Notice regarding Corporate Income Tax (CIT) issues related to fees paid to overseas related parties (SAT Announcement [2015] No. 16)

On 29 July 2014, the State Administration of Taxation (SAT) released Shuizongbanfa [2014] No. 146 (“Circular 146”, i.e. Notice regarding the launch of tax anti-avoidance investigations on remittance of substantial amounts of service fees and royalty payments) to urge tax authorities at all levels to carry out extensive tax investigations on substantial amounts of service fees and royalties payments made by domestic enterprises to their overseas related parties from 2004 to 2013. Further to Circular 146, on 18 March 2015, the SAT released SAT Announcement [2015] No. 16 (“Announcement 16”) emphasizing the arm’s length principle and economic benefits; particularly, it sets out the determining factors of non deductibility of fees paid to overseas related parties by PRC enterprises (hereinafter referred to as the “domestic enterprises”), it also lays out other related tax administration and collection issues.

The contents of Announcement 16 are as below:

1. Non-deductible fees paid to overseas related parties

  • Fees paid to the following types of overseas related parties
    • Overseas related parties with no business substance
    • Overseas related parties that undertake no substantial functions or risks
  • Fees paid to overseas related parties for the following services
    • Services not related to functions, risks and operations of the domestic enterprises
    • Control, administration and monitoring services conducted by the related parties to the domestic enterprises to secure the investment interests of the direct or indirect investors
    • Service fees for activities that the domestic enterprises have already performed by themselves or purchased from third parties
    • No specific services were provided by the overseas related parties even though the domestic enterprises may have obtained additional benefits due to their affiliations with the multinational group
    • Services have been compensated as part of other related party transactions
    • Other services that could not produce direct or indirect economic benefits to the domestic enterprises

The key factor for determination of deductible services fees is focusing on whether the services could result in direct or indirect economic benefits to the domestic enterprises.

  • Royalties paid to overseas related parties
    • Royalties paid to overseas related parties that merely own the legal rights of the relevant intangible assets but have made no contribution to the value creation of the intangible assets
    • Royalties paid for additional benefits to overseas related parties due to the establishment of holding companies or financing companies by the domestic enterprises in overseas for public offering purposes

The key factor to determine deductibility of royalties is focusing on whether the overseas related parties have made contributions to the relevant intangible assets. Announcement 16 also provides that the portions of contributions made to the intangible assets by the relevant related parties, such as contributions made or risks assumed by each related party during research and development, value increment, maintenance, application and promotion processes of such intangible assets, should be considered to define the portion of economic benefits to such related party; anything that does not comply with the arm’s length principle shall be adjusted.

2. Special tax adjustments

Announcement 16 provides that, for fees paid to overseas related parties that are not in accordance with the arm’s length principle, tax authorities are empowered to impose special tax adjustments within 10 years upon the occurrence of such transactions.

3. Record filings for fees paid to overseas related parties

For fees paid to overseas related parties, tax authorities may require the domestic enterprises to perform record filings by providing the following documents:

  • Contracts or agreements between the domestic enterprises and the overseas related parties
  • Relevant supporting documents that can prove the substance of the transactions and transactions are in accordance with the arm’s length principle

Domestic enterprises should still always ensure that the abovementioned documents are in place to justify the substances of the transactions for the payments made to overseas related parties. However, the domestic enterprises are not required to seek for approval or verification from the tax authorities in charge prior to the remittance.

4. Effectiveness

Announcement 16 took effect on its promulgation date, i.e., 18 March 2015.

If in any doubt, consultations from tax professional would always be helpful.

Below link the full content of Announcement 16:
http://www.chinatax.gov.cn/n810341/n810755/c1519231/content.html

Below link the full content of Interpretations of Announcement 16 from the SAT:
http://www.chinatax.gov.cn/n810341/n810760/c1519250/content.html

Below link the full content of Circular 146:
http://www.ay.gov.cn/zwfw/bmbs/dsj/xgzc/201501/t20150123_281862.html