Increased Scrutiny and Focus on Outbound Payments - Royalties
2022-01-26

It is a well-known fact that China imposes strict foreign exchange control on the inflows (inbound payments) and outflows (outbound payments) of funds from the country. There are, however, certain aspects which foreign investors are advised to particularly take note of in relation to the outflows of funds. In China, outbound payments are generally categorized into trade items (buy-and-sell transactions) and non-trade items (service transactions, royalty transactions etc.). Normally, the remittance under the non-trade items category is subject to stricter governance from a tax and transfer pricing perspective.

Royalties may be charged by overseas group entities to their Chinese entities for licensing the right to use trademarks, technologies, know-how, or other forms of intellectual properties owned by the licensor.

In China, the tax authority has the right to conduct a retrospective investigation on royalty payments for up to ten years.

China’s tax authorities follow the DEMPEP concept as stipulated under “Measures for Special Tax Investigation Adjustment and Mutual Agreement Procedures” (2017 Announcement 6”). That is to say, the value chain of intangible assets may consist of Development, Enhancement, Maintenance, Protection, Exploitation and Promotion.

Currently, China is focusing more and more on scrutinizing the actual involvement carried out by local Chinese enterprises and overseas related parties regarding the abovementioned aspects. For instance, if an overseas related-party has only obtained the legal ownership of an intangible asset through legal registration without being involved in any of the development, enhancement, or maintenance activities, the outbound royalty payments made by the Chinese entity are at a much higher risk of being deemed as non-tax-deductible in China.

Chinese tax authorities will also review whether the royalty rate is determined in accordance with the arm’s length principle, meaning a similarly situated third party would agree to a similar royalty arrangement. That means, a benchmarking study would be essential to serve as a supporting document to prove the reasonableness of the royalty fee amount. For risk management purposes, it is also recommended to conduct a review of the applied royalty rate every three years, to make sure that it is still solid based on an updated benchmarking study.

Moreover, enterprises shall also assess whether its royalty payments are dutiable as the Custom Order No. 213 has stipulated that royalty payments related to imported products and/or constitute the condition for the sales of such products within the PRC territory shall be included in the dutiable value.


How can we help your business?

We could assist you and provide the following tailor-made services:

·                      Review royalty agreements from a PRC tax and transfer pricing perspective;

·                      Provide a benchmarking study to assess an acceptable royalty rate

 

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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