistency. However, a difference remains in the 70 percent deduction: in indirect investment, an LLP’s corporate partner 11 Notice on Expanding the Pilot Tax Policies for the National Independent Innovation Demonstration Zones Nationwide, Cai Shui  No. 116, dated 23 October 2015, the effective date varies depending on the tax matters concerned. 12 Notice of the SAT on Issues concerning the Collection and Administration of Individual Income Tax on Equity Incentives and Conversion of Undistributed Profits, Capital Reserves and Surplus Reserves into Share Capital, SAT Bulletin  No. 80, dated 16 November 2015, effective from 1 January 2016. 13 Notice of the SAT on Issues concerning Enterprise Income Tax on Corporate Partners of Venture Capital Limited Partnership, SAT Bulletin  No. 81, dated 16 November 2015, effective from 1 October 2015. 14 Notice of the SAT on Issues concerning Enterprise Income Tax on Technology Transfer Income Derived from Licensing, SAT Bulletin  No. 82, dated 16 November 2015, effective from 1 October 2015. 8 China Tax Monthly | October & November 2015 can only take the deduction from profits distributed by the LLP; while in direct investment, the investing enterprise can take the deduction from its full taxable amount. EIT treatment of technology transfer Starting from 1 October 2015, resident enterprises are entitled to an EIT exemption of up to RMB5 million on income from a non-exclusive technology license with a minimum period of five years, and a 50 percent EIT reduction for amounts in excess of RMB5 million. Previously, only an exclusive license with a minimum period of five years or an ownership transfer of qualifying technology was eligible for these tax benefits. Notably, Bulletin 82 limits the tax benefits to technologies owned by the licensor. Thus, income derived from sub-license does not qualify the above tax benefits. IIT treatment of share capital increase by the enterprise According to Notice 116 and Bulletin 80, starting 1 January 2016, where a non-listed small- or medium-sized high-tech enterprise converts undistributed profits, surplus reserves or capital reserves to share capital, any of its individual shareholders may pay the individual income tax (IIT) due in instalments within a period not exceeding five calendar years if the individual shareholder has difficulty paying the tax on a lump sum basis. Where the relevant enterprise is a listed small- or medium-sized high-tech enterprise, no instalment payment option is available. But the individual shareholders are exempt from IIT when capital reserves resulting from share premiums are converted into capital. These provisions in Notice 116 and Bulletin 80 triggered heated discussion nationwide. One opinion holds that individual shareholders are not liable to pay IIT on capital increase from capital reserves by the enterprise under the previous rules (i.e., Notice 19815 and Notice 28916), and thus Notice 116 and Bulletin 80 increase the tax burden on the individual shareholders rather than providing a tax benefit. Capital reserves can result from various items in addition to share premiums. In fact, Notice 198 and Notice 289 only exempt individual shareholders from IIT when capital reserves resulting from share premiums are converted to share capital. Therefore, technically speaking, Notice 116 and Bulletin 80 do not conflict with the previous rules. 15 Notice of the SAT on the Individual Income Tax Exemption upon Conversion of Capital Reserves and Surplus Reserves into Share Capital and Distribution of Bonus Shares by Companies Limited by Shares, Guo Shui Fa  No. 198, dated 25 December 1997. 16 Reply of the SAT to Questions concerning the Individual Income Tax Treatment of the Value Increase of Shares owned by Individuals during the Reorganization of Urban Credit Cooperative into Urban Cooperative Bank, Guo Shui Han  No. 289, dated 15 May 1997. October & November 2015 | China Tax Monthly 9 IIT treatment of equity incentives As provided in Notice 116, starting from 1 January 2016, where a hightech enterprise grants stocks to its qualified technical personnel, any such technical personnel can pay IIT due in instalments within a period not exceeding five calendar years if having difficulty paying the tax on a lump sum basis. The relevant income shall be subject to tax as salaries or wages, with the taxable amounts determined by reference to the fair market value of the relevant stocks when they are received. Stock incentives granted to the entire staff are excluded from the instalment payment option. Therefore, enterprises should be mindful of the IIT consequences on their employees when establishing equity incentive arrangements. 5. The SAT Issues Internal Guidance on Nonresidents Claiming Tax Treaty Benefits On 29 October 2015, the SAT issued Notice 12817 providing tax authorities at all levels with further guidance on the implementation of Bulletin 60, which relates to the procedural rules on non-residents claiming tax treaty benefits. For a detailed discussion of Bulletin 60, please refer to the August & September issue of our China Tax Monthly. Focus of post-filing administration According to Notice 128, the in-charge tax authority should conduct spotchecks on non-residents’ eligibility for tax treaty benefits. The spot-check should focus on the following situations: • The non-resident is from a tax jurisdiction with a low effective tax rate; • The non-resident has an adverse record with respect to treaty benefits applications; and • The treaty benefit amount is relatively large. During the examination, the following issues should be specifically checked: • Whether the tax residency certificate fully complies with the relevant rules and whether the non-resident is a dual tax resident; • Whether the taxpayer correctly classifies the income item and applies the correct treaty provision, and whether the non-resident is entitled to the relevant treaty benefit; • Whether the tax amount calculation is correct; and • Whether the tax treaty is abused. 17 The Administrative Measures on Non-residents Claiming Tax Treaty Benefits, Shui Zong Fa  No. 128, dated 29 October 2015, effective from 1 November 2015. 10 China Tax Monthly | October & November 2015 Notice 128 requires the tax authorities to spot check a minimum number of cases from each quarter. They must spot check 30 percent of cases relating to tax treaty benefits for passive income (dividends, interest, royalties and capital gains) within three months of the end of the quarter and spot check 10 percent of cases relating to tax treaty benefits for other income items within six months of the end of the quarter. Centralization under the SAT In order to achieve more consistent practice, Notice 128 requires the local tax authorities report certain matters to the SAT in certain situations. If a non-resident taxpayer claims tax treaty benefits under the same provision in more than one location, the in-charge tax authority that decides to recover the unpaid or underpaid tax should report to the provincial tax authority within 30 days from the tax recovery decision. The provincial tax authorities in all locations where the taxpayer claimed the tax treaty benefits should coordinate to reach a consensus on the non-resident’s treaty benefit eligibility. If a consensus cannot be reached within 90 days, the provincial tax authority located in the place of tax recovery should report to the SAT. The SAT will then decide the nonresident’s treaty benefit eligibility and direct the in-charge tax authorities in implementing the decision consistently. Any case with the tax recovery amount of RMB5 million or more should be reported to the SAT within 30 days from the date of the tax recovery decision. The SAT will summarize and collate the reported cases for distribution to tax authorities nationwide. For cases with high tax risks or inconsistent implementation, expert joint hearings will be organized aperiodically. Observations Since the tax authorities are required to examine 30 percent of passive income cases and 10 percent of other income cases within three months and six months respectively of the end of each quarter, non-residents face a higher risk of treaty benefit claims being examined during those periods. However, while less likely to face an examination outside those periods, the statute of limitations for tax avoidance arrangements is 10 years. Therefore, non-residents cannot completely preclude a later examination and still must labor under the basic uncertainty from Bulletin 60. Nonetheless, the reporting mechanism introduced by Notice 128 is a welcome development. By requiring important decisions to be made by the SAT, Notice 128 should help to create a more consistent treaty benefit administration. 6. Referral Letter No Longer Required to Apply for a HK Tax Residency Certificate On 30 October 2015, the Hong Kong (HK) Inland Revenue Department (IRD) published on its website the revised application forms for tax October & November 2015 | China Tax Monthly 11 residence certificates (TRCs) relating to the China-HK Double Taxation Arrangement. A referral letter issued by the PRC tax authority is no longer required in the application. Prior to 1 November 2015, according to Bulletin 5318, the PRC in-charge tax authority can recognize an enterprise as a HK tax resident based solely on its corporate registration certificate or business registration certificate. However, if the in-charge tax authority doubts the entity’s HK tax resident status, it can issue a referral letter to the IRD, requiring the IRD to issue a TRC for the taxpayer. Only with this referral letter, can the taxpayer apply to the IRD for a TRC. But with Bulletin 53 being repealed by Bulletin 60 as of 1 November 2015, the PRC tax authorities will no longer issue referral letters. Initially, there was a concern that this would create difficulties for HK tax residents in claiming tax treaty benefits in PRC. Thus, the IRD’s decision to no longer require the PRC tax authority referral letter as of 30 October 2015 is a welcome development. Hopefully, the taxpayer can now apply for and receive the TRC in 21 working days. However, from looking at the revised forms, it is still unclear how much substance the taxpayer need have in HK for the IRD to issue a TRC. 7. Recordal Procedure Applies to All EIT Incentives On 12 November 2015, the SAT issued Bulletin 7619, which uniformly applies a recordal procedure to resident enterprises claiming any EIT incentive. Bulletin 76 also includes an administrative catalogue for the recordal of EIT incentives (version 2015) (“Catalogue”) to provide further guidance on the recordal procedure. Bulletin 76 Procedure Under Bulletin 76, an enterprise should self-assess its eligibility to enjoy a tax incentive. If the enterprise determines that it is eligible to enjoy the tax incentive, it should file a recordal with the in-charge tax authority and preserve the relevant materials for ten years. The documents required for the recordal depend on the type of tax incentive. For some incentives, a recordal form is sufficient. For some others, both the recordal form and supporting documents are required. 18 Notice of the SAT on Issues concerning the Identification of Tax Resident Status relating to the Implementation of the Arrangement between Mainland China and Hong Kong Special Administrative Region Regarding the Avoidance of Double Taxation on Income and Prevention of Tax Evasion, SAT Bulletin  No. 53, dated 13 September 2013, effective from 1 November 2013, repealed by Bulletin 60 from 1 November 2015. 19 Notice of the SAT on Promulgating the Measures for Handling Enterprise Income Tax Incentives, SAT Bulletin  No. 76, dated 12 November 2015, retroactively effective as of the same date. 12 China Tax Monthly | October & November 2015 Notably, for the preferential tax rate for small-scale and low-profit enterprises and for the accelerated depreciation of fixed assets, the recordal requirements can be fulfilled merely by filling the corresponding sections in the enterprise’s tax return. If the tax authorities find the taxpayer is not entitled to the tax incentive in the post-filing administration, they can levy late payment interest (i.e., 0.05 percent per day) and potential penalties (from 50 percent to 500 percent of the underpaid tax), in addition to recovering any underpaid tax. Tax incentives covered Bulletin 76 clearly limits its scope to resident enterprises, which means it is not applicable to non-resident enterprises or their Chinese establishments. The recordal procedure applies to all kinds of EIT incentives. The Catalogue specifically lists 55 tax incentives covered by Bulletin 76. Notably, Bulletin 76 does not impact the special qualification procedures required for certain tax incentives, such as the preferential tax rate for the high and new technology enterprises (HNTE) or TASEs. For these tax incentives, the enterprise still needs to complete the relevant recognition procedure before enjoying the tax incentive. Timing of recordal According to Bulletin 76, the enterprise should file the recordal no later than when it files its annual tax return, which must be filed by 31 May each year. For the majority of the tax incentives listed in the Catalogue, the enterprise can enjoy the tax incentive when making EIT prepayments and makes the relevant recordal filing later upon annual filing. If the enterprise has enjoyed the tax incentive without filing the recordal by the deadline, the tax authority can require the enterprise to fulfil the recordal within a specified period. Meanwhile, the tax authority may impose a penalty (up to RMB10,000) on the taxpayer pursuant to the TCAL. Observations It is not surprising to see Bulletin 76 being issued. Starting from 2014, the SAT has been repealing the approval system for EIT tax incentives. Up to the issuance of Bulletin 5820 on 18 August 2015, all EIT tax incentive approvals have been replaced by the recordal system. Bulletin 76 significantly simplifies the procedures for resident enterprise to enjoy EIT incentives. Besides, the recordal system could present an opportunity for an enterprise to take a position and then defend its tax incentive eligibility on audit. 20 Notice of the SAT to Announce 22 Tax-related Items for Which the Approval Procedure Has Been Abolished, SAT Bulletin  No. 58, dated 18 August 2015, effective as of the same date. October & November 2015 | China Tax Monthly 13 However, uncertainty could also arise under the recordal procedure. Historically, the advance approval could provide the taxpayer with certainty21 by forcing the tax authority to take a position on the taxpayer’s eligibility for a tax incentive before the taxpayer took the incentive. Under the recordal system, the tax authority will not take a position on a taxpayer’s eligibility for a tax incentive until after the taxpayer takes the incentive in most cases. At any time within the following five years, the tax authority can decide the enterprise was ineligible for the tax incentive and recover the underpaid tax plus late payment interest of 0.05 percent on a daily basis. If the tax authority determines the enterprise took the tax incentive as an act of tax evasion, tax refusal or tax fraud, then there is no time limit for the tax authorities to recover the tax and levy the late payment interest or fines. 8. New HNTE Recognition Rules Expected for January 2016 At the end of October 2015, the MOST solicited comments from some government departments on the Draft Administration Measures for the Recognition of HNTE (“Draft”). Though not officially published, the Draft has been available to the public on the Internet. According to the Draft, the new rules will take effect as of 1 January 2016. Changes to HNTE qualifications The Draft makes some notable changes to the current HNTE recognition qualifications22. • Ownership of IP is required. Currently, IP obtained through an exclusive license with a minimum period of five years can qualify the enterprise for HNTE recognition. However, according to the Draft, the enterprise now must own the relevant IP for it to qualify. • Technical staff requirements are lowered. Currently, technical staff must account for at least 30 percent of the enterprise’s total staff for the enterprise to qualify as an HNTE. The Draft lowers that threshold to 10 percent and repeals the educational requirement for the technical staff. • R&D expense requirements are lowered. The Draft provides that R&D expenses in the past three accounting years should not be lower than 4 percent of sales revenue for an enterprise with sales revenue of no more than RMB200 million in the last year, and 3 21 In rare cases, the tax authority could overrule an approval within three years. But in these cases, the tax authority was only permitted to recover the underpaid tax without levying any late payment interest or fines. 22 The Administrative Measures on the Recognition of High and New Technology Enterprises, Guo Ke Fa Huo  No. 172, dated 14 April 2008, retroactively effective from 1 January 2008. 14 China Tax Monthly | October & November 2015 percent for an enterprise with sales revenue over RMB200 million in the last year. The current rules set the threshold 6 percent for any enterprise whose last year’s sales revenue is below RMB50 million. Observations Once finalized, the lowered requirements for technical staff and R&D expenses23 will make it easier for an enterprise to obtain HNTE recognition. However, by requiring ownership of IP to qualify for HNTE status, the Draft is likely to affect many Chinese subsidiaries of multinational enterprises (MNCs). IP protection concerns in China make many MNCs reluctant to allocate IP ownership to Chinese subsidiaries. Therefore, in practice, many Chinese subsidiaries obtain the IP via a license from foreign affiliates. According to the Draft, these Chinese subsidiaries will no longer qualify for HNTE recognition, and their current HNTE status will expire three years after recognition was granted. 9. Consolidation of Three Certificates Rolls Out Nationally According to Notice 12124, starting from 1 October 2015, the registration reform to consolidate three certificates, i.e., the business license, the tax registration certificate and the organization code certificate, into a single business license, expanded to the whole nation. This single business license will contain a uniform social credit code that replaces the identification numbers from the previous three certificates. For tax purposes, the uniform social credit code will function the same way as the current tax registration code. From 1 October 2015, all newly established enterprises will receive this consolidated business license when registering with the competent industrial and commercial bureau. Any enterprise established before this date will have its three certificates replaced with the single business license by 31 December 2020. Observations Enterprises no longer need to apply for a tax registration certificate from the in-charge tax authority. However, every taxpayer will still need to record with the in-charge tax authority any changes in operational address, finance employee in charge and accounting methods. 23 Notably, the R&D expense threshold is only lowered for enterprises with sales revenue in the last year below RMB50 million. 24 Notice of the Six Departments under the State Council, Including the State Administration for Industry and Commerce, on Effectively Implementing the State Council General Office’s Opinions on Accelerating Registration Reform to Consolidate Three Certificates into One Certificate, Gong Shang Qi Zhu Zi  No. 121, dated 7 August 2015. October & November 2015 | China Tax Monthly 15 10. Xianyang Case: Tax Authorities Highly Sensitive to Indirect Transfers On 17 November 2015, China Taxation News reported that the Xianyang Local Tax Bureau collected RMB15.76 million on an indirect transfer by a BVI company (“Transferor”).25 This case is the first indirect transfer case reported within Shanxi Province’s local tax bureau system. Case Facts The indirect transfer in question was realized through a transfer of 100 percent of the shares in a BVI company (“Target”), which indirectly owned 100 percent equity in a PRC company. The tax authorities noticed the transaction when the PRC company’s previous individual shareholder, a Chinese tax resident, made tax declarations in July 2011. The documents submitted in the declaration indicated that the shareholder transferred 100 percent of the shares in the PRC company to a HK company, which was wholly owned by the Target, for RMB60 million in December 2010. The PRC company later changed its name in January 2012. The tax authorities suspected a second transaction might have occurred after the transfer by the individual shareholder (“the First Transfer”) because: (i) the price of the First Transfer was low; and (ii) the new name of the company was similar to the name of a HK listed company. Further, they found online news reports stating that the HK listed company acquired the Target, which was wholly owned by the Transferor, in June 2011 with the main purpose of acquiring the underlying PRC company. At this point, the Xianyang tax bureau launched an indirect transfer investigation. And the tax officials confirmed the existence of the second transaction according to a report of the HK listed company. The report also stated that both the Target and the HK company did not have any operational business other than share acquisition. On this basis, the tax authority concluded that the substance of the second transfer was to transfer the PRC company, and it began direct negotiations with the offshore Transferor to recover the taxes. During this time, the tax authority sought leverage by restricting the enterprise’s actual owner from travelling abroad (it was not clear in the China Taxation News report whether the “owner” referred to the owner of the offshore Transferor or the underlying PRC company). After more than a year of negotiation, the Transferor finally agreed to pay the tax. 25 See http://www.ctaxnews.net.cn/html/2015-11/17/ nw.D340100zgswb_20151117_1-05.htm, accessed on 8 December 2015. China Taxation News is a newspaper indirectly owned by the SAT. 16 China Tax Monthly | October & November 2015 Beijing Suite 3401, China World Office 2 China World Trade Centre 1 Jianguomenwai Dajie Beijing 100004, PRC T: +86 10 6535 3800 F: +86 10 6505 2309 Hong Kong 14/F Hutchison House 10 Harcourt Road Central, Hong Kong T: +852 2846 1888 F: +852 2845 0476 Shanghai Unit 1601, Jin Mao Tower 88 Century Avenue, Pudong Shanghai 200121, PRC T: +86 21 6105 8558 F: +86 21 5047 0020 www.bakermckenzie.com To find out more about how we can add value to your business, please contact: Beijing Jon Eichelberger (Tax) +86 10 6535 3868 firstname.lastname@example.org Jinghua Liu (Tax and Dispute Resolution) +86 10 6535 3816 email@example.com Shanghai Brendan Kelly (Tax) +86 21 6105 5950 firstname.lastname@example.org Glenn DeSouza (Transfer Pricing) +86 21 6105 5966 email@example.com Nancy Lai (Tax) +86 21 6105 5949 firstname.lastname@example.org Hong Kong Amy Ling (Tax) +852 2846 2190 email@example.com William Marshall (Trade and Customs) +852 2846 2154 firstname.lastname@example.org New York Shanwu Yuan (Tax and Transfer Pricing) +1 212 626 4212 email@example.com Observations It is not clear from the China Taxation News report whether the Xianyang tax bureau conducted a reasonable commercial purpose analysis. The report indicates only that the focus of the investigation was the identification of the indirect transfer. Regardless of whether the Xianyang tax bureau conducted a reasonable commercial purpose analysis, this case shows that the tax authorities have become sensitive to indirect transfers and can utilize various resources and techniques to identify them, including news reports and listed company reports. This update has been prepared for clients and professional associates at Baker & McKenzie. Whilst every effort has been made to ensure accuracy, no responsibility can be accepted for errors and omissions, however caused. The information contained in this update should not be relied on as legal advice and should not be regarded as a substitute for detailed advice in individual cases. No responsibility for any loss occasioned to any person acting or refraining from action as a result of material in this update is accepted by the editors, contributors or Baker & McKenzie. 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