China transfer pricing alert

A new landscape of supervision for outbound payment
—-In-depth practical analysis of Announcement 16 and the solutions

On 18 March, 2015, China State Administration of Taxation (“SAT”) released one important regulation regarding outbound payments by Chinese entities to overseas related parties – Announcement of the State Administration of Taxation Regarding Corporate Income Tax (“CIT”) Matters on Outbound Payments to Overseas Related Parties (“Announcement 16”). With the aim to further standardize and strengthen the transfer pricing administration on outbound payments to overseas related parties, Announcement 16 specifies the service expenses which cannot be deductible for corporate income tax purpose as well as the relevant supervision procedures to be carried out by China tax authorities. This will directly impact the daily operation of Chinese taxpayers. Announcement 16 is also issued as a proactive response to the Base Erosion and Profit Shifting (“BEPS”) action plans, one of the major tax initiatives launched by the Organization for Economic Cooperation and Development (“OECD”) recently. This alert provides an in-depth analysis of Announcement 16 mainly from the perspectives of tax authorities’ supervision. The full text of Announcement 16 can be found in the appendix of this alert.

Target of supervision:
Five types of non-deductible outbound payments Announcement 16 specifies the following scenarios of outbound payments as nontax- deductible for the Chinese taxpayer:

1. The overseas recipient of the payment lacks business and operational substances;
2. Evidence on the authenticity of the transactions can’t be provided;
3. Service transactions have not, directly or indirectly, benefited the Chinese domestic entity;
4. Royalties paid to the overseas related party who claims legal ownership of the intangible asset yet has made no contribution to its value creation; and
5. Royalties paid to the overseas related party in compensation for incidental benefits arising from overseas financing or listing activities.

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