On March 18, 2015, the State Administration of Taxation in China (SAT) released the ‘Public Notice Regarding Certain Corporate Income Tax Matters on Outbound Payments to Related Parties Abroad’ (SAT Public Notice  No.16, hereinafter referred to as “Notice 16”). The SAT announced its interpretation to Notice 16 the next day. In Notice 16 China gives further guidelines that outbound payments to related parties abroad should follow the arm's length principle and also specifies various circumstances where payments, service fees or royalties paid to related parties abroad would not be deductible for corporate income tax purposes. Notice 16 shows China’s support to protect its tax base and its support to the overall base erosion and profit shifting (BEPS) project from the G20/OECD with local law initiatives on Chinese enterprises.
In line with earlier guidelines that were issued based on the “Regulation on the implementation of the enterprise income tax law of the People’s Republic of China”, Notice 16 states in article 1 that taxpayers must comply with the arm’s length principle when making payments to the related parties abroad. According to article 2 taxpayers shall provide relevant documentation upon request, such as intercompany agreements, documentation that verifies the authenticity of the transaction as well as the arm’s length nature of the transactions.
Notice 16 lists the following types of payments as not deductible for corporate income tax purposes:
According to the rules of Notice 16, if the enterprise having the four types of payments to an overseas related party, the related expenses are not deductible for corporate income tax purpose.
Article 7 of Notice 16 reaffirms China’s existing legal framework for the 10 year statute of limitations for special tax adjustments, which include transfer pricing matters.
Notice 16 is also generally consistent with the OECD Guidelines in respect of benefit tests, duplication of services and shareholder activities.
In the light of the above review of current transfer pricing models in place regarding royalty payments for intangibles made to entities located in jurisdictions such as Cayman Islands or even Hong Kong is strongly recommended, to ensure that these structures can be supported from an economic substance perspective, including demonstrating that the entity was involved in the value creation of those intangibles and that key functions related to the intangibles are performed in that jurisdiction. Such structures will be subject to ongoing and increased scrutiny within the scope of Notice 16.
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