GUEST ARTICLE: Base Erosion, Profit Shifting - China Squeezes Business Owners

Kathy Siu

Equiom

18 December 2015

Leaders at a recent Group of 20 meeting of leading industrialised nations have agreed on proposals to stamp out what is called “base erosion and profit shifting” or BEPS, a practice associated with firms that allegedly avoid tax and reduce taxes in their home countries by shuffling financial affairs to lower-tax jurisdictions, or by “inversions”, the practice of moving operations to low-tax jurisdictions. According to the Organisation for Economic Co-operation and Development, the Paris-headquartered club of wealthy nations, anywhere between $100 billion and $240 billion in tax is “lost”, equating to 4 to 10 per cent of global corporate income tax revenues. It is argued that developing nations tend to be more reliant on such revenues than is the case with developed nations, although also worth noting that, ultimately, only individual humans pay taxes, since corporations are owned by people. (See a recent editorial on this issue here.)

While BEPS is a corporate issue, as far as many wealthy individuals are concerned, there are clear parallels when it comes to moves by governments to clamp down on steps by people to shuffle their own money in order to reduce tax burdens. And many wealthy persons today hold their wealth primarily through a business, so the dividing line between the corporate and personal one is at best an artificial one. For that reason, we hope readers find this topic to be interesting.

The following article addresses how China is handling the BEPS issue. This article is from , a business of trust and estates professionals serving organisations and high net worth individuals. The item is written by its Hong Kong-based tax director, Kathy Siu.

The views of the article are those of the author and not necessarily endorsed by the editors of this publication but they are very pleased to share these insights and invite readers to respond.

The China State Administration of Taxation published the Chinese translation of all 15 action points of the Base Erosion and Profit Shifting reports only five days after they were released by the Organisation for Economic Co-operation and Development in October.

In November 2015, the Commissioner of SAT, Wang Jun, attended the G20 and the BRIC Leaders summits, held in Turkey and Moscow respectively. At those summits, consensus was achieved on the strengthening of global tax governance against international economic risks.

At the meetings, the leaders from G20 and BRIC countries discussed and reached consensus on BEPS, the automatic exchange of tax-related financial account information standards, and ways to help developing countries raise their ability to collect revenues.

SAT has expressed its full support for the BEPS Project and is localising the BEPS recommendations into China’s tax legislation, whereby multinational corporation taxpayers are expected to comply better and be more transparent.

The BEPS Project will help protect China’s tax base and will enable SAT to obtain a fairer share of tax revenues from multinational corporations with cross-border businesses in China.

The project will bring many significant changes in China’s tax landscape over a reasonable time span. However, SAT has not yet announced a timeline. SAT will localise some of the BEPS recommendations into its domestic tax laws, but not all of them will be copied directly. China will adapt the BEPS recommendations based on its own circumstances on an as-needed basis, and may develop some new tax rules to address China-specific issues.

SAT’s action plan for the near future includes the following:

(1) Revising its domestic transfer pricing regulations (i.e., Circular 2, which was published in 2009) to empower SAT to make bigger adjustments on transfer pricing. SAT has released a draft Revised Circular 2, which requires multinational corporations to start with their functional analysis, for public comment;
(2) Revising its Tax Collection and Administration Law;
(3) Adjusting its international tax administration divisions, including the creation of an additional transfer pricing division and a new offshore tax administration division;
(4) Setting up a national tax risk monitoring system to strengthen the monitoring of tax-avoidance activities;
(5) Using information technology to facilitate international tax administration and the exchange of information with other countries;
(6) Strengthening China’s co-operation with developing countries, providing them with support regarding knowledge, training and technology on tax collection and administration;
(7) Being closely involved in a global tax administration and collection summit in Beijing in May 2016, focusing on the preparation and promotion of a “multiple-jurisdictional tax administration and collection co-operative agreement”.

Our comments
China has shown full support for the BEPS Project and is determined to raise its tax regime to a new international standard by co-operating with other jurisdictions. SAT is localising the BEPS recommendations into its tax legislation.

We recommend that multinational corporations with cross-border businesses with China, i.e., foreign multinational corporations doing business in China or China entities doing business overseas, review their business arrangements, transfer pricing policies and supply chain strategies to better manage their tax risks, given the challenge of upcoming new requirements regarding transparency and the substantive nature of the enterprise.

To prepare for these new challenges from SAT, MNCs should:

(1) Review their group’s business arrangements;
(2) Revisit their group transfer pricing policies and value chain strategies;
(3) Assess their system requirements for transfer pricing compliance, including the preparation of supporting transfer pricing documentation;
(4) Review their group organisational structure and assess any tax treaty access that might be constrained in some uncertain situations;
(5) Build substance in group entities;
(6) Be prepared for more transparency in disclosure requirements.