Special Tax Adjustments and Special Tax Investigations

Date:  2017-04-28    Autor:   Helen FANG

Recently, the State Administration ofTaxation issued the tax circular "Measures for Special Tax Adjustment andInvestigation and Mutual Consultation Procedures" (hereinafter referred toas “The Measures"), effective from May 1st.  Combined with the practice of Taxation inChina, The Measures have absorbed several important tax circulars and madefurther improvements respective of special tax adjustments.  The main changes include:

A. Further standardize the workingprocedures of the tax office for special tax investigations

-     Includingroutine monitoring, risk warning, place the case, investigation and evidencecollection, the development of adjustment methods, negotiations, tax paymentand other aspects. At the same time it made clear that, the non-residententerprises may also be filed as the object of investigation.

B. Furtherstandardize the steps and methods of comparability analysis applied by the taxoffice, with some specific requirements, e.g.

-       The taxoffice shall select the party with a relatively simple function as the objectto be tested on the basis of the analysis and evaluation of the functionalrisks of the parties involved in the transaction;

-       Whenthe tax office use the quartile method to analyze and evaluate the profit levelof an enterprise, and the actual profit level of the enterprise is lower thanthe median value of the profit margin of the comparable enterprise, adjustmentwill be made at a rate not lower than the median in principle.

C. Set up the mutual consultation procedures

-       TheState Administration of Taxation may initiate mutual consultation procedures asapplied by some enterprises already, or as requested by the competent taxauthority of the contracting party to negotiate with that competent taxauthority tax treaties to avoid or eliminate international double taxation as aresult of a special tax adjustment.

D. Add the related stipulations for intangible assetsand labor services transactions

-       Forintangible asset transaction, it emphasizes income distribution of intangibleassets should be matched by the value of contribution to the asset of eachparty;

-       Forlabor service transactions, it is necessary to distinguish between beneficialand non-beneficial services. The tax office may, in accordance with the fullamount deducted before tax, implement the tax adjustment on non-beneficiallabor services.

The Measures clearly stipulate that, thetax office should focus on 9 types of risk characteristics of enterprises asfor example those where profit level is lower than the industry level.  Even if enterprises make the adjustment andpay taxes at their own discretion, the tax office may also carry out specialtax investigations and adjustments. As long as transactions among domesticaffiliates subject to the same actual tax do not directly or indirectly lead toa reduction in the country's overall tax revenue, no special tax adjustmentwill be conducted in principle.

It is worth noting that the Measures havelisted the non-beneficial labor services:

ž Labor services that have beenaccepted by receiving party's affiliates, or have been purchased or implemented by thereceiving party;

ž Laborservices such as control, management andsupervision conducted to ensure investment gains for direct or indirectinvestors that have been accepted by the receiving party through affiliates.These labor services mainly include:

(a)  activitiesof the board of directors, the shareholders' meeting and the board of supervisors,the issuance of shares and other activities providing services for theshareholders;

(b)  activitiesrelated to the preparation and analysis of the operating or financial reportsof the direct or indirect investors, the group headquarters and the regionalheadquarters of the receiving party;

(c)  financialactivities related to the operating and capital operations of the direct orindirect investors, the group headquarters and the regional headquarters of thereceiving party;

(d)  financial,taxation, personnel, legal and other activities for group decision-making,supervision, control and compliance; and

(e)  othersimilar cases.

ž Laborservice that have been accepted from the receiving party's affiliates and only aim to obtain additional income due toaffiliation to the group instead of increasing income for the receivingparty;

ž  Laborservices that have been accepted from the receiving party's affiliates or the receiving party has been compensatedfrom other connected transactions. These labor services mainly include:

a)     servicesrelated to patent or non-patent technology, which are compensated out of theroyalties;

b)    loan-relatedservices that are compensated out of the interest on loans; or

c)     othersimilar cases.

ž  Laborservices that are not related to thefunctions assumed and risks undertaken by the receiving party or are not inconformity with the operations of the receiving party;

ž  Otherrelated labor services that cannot bringdirect or indirect economic benefits to the receiving party, which thenon-affiliated parties are unwilling to buy or carry out by themselves.

In cross-border transactions, it occurred from time to time that, the foreignrelated parties provide a full range of consulting services includingfinancial, taxation, personnel, legal to domestic subsidiaries. If suchservices are for the purpose of group decision-making, supervision, control,compliance, it might be considered by the tax office that main beneficiary isat the group level, rather than the domestic subsidiaries, and such serviceswill face the risk of tax adjustment. Therefore, for the future tax planning,in addition to service content and service pricing, the enterprises shouldspecially pay more attention to the rationalization of service drivers. For theintercompany service charges already deduct as expenses, the enterprises shouldconduct self-examination in accordance with the provisions of The Measures, andtake actions timely.

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