As a corporate management tool, transfer pricing derived from American enterprises in the 20th
century. Transfer pricing issues have gained extensive attention in developed countries, research achievements on transfer pricing system are great as well. Compared with developed countries, transfer pricing and tax avoidance investigation system in China starts relatively later.
The first authority that formulate transfer pricing regulations to foreign-investment enterprises is Shenzhen government. In 1987, Shenzhen issued “Shenzhen special zone foreign-investment enterprise and affiliate transaction taxation administrative provisional measures”, which covers transfer pricing and tax avoidance contents. However, the real proposal promoted the nationwide tax avoidance investigation was submitted in 1987 or 1988 by the deputies of National People’s Congress.
In 1990, SAT launched the first tax avoidance investigation, which focused Fujian and Guangdong province. This investigation discovered two existed tax avoidance methods, one based on Taiwan investment in Fujian province, the other based on Hong Kong and Macao investment in Guangdong province. Most enterprises set multiple account books, and run irregularly and unsteadily, which hindered tax authorities to grasp enterprises’ financial statement. Therefore, in general, tax authorities adopted verification collection methods during tax collection management. At this stage, the legal ground to transfer pricing and tax avoidance investigation was insufficient, tax administrative measures were simple and tax collection management was still in its infancy.
In 1991, “Tax law of PRC for foreign-investment enterprises and foreign enterprises” and its implementing regulations brought in transfer pricing taxation system entirely. From 1995 to 1998, tax authorities and financial departments made relevant adjustments on tax avoidance administration. Since then, from legislation aspect, general legislation frame on transfer pricing and tax avoidance administration has been set up.
From 1998 to 2005, tax avoidance investigation and adjustment was still general administration, many local governments issued index according to traditional planning economy, such as Guangdong 200 cases, Fujian 150 cases and so forth. Local tax avoidance administration was still inexperience.
In 2005, tax authorities issued “Notice on 2005 Tax Avoidance Administration” and stipulated that local transfer pricing including report to settlement all should report to SAT for approval. Since then, transfer pricing and tax avoidance administration became more regular.
With the implement of new EIT and its implementing regulations, SAT issued a series of regulations and measures to regulate transfer pricing and tax avoidance investigation. “Implementation Regulations for Special Tax Adjustments (Trial)” of 2009 was the most systematic regulations. Theses laws and regulations guaranteed the smooth launch of nationwide tax avoidance management during new EIT implementation and provided explicit legal guidance to both tax authorities and tax payers.
2010 is the first year that carry out transfer pricing contemporary documentation according to new EIT. To raise transfer pricing management level and enhance tax avoidance administration, tax authorities launches extensive selective inspection on transfer pricing contemporary documentation to gain overall feedback on transfer pricing contemporary documentation preparation and management and promote contemporary documentation management regularity.
In the future transfer pricing and tax avoidance investigation management, tax authorities will enlarge industry scope and raise the investigation force ulteriorly, which raises higher requirements to enterprises during related party transaction. Meanwhile, tax authorities will make further input on tax avoidance database to provide more reasonable economic analysis foundation and raise the scientific of transfer pricing and tax avoidance investigation. Transfer pricing management and contemporary documentation preparation will be regular obligation of all kinds of investment enterprises, holding enterprises and corporate groups. Whereby, transfer pricing and tax avoidance investigation will face new development, and transfer pricing implementation in China will march toward new progress.
In 2008 China dramatically reformed its taxation system through the introduction of the Enterprise Income Tax Law. There were two substantial changes brought about by the EITL. Firstly, it removed the previous tax distinction for domestic enterprises and foreign invested enterprises (FIEs) under which FIEs had been subject to a highly concessional rate of tax. The second significant change was the introduction and strengthening of China’s international anti-avoidance rules. This included a wider definition of a tax resident company, the introduction of rules relating to thin capitalisation, extensive documentation requirements in respect of transfer pricing, the introduction of a general anti-avoidance rule and controlled foreign company rules.
Throughout 2008 and 2009 various regulations, measures and circulars were promulgated at all levels of the tax administration system for the purpose of implementing the new law. The SAT spent much of 2009 assembling an large enforcement team and hired 500 more officials. One common theme in all of this was the push to target the shifting of profits off-shore. It had been quite a common practice, up until 2008, for foreign invested enterprises to effectively generate no profit in China through an array of related party transactions. As a result of this new environment, nearly all foreign invested enterprises have had to undertake a review of their structures.
It is also important to note that, and in the usual manner of Chinese bureaucratic politics, traditionally local tax bureaus only sporadically, if at all, followed the mandate of the State Administration of Taxation (SAT). This was because the local tax bureaus were also answerable to the provincial and local level governments. Such governments were more interested in encouraging investment in their regions, then ensuring that national level policies were followed to the letter of the law. Accordingly, many legal and non-legal concessional arrangements were entered into at a local level. However, more recently there has been a growing willingness by the local tax officials to follow intructions from the national guys. This has three potential implications. Firstly, we can expect national level policies to enforced more effectively and consistently at a local level. Secondly, many non-legal concessional tax arrangements that were entered into in the past may no longer receive protection by the local officials. Thirdly, it will be less likely that such arrangements will occur in the future.
Yet, we are yet to feel the full brunt of the changes. This is because the tax authorities, whilst having undertaken internal reviews of files, have generally not put taxpayers on notice that they are being subject to an investigation in respect of the 2008 year. The authorities commenced their internal reviews in May/June 2009 and, from what we have been told, will commence sending out notices of tax adjustments in the first quarter of this year. Interesting times ahead – for us anyway.
Here are some selected recent tax disputes in China.
- Guangxi Jiayuan Real Estate Company fined RMB 1.44 million for failure to declare income from sale of shares – In a very simple case of tax avoidance the taxpayer failed to disclose its income from an equity transfer and accordingly was required to pay the full amount of tax on RMB 1.51 million plus a late fee surcharge of RMB 430,000 in addition to the above penalty.
- Fujian foreign invested enterprise receives transfer pricing adjustment – In a case decided late last year in Fujian, the local authorities investigated a FIE’s transfer pricing practices over a 6 year period. In reliance on the new anti-avoidance provision in the Enterprise Income Tax Law, the authorities re-adjusted the taxable income of the company and increased it by RMB272.9 million. Reports indicate that the company was relatively content with the result, suggesting that it’s potential exposure was significantly higher. The fine was the result of a negotiated settlement between the authorities and the taxpayer.
- VAT Invoice forger sentenced to 15 years in prison – Ye Mou Biao has been sentenced to 15 years in prison by the Zhuhai Intermediate People’s Court and fined RMB500,000 after creating RMB400 million worth of fake VAT invoices. Ye Mou Biao’s conduct resulted in a loss of tax revenue in the amount of RMB12.463 million