China Focuses on Outbound Transfer of Funds, TP and Tax Avoidance
2021-06-01

Case 1: The risk of denial of outbound payments and denied deductibility of payments

Recently, we have witnessed cases where tax authorities have either denied outbound payments or rejected the deductibility of such royalty and service payments leading to an additional tax burden. This can happen if no sufficient evidence is provided to support the overseas recipient’s contribution to the license or IPs, the reasonableness of the charging mechanism, the substance of royalties, as well as the authenticity, substance, and reasonableness of the services.

In China, the tax authorities have the right to conduct a retrospective investigation on payments for a maximum of ten years, raising requirements on agreements and transaction planning.


Case 2: The right of tax authorities to conduct the adjustment on the profit margin to a reasonable level.

This occurred in a case where a WFOE was essentially engaged in the simple processing of goods mainly for exportation, and those goods are primarily sold to foreign affiliated companies. 

The tax authorities discovered that the company earned minimal profits for an extended period of time, with its profit margins much lower than similar enterprises in the industry.

Through further analysis, the tax authorities discovered that the related party transaction mechanism was not compliant and subsequently selected 8 enterprises through the Global Database as comparable companies. Based on the related calculations, the company agreed to make special tax adjustments according to the profit margin of 6.5%.

If the transactions between an enterprise and its related parties do not conform to the arm’s length principle and reduce the taxable income, the tax authorities will most likely proceed to adjust the profitability to a level not lower than the median of the benchmarking result, which serves as an indication of reasonable profitability.

The tax authorities tend to hold the expectation of a profit level higher than the median of the benchmarking study, which shall be updated every year.


Case 3: Related parties may be identified even without direct or ultimate shareholding 

A Chinese company has been paying service fees and royalty fees to another Chinese company and based on such business transactions, the tax authorities detect that the two companies are most likely related parties. By referring to tax, industrial and commercial information and third-party data, the tax authorities spotted that both companies shared many senior executives, and therefore constituted related parties.

The company therefore realizes its fault, submits the previous years’ Related Party Transactions filing forms and pays the imposed fine accordingly.

In practice, many enterprises mistakenly believe that only direct and indirect shareholding relationship constitutes a related party. In fact, the relationship of control, such as sharing of more than half of the senior management, substantial loans owed or guaranteed, as well as the decision-making authority on one party’s business operations by the other party may all be factors that determine related parties.


How can we help you?

Facing the ever-stringent environment of transfer pricing and tax anti-avoidance in China, taxpayers need to pay special attention to intercompany agreements not only in terms of legal consequences, but also the underlying tax implications in order to substantiate their intercompany transaction mechanism so as to control their overall tax and transfer pricing exposure.

Our pool of experienced professionals can support in:

-Preparing supporting documents for outbound payments (e.g. issue comprehensive analysis reports on cash repatriation, provide tailor-made revisions and comments on existing agreements);

-Planning of supply chain and intercompany transactions;

-Conducting a risk and opportunity review analysis for current transactions;

-Preparing the Related Party Transaction form filing and transfer pricing documentation.

If you would like to know more about the most recent tax and financial developments in China, or about the services mentioned above, please contact us at info@phcadvisory.com.



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