On 29 July 2014, the highest tax authority in China, namely the State Administration of Taxation (“SAT”), has issued the circular Shuizongbanfa  No. 146 (“Circular 146”) to instruct all of its subordinate State and Local Tax Bureaux to perform a review of those enterprises paying significant amount of service fees or royalties to overseas related parties.
Salient points of Circular 146
- The review targets enterprises paying service fees or royalties to overseas related parties during the years 2004 to 2013, especially on the sums paid towards tax havens, low tax rate countries / regions, etc.
- The tax bureaux have to analyze the commercial reasons and economic substance of the transactions to determine whether the payments are reasonable.
- The following sums are regarded as service fee payments with suspicion of tax avoidance and will be targeted:
- Service fees paid to the shareholder for services including planning, management, supervision of the PRC enterprises’ operation, finance, human resources, etc.
- Group management service fee for centralized group management
- Fees for services that could be either performed by the PRC enterprise itself, or for services duplicated with those already rendered by third parties
- Fees paid either for services not relevant to the functions or risks borne by the PRC enterprises, or for services not in line with the PRC enterprises’ operation or stage of operation even though the services are relevant to the functions or risks borne by the PRC enterprises.
- If the service occurred simultaneously with another transaction, and payment for the transaction already includes the payment for the service, the fee should not be charged repeatedly for such service.
- The following are regarded as royalties with suspicion of tax avoidance and will be targeted:
- Royalties paid to tax havens
- Royalties paid to overseas related parties with no functions or just simple functions
- Significant amount of royalties paid to overseas even though the PRC enterprise has valuable contribution to the intellectual property or the intellectual property has already depreciated
- The SAT has instructed the subordinate tax bureaux to submit the review results by 15 September 2014. For those enterprises that are suspected of tax avoidance, the tax bureaux should initiate special tax adjustment investigation.
Our observation and remarks
The circular does not define ‘significant amount’ and does not specify how the tax bureaux will conduct the review on the targets i.e. whether it is conducted as desktop review, self-report, or field audit.
Circular 146 has provided hints of the situations where the PRC tax bureaux are suspicious of the reasonableness of overseas intercompany service fees or royalties. For enterprises making payments to overseas related parties, which are not being selected and investigated by tax bureaux pursuant to Circular 146, it is recommended that they review whether their overseas payments fall into the situations described by Circular 146, and revisit the charging basis or arrangement if necessary. It is not impossible that the PRC tax bureau scrutinize or challenge an enterprise’s overseas intercompany charges at a later stage with reference to the situations described by Circular 146.
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