What kind of documents need to be submitted under China's transfer pricing regime when enterprises file their annual income tax returns?
The principal documents are as follows:
(i) The group organizational structure;
(ii) The nature of the taxpayer's business, and the industry and market conditions;
(iii) The controlled transactions, including identification of relevant data and inter-company agreements;
(iv) The assumptions, business strategies, and transfer pricing policies, including information regarding factors that influenced price-setting;
(v) An analysis of functions, risks, and tangible and intangible assets;
(vi) The selection of the transfer pricing method;
(vii) The application of the transfer pricing method including comparability analysis; and
(viii) The conclusions on the arm's length nature of the inter-company transactions.
The supplementary documents are as follows:
(i) Original entry books and transaction records;
(ii) Pricing documents such as invoices and shipping documents and inter-company correspondence;
(iii) Analysis of special factors that have directly or indirectly impacted the inter-company pricing, such as an explanation of any continuous losses for a period of time, market entry strategies and set-off transactions.
Q2. Under what circumstances will the tax authorities make transfer pricing adjustments?
(i) The cumulative amount of related-party transactions exceeds RMB100,000;
(ii) The estimated retrospective adjustments exceed RMB500,000;
(iii) A taxpayer has failed to comply with the related-party disclosure requirements in its annual return for previous years, or if, upon further audit investigation, a taxpayer is found to have provided incorrect information on its pricing and costs in relation to the related party transactions; and
(iv) A taxpayer has previously had transactions with related parties in tax-haven countries.
Q3. What kind of enterprises are most likely to expose themselves to transfer pricing investigation by the tax authorities for non-compliance?
(i) The production and operation decisions are controlled by related parties;
(ii) Amounts of the controlled transactions with related parties are significant;
(iii) Continuing losses for more than two consecutive years;
(iv) Fluctuating profits, i.e. profits and losses in alternate years;
(v) Profit margins lower than the industrial average or group average;
(vi) Payment of unreasonable fees to related parties; and
(vii) Sudden drop in profits after the expiration of a tax holiday period
What is the time limit for government agencies to carry out the annual inspection on total export FIEs?
According to the interim measures recently issued by several government agencies concerning the inspection of the exportation of products of a permitted category foreign invested enterprise (FIE) that exports its entire products directly, which only apply to 100% export FIEs established after 1 October 2002, the time limit is five calendar years from the day the total export FIE begins production.
The specific date for starting and ending the inspection period is broken into three categories:
(i) For a Total Export FIE established before 1 October 2002 that started production and needs to continue importing equipment within the total investment after that date, the inspection period runs from 1 October 2002 until five years after the FIE begins production. If, at the time the FIE begins production, the import equipment has not actually been put into production and use, the inspection period on such equipment will be the five years after the day the equipment is put into production.
(ii) If such a Total Export FIE has not started production but needs to continue importing equipment within the total investment after 1 October 2002, the inspection period runs five years from the day the FIE begins production. If the FIE begins production after 1 September, the period is calculated from 1 January of the following year.
(iii) For a Total Export FIE established before 1 October 2002 that does not need to import equipment after that date, the inspection period is five years from 1 October 2002 until the Total Export FIE begins production.
Can all export enterprises apply for an export tax refund or exemption?
The tax authority shall make an assessment on the taxable income of the FIE and decide the amount to collect, according to the Provisional Measures for Assessment and Collection of Enterprise Income Tax (the "Assessment and Collection Measures").
The State Administration of Tax and the Ministry of Commerce jointly issued a Circular (Guo Shui Fa [2006] 24) on 13 February 2006, specifying that an export enterprise will not be eligible to apply for an export tax refund/exemption if any of the following situations exists:
1. The export enterprise provides parties, other than its appointed transportation agent, customs declaration agent or transportation agent of the importer, with blank export tax refund/exemption documents (e.g. customs declaration forms or export remittance receipt confirmation statements);
2. The export enterprise proclaims itself to be an exporter of its own goods or goods of its invested companies in the case of a China Investment Enterprise, where in substance the export is for goods of another enterprise and is performed by that other enterprise;
3. The export enterprise proclaims itself to be an exporter of its own goods and signs both an export agency agreement and a purchase agreement in respect of the same shipment;
4. The export enterprise amends the details on the bill of lading after customs clearance such that the details stated differ from those stated in the customs declaration form;
5. The export enterprise proclaims itself to be an exporter of its own goods but does not assume responsibility for the quality of the products or timely settlement of foreign exchange or tax refunds as a result of improper export declarations;
6. The export enterprise does not participate in export activities in substance, but accepts and undertakes other export business introduced by an intermediary, and exports goods on its own account; or
7. The export enterprise is involved in any acts that contravene the laws and regulations on export tax refunds.
How are Stamp Tax related disputes resolved?
Under the Stamp Tax Implementing Rules, an overpayment of the Stamp Tax will not be refunded or credited. If there is a dispute with the tax authorities regarding the nature of the document and the applicable Stamp Tax rate, the party may appeal to a higher-level tax authority for examination of the document in question.
What are the penalties for violation of Stamp Tax regulations?
Both the Stamp Tax Regulations and the Stamp Tax Implementing Rules empower tax authorities to impose penalties on taxpayers who violate any of the provisions contained in the laws. To clarify the position of the laws on penalties for Stamp Tax violations, the Ministry of Finance and the State Administration of Taxation issued the Notice on Issues Concerning the Penalties for Violation of Stamp Tax Regulations in October 1994, which sets forth streamlined penalty provisions for the following Stamp Tax related offences:1 1. Taxpayers who fail to affix adequate stamps on taxable documents must pay a fine of up to five times the amount of tax payable, plus the shortfall; 2. Taxpayers who reuse a used stamp must pay a fine up of to five times the amount of tax evaded, or a fine of between RMB2000 to RMB1000; 3. Taxpayers who fail to cancel an affixed stamp for tax which have to be paid must pay a fine of between one to three times the amount of the stamp; and, 4. Persons who forge tax stamps will be prosecuted.
Since all government agencies are responsible for implementation of the Stamp Tax, additional penalties may arise from official or administrative use of the document, including denial of applications for registration and filing.
How is Stamp Tax paid?
Each party to a document calculates the amount of tax payable according to the Stamp Tax Regulations and purchases stamps in one lot in the full amount owed. If the tax on a document exceeds RMB500, a tax payment receipt may be issued instead of stamps. Stamps or receipts are then affixed to taxable documents at the time of their execution or at the time they are brought into China for use. Normally, stamps are pasted to the cover page or signature page of a document. Once the stamps or receipts are affixed, they are then immediately cancelled by the placement of either a seal or horizontal pen strokes across the face of the stamps.
Can the Stamp Tax be reduced?
Foreign enterprises without business establishments in China are obligated to pay Stamp Tax, as are those with resident representative offices, which essentially carry on liaison activities for their head office. However, in consideration of the relatively large amounts of money involved in some projects, which in turn result in comparatively high amounts of Stamp Tax, the Ministry of Finance has made available the opportunity to apply for a tax reduction. Where foreign enterprises have sale and purchase contracts, or lease agreements executed or obtained by them, the parties may apply for, and be awarded, a tax reduction by the State Administration of Taxation.
What documents are exempted from the Stamp Tax?
Certain documents are exempt from the Stamp Tax regardless of the identity of the parties involved, for example documents that show evidence of contributions to the government and qualified charitable organizations and schools. The Ministry of Finance retains authority to approve as tax-exempt other documents not specifically exempted by the Stamp Tax Regulations or the Stamp Tax Implementing Rules. Loan documents for interest-free loans or loans at discount rates also fall under the category of being exempt form the Stamp Tax, as do documents which relate to loans 'on preferential terms' made by foreign governments or international financial organizations to the Chinese government or Chinese financial institutions.
How is Stamp Tax applied if the execution is outside of China?
The parties to a taxable document signed outside China are liable to pay the Stamp Tax only when they first 'use' the document in China. The term 'use' is considered to include enforcement, registration, and filing of the document with government agencies as well as the document's submission into evidence during the course of legal proceedings.
How is stamp tax paid on contracts?
In March 1995, the Ministry of Finance and the State Administration of Taxation clarified that the Stamp Tax applies not only to general contracts, but also to subcontracts, irrespective of whether the contract is signed within or outside China. Unless documents are used as substitutes for the originals no stamp tax is applied. If the originals have been destroyed or lost, the copies must be stamped regardless of whether the holder had previously paid a Stamp Tax on the originals. Stamp Tax is also imposed on transactions in China involving both A and B shares which are traded on the two stock exchanges in China. With respect to for example contracts, which involve more than one party, each party is obligated to pay the Stamp Tax in full on original documents, which it retains. Current legislation does not require the concurrent application of the Stamp Tax to documents executed in more than one language. It has been the practice thus far that only one language version is stamped.
What is the nature and scope of the stamp tax?
The local tax bureaus collect the Stamp Tax. Stamps can be obtained from tax agencies and designated sales agents, including some banks. Sales agents (either enterprises or individuals) can retain a 5 per cent commission drawn from the proceeds from the stamps sold. The Ministry of Finance is responsible for interpreting the Stamp Tax Regulations, while the State Administration of Taxation has the authority to interpret the Stamp Tax Implementing Rules. The Stamp Tax is applied to all units and individuals, who write or obtain the following types of documents: (a) contracts or documents of a contractual nature, (b) documents relating to the transfer of property, (c) business account books, (d) documentary evidence of rights of license, and (e) other documents determined to be taxable by the Ministry of Finance.
What laws are there regarding stamp tax?
The Stamp Tax is governed by the Provisional Regulations of the People's Republic of China Concerning Stamp Tax (the 'Stamp Tax Regulations') and the Detailed Implementing Rules for the Provisional Regulations of the People's Republic of China Concerning Stamp Tax (the "Stamp Tax Implementing Rules"). The Stamp Tax Implementing Rules and the Stamp Tax Regulations were later supplemented by a number of regulations and notices which address the treatment of the Stamp Tax as it applies to specific documents executed and obtained by both Chinese and foreign parties.
What vehicles can be used for profit repatriation?
In China the most common forms of foreign invested enterprises are Wholly Foreign Owned Enterprises (WFOE) and Equity Joint Ventures (EJV). Both of these types of enterprises can repatriate their profits. Another option for repatriating profits is using an offshore company to incorporate the WFOE or JV. The offshore company would preferably be located in a low tax jurisdiction close to China. Such a structure keeps the business risk further away from the parent company and functions as a tax-planning instrument. Profit repatriation can also be carried out by a local operation as a branch. The branch is deemed as being a part of an offshore company, thus the income is deemed to be earned by in China by the foreign company and therefore taxable in China. Foreign invested Enterprise's Income Tax and other taxes applicable must be paid before profits can be repatriated to the foreign parent company.
Which methods are used to determine the pricing?
There are methods that are currently used: 1. Comparable Uncontrolled Price Method, where the prices are compared to comparable transactions between unrelated entities. 2. The Resale Price Method, whereby the gross profit margin is determined according to what would be appropriate if it were an independent business. 3. The Cost-plus Method. Whereby the price is based on a mark-up comparable with an independent seller.
How is the term "associated entities" determined?
In that context ownership is defined as no less than 25% shareholding; provision of loans accounting for no less than 50% of the owner's capital; provision of guarantee of loans that accounts for no less than 10% of the company's total loans. An enterprise is deemed to be under the control of another enterprise if the legal representative or not less than half of the directors are appointed by another enterprise; when the business operations are dependent on the provision of proprietary technology of another enterprise; when the purchase of raw materials or components or the sales of products are controlled by another enterprise.
What penalties are employed in the Chinese tax system?
General penalties that can be imposed are A) Fines, destruction of illegally printed invoices, confiscation of illegal incomes. B) Confiscation of incomes of other parties who illegally provide bank accounts, invoices, certificates etc. so that taxpayers pay less or no tax. More specifically penalties are as follows: 1. If a taxpayer does not pay on time a daily fine is collected equivalent to 0.0.5% of the tax unpaid from the date the tax became due. 2. If there is a failure to accomplish tax registration issues there may be a fine imposed not exceeding 2,000RMB or a fine exceeding 2,000 but not 10,000RMB. The same fines are applied to cases where the taxpayer fails to use the tax registration certificate as required. Under serious circumstances the fine may exceed 10,000RMB but not 50,000RMB. 4. If a tax payer fails to make a declaration of tax or underpays the amount payable, the fine imposed may exceed 50% but not five times the amount of tax unpaid or underpaid.
What are some requirements concerning tax registration and reporting in general?
Registration should be conducted within 30 days of the Administration of Industry and Commerce (AIC) has issued the business license. Changes to the taxation should be reported within 30 days to the same authority and cancellation of taxation should be made before cancellation of the business license. When registering at the AIC the following information is required: a) Business license. b). Articles of Association, contracts. c) Bank account certificate. d) ID card. e) Other documentation that may be required by the tax authorities.
Reporting of taxes should be made within the stipulated time requirements in a correct manner. If there are problems that hinder payment the taxpayer can apply for delay of payment, which must be approved by the authorities.
At which points do tax obligations occur?
As we all know there are many different kinds of taxes. The following shows a short list of examples when different tax obligations occur.
1. VAT
The obligation occurs at the following points: a. When sales proceeds are received or the evidence of collecting money is obtained if taxpayers sell goods or services. Payment periods can be every one, three, five, ten, or 15 days or per month. b. When taxpayers declare their imported goods at customs. The VAT for imported goods should be paid within seven days after customs fills in the tax payment certificate.
2. Foreign invested entity income tax
The FIE tax should be paid in advance quarterly within 15 days and should be declared within 5 months after the end of every year. The tax is calculated on an annual basis.
3. Individual income tax
Employers are to be the withholders of IIT. IIT shall be paid within the first seven days of every month. If there is no withholder the individual shall report the tax in person.
4. Land value added tax
Taxpayers shall provide the tax authority with property certificates, land use certificates, sales contracts, valuation reports etc. relating to the sales of real estate within seven days after transferring the real estate.
What is the structure of Chinese tax system?
The answer to this question lies in legal theory: Since China is a civil law country, judges are not authorized to create new rules or principles that are to be followed as binding law. Legal rules are codified and not based on precedent. As far as taxation, the main sources of legislation are national statutes and regulations and various rulings by the State Administration of Taxation (SAT). Legislation regarding specifically foreign enterprises are issued by the National People's Congress and the State Council. China's tax system is complex and non-compliance may trigger serious penalties. It is therefore not as simple as to say that all tax issues can be negotiated and it is highly important to understand and follow the statutes and SAT rulings. The main source of legislation is the Law on Administration of Taxation of the People's Republic of China, effective from May 2001.
