New Chinese tax rule to take aim at multinationals’ profit shifting

Move shows that Beijing is joining the global move against diversion of profits to low-tax jurisdictions

PUBLISHED : Sunday, 02 April, 2017, 12:04am
UPDATED : Sunday, 02 April, 2017, 4:12am

Beijing on Saturday posted a new rule on scenarios that could trigger tax-avoidance investigations of multinationals, under­lining its commitment to a global move to combat profit shifting.

The new rule, posted on the website of the State Administration of Taxation, comes as China further joins a global effort to stop tax distortion through transfer pricing, or multinationals altering prices of goods and ser­vices, intangibles and financial assets within global operations to divert profits to low-tax jurisdictions.

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In a nutshell, the tax authority wants to make sure complicated transactions and corporate structures are for real business operation, and are not being manipu­lat­ed for avoiding tax.

The new rule, which takes effect on May 1, sends a clear signal that the top tax authority will not just focus on overall profitability of multinationals – foreign or Chinese – but also factor in other conditions such as whether the company receives a fair share of global profit commensurate with its value contribution.

The tax man will also monitor a company’s interest expenditure associated with debt investment from related parties and profits distributed from an overseas subsidiary controlled by a Chinese company, according to the rule.

As a balancing act, the rule also includes streamlined procedures to mitigate double taxation in line with China’s tax treaties with trading partners.

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“The new rule is of great significance as it reflects China’s commitment to join the OECD’s effort to combat “base erosion and profit shifting” (tax avoidance strategies that exploit gaps and mis­matches in tax rules to artificially shift profits to low- or no-tax locations), said Jeff Yuan, transfer pricing services leader for PwC mainland China and Hong Kong . “The stipulation on thin capitalisation and controlled foreign entities all reflect the trend.”

China’s transfer pricing investigations started in the 1990s and gained significance since in the turn of the century in both value and volume as the country gained experience and better resources to deal with the issue, Yuan said.

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Travis Qiu, Greater China transfer pricing leader at EY, said the new rule not only meant greater oversight, but also served as a risk alert to multinationals as it “clearly shows what types of scenarios the tax authority will frown upon, and push them to comply”.

Qiu said that Chinese companies moving abroad were not fully aware of the significance of the tax issue: “If they unduly retain profits overseas, they will face scrutiny from Chinese tax authorities. But if they unreasonably repatriate profits home, they might trigger attention and challenges from overseas tax authorities.”.

Chi Cheng, head of transfer pricing at KPMG China, agreed

“In the past, Chinese companies going abroad might have just focused on commercial matters, but the new rule shows that tax issues play a bigger role when they invest overseas,” Chi said.