China publishes key tax considerations for fees paid to offshore affiliates

China publishes key tax considerations for fees paid to offshore affiliates

The Announcement, issued by SAT on 18 March 2015, sets out the principles for testing compliance with the requirement that payments of fees by PRC enterprises to their affiliates outside the PRC must be on an arm’s length basis and bring economic benefits to the paying enterprise. The Announcement seeks to stop the perceived loss of tax revenue for China from disproportionate fee payments by MNCs in the PRC to their affiliates outside the PRC which SAT identified following anti-avoidance investigations conducted in relation to selected businesses in 2014, and shows China’s efforts in implementing the OECD’s Action Plan related to Base Erosion and Profit Shifting (discussed at the November 2014 G20 meeting) to counter international tax evasion. The principles of the Announcement, summarised below, are key PRC tax considerations for MNCs in structuring their international financial affairs, and for parties structuring cross-border payments in M&A transactions.

  • Arm’s length requirement. Fees paid by a PRC enterprise to an affiliate outside the PRC must comply with arm’s length transactional principles.
  • Payments to non-functional offshore affiliates. Fees paid by a PRC enterprise to an affiliate outside the PRC which performs no function, assumes no risk and has no substantial operations are not deductible when calculating PRC income tax.
  • Economic benefit test. If an enterprise pays for a service rendered by an offshore affiliate, the service must yield direct or indirect economic benefits to the service recipient, and any fees paid for services not yielding economic benefits will not be deductible when calculating PRC income tax. By way of example, fees paid in any of the circumstances below are not deductible when calculating PRC income tax:
    1. the service provided is unrelated to the function and risk of the service recipient or to its operation;
    2. the service provided relates to control, management or supervision of the receiving enterprise by the payee affiliate, the purpose of which is to protect the interests of a direct or indirect investor in the service recipient;
    3. the service provided has already been purchased by the service recipient from a third party or undertaken by the service recipient itself;
    4. fees paid by a service recipient in receipt of additional income by virtue of its membership of a group, where the service recipient has not received specific services from the payee affiliate; and
    5. the service has been paid for as part of other related party transactions.
  • Special provisions for intangible assets. When applying the economic benefit test to licence fees for the use of intangible assets, each affiliate’s contribution to the value of the relevant assets is to be taken into account. The assessment of contribution includes the development, value enhancement, maintenance, protection, application and promotion of the relevant asset as well as investment made and risk assumed in relation to the relevant asset. Licence fees paid to an affiliate which is only the legal owner of the intangible asset and has not contributed to its value are not deductible when calculating PRC income tax.
  • Fundraising. Fees paid by a PRC enterprise to its affiliate outside the PRC for services rendered in connection with the fundraising or listing by a holding company or financing company of the PRC enterprise established primarily for the purpose of fundraising or listing are not deductible when calculating PRC income tax.
  • Key risks reemphasised. The Announcement reemphasises that the risks of non-compliance with the above requirements from a PRC tax perspective are an adjustment of the relevant fee or licence payments by the tax authorities within 10 years from the tax year in which the transaction occurred, and the relevant payments not qualifying for a deduction when calculating PRC income tax. Accordingly, taxpayers should, together with their tax advisers, prepare sufficient documentation showing the arm’s length nature of the payments and the economic benefit to the payee. Under the Announcement, the tax authority may also require production of contracts relating to the payment of fees by a PRC enterprise to its offshore affiliate to prove that the relevant transaction has actually taken place and been conducted on an arm’s length basis.

Reference: Announcement of the State Administration of Taxation on Issues Relating to Corporate Income Tax on Expenses Paid by an Enterprise to its Overseas Affiliated Party (国家税务总局关于企业向境外关联方支付费用有关企业所得税问题的公告), 18 March 2015 (the "Announcement")

Issuing authority: State Administration of Taxation ("SAT")