On Aug. 13, 2013, SAT officially announced “China Advance Pricing Arrangement Annual Report (2012)” in both Chinese and English. This is the fourth APA annual report released by the State Administration of Taxation (“SAT”). This report introduces China’s APA mechanisms, procedures and practices, and provides statistics for 2005 through 2012 accompanied by an analysis of the statistics.
一、 Introduction to APAs that China has signed
From 2005 to 2012, China has signed 56 unilateral APAs and 29 bilateral APAs, accounting for 66% and 34% of the total number of APAs in China respectively. So far China has not signed any multilateral APA. Below table summarizes the number of unilateral and bilateral APAs that the Chinese tax authorities signed during each of the 2005 to 2012 calendar years.
In 2012, a total of 3 unilateral APAs and 9 bilateral APAs were signed, the number of bilateral APAs representing a new all year high. The time taken for completing the APAs signed in 2012 was shorter than those signed in 2011: all unilateral APAs were completed within 2 years, 67% of which took less than 1 year; 67% of all bilateral APAs signed in 2012 were also completed within one year. Of the 9 bilateral APAs signed in 2012, 5 were signed with Asian countries, 1 was signed with European countries, and 3 were signed with North American countries, marking an all year high in terms of the bilateral APAs signed with non-Asian countries. Most of the APAs signed in 2012 still involve the manufacturing industry but we see a further diversification in the types of industries covered.
二、 Period of APA program operation
By December 31, 2012, the SAT has 79 APA requests that are yet to be officially accepted, 6 unilateral and 73 bilateral.
Practically, application with below factors will merit the SAT’s prioritized attention: (1) Overall principle: first come, first served; (2) The quality of the request submission, e.g. all required documents have been submitted, the transfer pricing method applied is appropriate, and the calculation is correct. Applying taxpayers will be required to make additions or revisions to the submission when necessary; (3) The applying taxpayer is in a specific industry or located in a specific region that merits prioritized attention; (4) For a BAPA request, whether the BAPA partner country has the intention to accept the case and pursue a BAPA will also be an important factor for consideration. Among the four factors, the one the SAT values most is the quality of the submission. A submission that presents innovative application of TP methods or high quality quantitative analysis for intangibles, cost savings or market premiums will merit the SAT’s prioritized attention.
After the formal application, below exhibit illustrates the time taken for unilateral and bilateral APAs signed by China in 2012:
As shown in the above exhibit, all unilateral APAs signed in 2012 were completed within 2 years, 67% of which took less than 1 year; 67% of all bilateral APAs signed in 2012 were also completed within one year.
三、 APA Process
The APA application and administration process involves the following six stages: (1) Pre-filing meeting; (2) Formal application; (3) Examination and evaluation; (4) Negotiation; (5) Signing; (6) Implementation and monitoring.
The following chart illustrates the process:
四、 Tax benefits of APA
An APA is a voluntary agreement conducted on the basis of equality and mutual trust. It provides an effective way to enhance understanding, strengthen collaboration, and mitigate disputes between enterprises and tax authorities. APAs have the following benefits:
(1) Provide certainty for tax authorities and enterprises in regards to transfer pricing issues for future years, which will offer certainty with regard to taxpayers’ operations and relevant tax obligations and provide tax authorities with an expectation of stable revenue;
(2) Reduce tax authorities’ costs related to transfer pricing administration and audit as well as enterprises’ tax compliance costs by mitigating the risk of a transfer pricing audit; and
(3) Improve the tax compliance services provided by the tax authorities, facilitate the balanced development of administration and service, and assure taxpayers of the relevant rights and benefits.
Bilateral and multilateral APAs can also provide the following additional advantages:
(1) Facilitate communication and collaboration among the competent tax authorities of different jurisdictions; and
(2) Help enterprises avoid transfer pricing adjustments as well as double taxation risks in two (for bilateral APA) or more (for multilateral APA) tax jurisdictions.
As for some companies, sales commission may take up a substantial proportion of gross income. Generally speaking, sales commission can be deducted as selling expenses before tax. However, due to the complexity of transactions, not all sales commission can be deducted entirely. Hence companies shall comply with the law when deducting such expenses so as to avoid potential tax risks.
1. Payments to employee
A US foreign representative office asked us to review its tax planning proposals concerning sales commission previously. Its employees complained about their heavy tax burden on individual income tax and they asked the company to change part of their income into sales commission.
According to Circular Caishui  No. 29, sales commission is subject to intermediary service companies or individuals with certain qualifications. Therefore, sales commission can only be paid to an independent third party and any employee, agent or representative is strictly excluded. In addition, we also want to remind the company about the potential tax risks in tax planning. Without solid legal basis, tax planning can easily result in tax evasion and the company may suffer severe legal liabilities as a consequence.
2. Payments to individuals
Many companies are troubled by the problems of payments to individuals. Indeed payments to individuals for their intermediary services actually happen during business operation. However, such payments can only be deducted as sales commission when paying individuals with intermediary service qualifications. Hwuason Lawyers suggest company aware that payments to individuals without qualifications are subject to individual income tax under remuneration category. And the company is liable to withhold their individual income tax according to PRC Individual Income Tax Law.
In fact, there exist certain requirements for deduction of sales commission and company shall not claim such deduction at its own will. On the contrary, company shall submit adequate materials to the tax authority to support such deductions, like sales contract, sales commission agreement, payment receipts, invoices, etc.
3. Oversea sales commission payments
Oversea sales commission is quite common especially in international trade. When dealing with the deduction of oversea sales commission, company shall pay special attentions to the withholding tax of such payments. To be precise, if the foreign company or individual has no agent in China, the company is liable to withhold the business tax and corporate income tax or individual income tax according to the current tax law.
Since the total amount of sales commissions can add up to significant numbers as for some companies and the tax law imposes strict rules on the deduction of sales commission, Hwuason Lawyers suggest companies follow the rules to avoid the potential tax risks on deduction of sales commission.
For more information or advice on the above tax issues, please feel free to contact us by Tianyong Liu (firstname.lastname@example.org) or Lingyan Hu (email@example.com). Or you can visit our website at www.hwuason.com.
Hwuason Lawyers, a prominent law firm with a focus on taxation, are committed to providing comprehensive tax law services including international tax, tax consulting, tax planning, tax incentives, tax controversy, etc. And we are granted ALB China Law Awards and Chambers China Awards respectively in 2012 for our excellent performance in taxation.
In Shanghai, China, the new pilot reform on value-added tax has been introduced by the “Ministry of Finance and State Administration of Taxation on issuing the ‘Business tax reform pilot program’” (Caishui  No.110) and the “Notice of Ministry of Finance, State Administration of Taxation on carrying out the Business tax reform pilot program in Transportation and Modern Service Industry in Shanghai” (Caishui [2011 No.111]). Since 2012, transportation and selective modern service enterprises will begin to pay the value-added tax instead of business tax. The theme of this tax reform is “structural tax cuts” in an attempt to avoid duplicated taxation in business tax.
In this reform, technology related taxation issues in high-tech industries have been distinguishable. From a developing prospective, the overall impact on high-tech enterprises would be positive and beneficial.
State sponsored high-tech fields are incorporated in the pilot program
In the No. 111 notice, the state sponsored high-tech industries are highlighted in industrial division R&D and technology services, which are categorized as R & D services, technology transfer services, technical advisory services, contract energy management services, and engineering, survey and exploration services. Also, the former three kinds of services are not exclusive to only one technical field but eight categories of high-tech fields.
However, the IT technology services are more limited in terms of using computers, communication networks on the production, collection, process, storage, transportation, retrieval and utility of information and related services, including software services, circuit design and test, information systems, and operation management.
Most enterprises in IT industry are high-tech enterprises that specialized in either electronic information technology or high-tech services. The electronic information technology services are widely ranging from software, network, and telecommunication to broadcasting industry. Nevertheless, telecommunication and broadcasting services are not included in the pilot program.
Nominal tax burden in high-tech enterprises might increase
In accordance to the No.111 document, the tax ratio of modern service industry, excluding the leasing service in tangible movable property, is 6% in high-tech enterprises. When calculating the value added tax, they will deduct the input tax in each concurrent period. Water, electricity, equipment become deductible in the value added tax in these enterprises. But for the majority of high-tech industry, costs for human resources are numerically crucial. Similar enterprises in software development, software services, circuit design and testing services, information systems, and operation management services are producing information as well as intelligence which do not need much equipments or raw materials. As a result, the amount of input tax is not large. With the implementation of the reform, the tax burden on these enterprises will slightly be increased compared with the 5% tax ratio.
Foreign Invested R&D institutes will confront a better future
R&D centers are nationally sponsored institutes that have unique places in contributing the development of China’s science and technology. R&D centers are significantly distinguished from general private enterprises in tax cost. Since 2008 when value added tax was changed from production-based to consumption-based, the government was aimed to encourage equipment upgrading among enterprises. However, according to the previous value-added tax law, only the sales of physical goods are subject to value-added tax, which are also applied to input tax deduction. Subsequently, the foreign invested R&D institutes can not benefit but get hindered. R&D centers are essentially cost centers, and provide service, which are not objects of value-added taxation. Purchase of equipment could only be additional cost in an R&D center. After the pilot reform, the benefit for foreign invested R&D institutes is significant. For instance, the input value-added tax on purchasing equipment can be deductible in the pilot reform. In consideration of the low profit margin in R&D centers, the deducted tax amount would be dropped significantly. More and more foreign invested R&D institutes will be attracted to China consequently.
More high-tech enterprises go overseas
According to “On the application of zero value-added tax rate and duty free policy in taxable services” (Caishui  No.131), mineral resources in offshore engineering and exploration services and technology transfer providers, technology consulting and software services are enterprises that will enjoy the tax treaty. This will open the door for many high-tech enterprises to go overseas and get globalized.
In September 2011, the biggest PE investment corporation Blackstone group transferred 95% equity of Channel 1 shopping mall in Shanghai at 1.46 billion Yuan to new world development limited corporation. The tax related issues of this case attracted broad attention and some people thought the real aim of this trade is to avoid tax. No matter what’s the real aim of this trade, transferring the real estate in the name of transferring the equity is indeed a main method to avoid business tax and land value increment tax for the following reasons:
First, avoid the business tax. According to relevant rules, the act that enters investment with the real estate, allocates profits, and takes investment risks together doesn’t need to pay business tax. However, in 2002, Caishui Circular No 191 changed that regulations, and stipulated that equity transfer doesn’t need to pay tax.
Second, avoid the land value increment tax. There are no explicit regulations on this aspect. Under “Land value increment tax provisional regulations” and implement rules, equity transfer is beyond the scope of land value increment tax and doesn’t need to pay land value increment tax.
However, in the fact, this doesn’t mean that equity transfer could avoid the high tax. On one hand, tax authorities might collect tax at the substantial trade. In 2000, SAT issued a regulation and stipulated Shenzhen XX Corporation should pay land value increment tax for the equity transferred were mainly land use right, estate in land and attachment. This regulation was merely in case and its validity was questioned for long time. However, if this regulation was applied, transaction parties would encounter huge loss. On the other hand, transfer the real estate in the name of transferring the real estate just deferred tax payment. After the assignment, although the assignee owned the real estate actually, when explores the real estate, they could only book the history cost into products as land cost. Compared with the real price of equity trade, the balance was huge. If enterprise needs to pay land value increment tax after exploration, the tax rate will be very high and the taxable income will be increased dramatically. Hence, this kind of transaction could not save tax at all.
Therefore, transfer the real estate in the name of transferring equity shouldn’t be deemed a method to avoid tax. The final cost of exploring the real estate needs to be booked. Otherwise, the tax save purpose couldn’t be reached. Both parties should make long-term and comprehensive tax planning.
In the first half of this year, the government issued series of regulatory measures on the real estate industry, and the price of real estate started to fall. Obviously, the government will issue more measures in the future. Currently, besides the first tier cites, the second tier cities starts to response as well.
Recently, Haikou local tax bureau issued Opinion on land value increment tax liquidation, and Jiangsu local tax bureau issued Notice on enhancing collection and management of land value increment tax (Sudishuifa  No 53).
Haikou Opinion stipulates the concept of expense, the deduction demands and such in detail and the summary is as follows:
i. Expense (except development indirect cost) listed in the project development cost with national tax invoice, should get matched fabrication invoice, and mark in category in the report notes. Otherwise, it will be deemed as duplicate project cost.
ii. Expense listed in the project development cost could not be confirmed merely by “project content” of invoice. The opposite party should get relevant qualification as demand. Otherwise, the expense will not be confirmed.
iii. In preliminary project fees-three connections and one leveling expense, three connections refer to three connections project outside planning, three connections project within planning belong to project measures fee according to construction contract, and should be assumed by contractor.
iv. The planning construct expense in preliminary project fees refers to the whole planning construct expense of project, excludes the expense of single project; the same is the design expense in preliminary project fees.
While, the NO 53 notice of Jiangsu emphasized on the development expense accounting management:
i. Local tax bureau should formulate “the real estate exploitation expense reference standard” according to the construction and installation project cost index issued by construction and installation project cost management departments, quota standard and guide price in construction material market.
ii. To excessively high expense, tax authorities could demand tax payers to provide the final audit report or settlement audit report of projects. To excessively high expense without due reason, tax authorities should deduct the expense according to “the real estate exploitation expense reference standard”, and transfer it to tax inspect departments if serious.
Seen from these two documents, the tax authorities will pay more attention to the rationality of expense and the conformity of vouchers during land value increment tax liquidation. Both format and substance should be qualified, and the format seems more important.