News updates: Jiangsu expressed China’s first official position on BEPS

On 29 April 2014, the State Tax Bureau of the Jiangsu Province (“Jiangsu STB”) issued a notice “Administrative Plan on International Tax Compliance for 2014-2015” (“Notice”) (http://www.jsgs.gov.cn/art/2014/4/29/art_55_212500.html ). Being the first written public statement of Chinese government on the Action Plan on Base Erosion and Profit Shifting (“BEPS”) released by the Organization for Economic Cooperation and Development, the Notice summarized Jiangsu STB’s views and understanding of the international initiative, addressed specific international tax avoidance schemes in the province, and introduced an action plan to tackle BEPS.

Jiangsu STB has given avid attention to the BEPS report. The report and the action plans, according to the Notice, would introduce new orders in international tax planning, and pose significant challenges for multinational corporations’ (“MNC”) mode of operation, and tax planning and compliance. Jiangsu STB raised the following points of attention in the context of China’s tax laws and administrative practice:

The significance of markets in value creation

The Notice recognized that markets played a significant role in value creation and profit realization, and as such should be accorded with adequate weight in allocating profits among jurisdictions. It made a direct reference to the United Nations Practical Transfer Pricing Manual for Developing Countries when emphasizing Jiangsu STB’s longstanding support for the concept of location saving and market premium.

Taxing rights should consistent with economic substance

Jiangsu STB voiced its disagreement with the ubiquitous practice of setting up shell companies to artificially shift profits out of China. It vowed to fully enforce China’s existing domestic laws in determining tax residence by the effective management test, look through shell companies with no other purposes of being in existence other than to obtain tax benefits, and deny treaty benefits for companies which fail the beneficial ownership test.

Tax filing should reflect economic realities

The Notice states that the determination of operational activities not only determines the place of tax filing but also the adequate profits level. For example, when the majority of an MNC’s manufacturing operation is located in China, and that the MNC has no significant intangible assets, the profits allocated to China’s operations should be in proportion to its number of employees, wages and fixed assets.  

Greater transparency in the contemporary transfer pricing documentation

Jiangsu STB agreed with OECD’s claim that the crux of the transfer pricing problem had been the asymmetry of information between tax payers and tax authorities. It advocated that tax payers should be proactive in offering up information relating to their overseas related entities.

Taxing rights in the digital sector

Advancement in the information technology has allowed MNC to made profits in China with no entity or operational substance therein. Jiangsu STB was of the view that new rules should be introduced in determining the source of profits made in the digital sector. This may allocate profits more fairly between source and residence jurisdictions.

Use of safe harbour rule

The Notice cited the Indian safe harbour rules specifying the quantitative threshold in 13 types of cross border transactions. Jiangsu STB recognized the lack of similar safe harbour rules in China but was of the view that the Indian safe harbour rules can be of important reference, due to the similarity between the two Asia emerging economies.

Strengthening internal taxation and control system

Jiangsu STB will take new measures in evaluating companies’ internal control system in related party transactions.

The Notice also specified 13 international avoidance schemes common witnessed in the Province to the detriment of revenue protection. Examples include double non-taxation by way of abusing group structures, base erosion due to cross border financing, profits loss due to free export provision of intangible assets, non-disclosure of offshore profits, tax avoidance transactions by setting up offshore shell companies or offshore bank accounts and so on.

To tackle those schemes, Jiangsu STB has considered multiple approaches. It plans to make use of the newly set up taxation database by which Jiangsu STB can access information collected by other government bodies such as the Customs, the Administration for Industry and Commerce. Also, Jiangsu STB will take advantage of all available exchange of information mechanisms with other jurisdictions.