Outbound payments under close scrutiny by the Chinese tax authority
By Ricky W. P. Wong, Wong Brothers & Co
In recent years, the Chinese tax authority has intensified its efforts to control outbound inter-group service fees and royalty charges. In July 2014, the State Administration of Taxation (SAT) released an internal circular (“Circular (2014) No. 146”) asking local tax authorities to initiate detailed investigations on all significant outbound service fee payments and royalty charges made by domestic enterprises to their overseas related parties between 2004 and 2013, with a view to identifying avoidance schemes for profit shifting.
In March 2015, the SAT issued a “Public Notice Regarding Certain Corporate Income Tax Matters on Outbound Payments to Overseas Related Parties” (“Notice  No. 16”). In the Notice, the SAT re-affirmed that service fees and royalty charges paid to overseas related parties must be in compliance with the “arm’s length principle”. The Notice mirrors the position expressed in Circular (2014) No. 146, and formalises the SAT’s position with regard to outbound payments of service fees and royalty charges from transfer pricing perspectives. The Notice allows the Chinese tax authority to request a domestic enterprise to submit supporting evidence including relevant agreements, grounds, pricing details, etc., pertaining to an outbound payment. If the authority considers that the payment is not in accordance with the arm’s length principle, it can make special tax adjustments by retroactively denying tax deduction of the payment within 10 years.
In brief, the following types of inter-group payments, as indicated in the Notice, are not tax deductible:
- Fees paid to overseas related parties with no business substance
- Fees paid to overseas related parties that undertake no substantial functions or assume no business and commercial risks
- Fees paid to overseas related parties for services:
- irrelevant to the functions and risks borne by the domestic enterprise, or irrelevant to the operations of the domestic enterprise
- connected with controlling, administering and monitoring the domestic enterprise so as to secure the investment interests of the overseas investors
- for activities that the domestic enterprise has already performed by itself or purchased from third parties
- not specifically required although the domestic enterprise may benefit incidentally from being part of the group
- already compensated as part of other related party payments
- which do not produce direct or indirect economic benefits to the domestic enterprise
- Royalties paid to overseas related parties that merely own the legal rights of the relevant intangible assets but have made no contribution to the value creation of the intangible assets
Notice  No. 16 indicated the SAT’s intention to implement anti-avoidance measures based on the BEPS action plan. Foreign companies having subsidiaries or associates in China should pay special attention to the requirements of the Notice, and assess the authenticity and reasonability of the outbound service and royalty payments previously received from them. In addition, they should consider putting a sustainable action plan in place for inter-group charges, including sufficient and plausible transfer pricing documentation.
Ricky W. P. WongWong Brothers & Co., Hong Kong
Mr Wong has been in public practice for over 30 years, and has extensive experience in tax consulting engagements in Hong Kong and China. He is a Vice Chairman of the ITPG for the Asia-Pacific region.
Wong Brothers & Co. was established in 1964 and currently has four partners. It is one of the most reputable CPA firms in Hong Kong. The firm has approximately 90 staff, including professionals and support staff, employed at two offices: one in Hong Kong and the other in Shenzhen, China. Clients of the firm include many international and local companies engaged in different types of business.
Published: March 2016 l Photo: Colourbox.de/James Hardy