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Impact of Public Notice on Certain Corporate Income Tax Matters
Released in March 2015, State Administration of Taxation (SAT) Public Notice  No.16 (“Public Notice 16”) is expected to change the way foreign enterprises repatriate profits out of China.
It is obvious that the SAT aims to strengthen tax administration of outbound payments to related parties overseas. The opinions of taxpayers and tax authorities regarding the deduction of an outbound payment to related parties overseas may also differ. Therefore, we suggest enterprises should consider the following actions to monitor the tax risks of outbound payments:
For historical outbound payments:
- Conduct health checks to identify the status and potential risks; and
- Prepare necessary supporting documents to substantiate and justify the payments (e.g., intercompany agreements, transfer pricing documentation/benchmarking) to address any challenges by the tax authority regarding such transactions.
For future outbound payments:
- Explore opportunities to optimise profit repatriation channels to ensure business sustainability and tax compliance; and
- Build up an effective monitoring system for outbound payments in daily operations and conduct adjustments when necessary.
Recap on details of Public Notice 16
Public Notice 16 states that enterprises should comply with the arm’s length principle when making payments to their related parties overseas. Taxpayers shall provide relevant documentation upon request, such as intercompany agreements, and documentation that verifies the authenticity as well as the arm’s length nature of the transactions.
Public Notice 16 clarifies that four types of expenses cannot be deducted for the purpose of corporate income tax (“CIT”) assessment:
Article 3: Unqualified Related Parties Overseas
If the enterprise disburses expenses to its related parties overseas that fail to perform their functions or bear risks and have no substantial operating activities, such expenses shall not be deducted when the taxable income of the enterprise is calculated.
Article 4: Unqualified Service Fee
If the enterprise pays for services rendered by related parties overseas, these services shall enable the enterprise to obtain direct or indirect economic benefits. Otherwise, the payments for non-beneficial services shall not be deducted for the purpose of CIT assessment. More specifically, non-beneficial services include:
- Services that have no relation to functional risks assumed by the enterprise or its operations;
- Services such as the control, administration and supervision of the enterprise carried out by the related parties to protect the investment interests of the enterprise’s direct or indirect investors;
- Services that are rendered by the related parties and have been paid for by the enterprise to third parties or conducted by the enterprise itself;
- No concrete services were conducted for the enterprise by related parties within the group, but the enterprise obtains extra benefits because it is affiliated to these parties within the group;
- Services whose costs have been disbursed in other related transactions; and
Other services that cannot, directly or indirectly, bring economic benefits to the enterprise.
Article 5: Unqualified Related Parties Overseas
Royalties paid to a related party overseas that only owns the legal rights of the intangible asset but does not contribute to its value creation and comply with the arm’s length principle.
Royalties paid to a related party overseas as compensation for incidental benefits arising from financing or listing activities