Corporate Tax Planning

We provide tax planning ideas for the following situations:

1. DOUBLE TAXATION ARRANGEMENTS BETWEEN HONG KONG AND OVERSEAS JURISDICTIONS

1.1 DTA WITH BELGIUM
Has extensive double tax arrangement between HKSAR and Belgium; under OECD model, the exchange of information between tax authorities, restricts to the commercial purposes are permitted between tax authorities of the jurisdictions concerned,

Benefits under the new DTA:

– Elimination of capital gain on disposal of shares:
– The elimination of tax on dividend paid if:
The Belgium intermediate holding co. has held at least certain percentage of shares and for certain period, the dividend, royalty, interest declared from HK to such intermediate holding co, and the ultimate holding co incorporated in the members of European Union countries can be entitled to be exempt from being taxed
– The tax rate imposed on royalty is reduced:

So a corporate structure planning for both the outbound and inbound investment is essential to achieve the goal to mitigate the tax burden on those income received.

1.2 DTA WITH THAILAND
Benefits under the new DTA:
The elimination of withholding tax on the service income paid by a Thailand Co. to HK Co.;
Saving the capital gains when disposal of shares of the Thailand company if certain conditions are fulfilled under the DTA relief;
Saving on the tax on the royalty paid by the Thailand Co. to HK Co. as the tax rate drops under the new DTA.
1.3 DTA WITH THE MAINLAND CHINA (PRC)
With effective from August 2006, new DTA signed between HKSAR and PRC came into force.

It replaces the limited scope arrangement for the avoidance of double taxation signed in 1998. The new arrangement will take effect next year (1 January 2007 and 1 April 2007 in the Mainland and Hong Kong.
Withholding Tax on the following items (i) dividend, (ii) royalty, and (iii) interest received from the FIEs or China entity.

TAX PLANNING IDEALS:

The tax exemption for capital gains mentioned above and the reduced withholding tax on dividends, royalties and interest would increase Hong Kong’s competitiveness and provide added incentives for Hong Kong companies and foreign companies to use Hong Kong to do business or to invest in the Mainland. Tax planning ideas that can be introduced by:

  1. Making use of a Hong Kong company to be the intermediate holding company for holding investments such as FIEs in the Mainland;
  2. Making use of a Hong Kong company as a vehicle for financing investments in the Mainland;
  3. Making use of a Hong Kong company to license intellectual properties such as copyright, trademark to the Mainland entities.

CAPITAL GAINS

The new arrangement includes an article on capital gains. Under this article, a full tax exemption in the Mainland is available on a capital gain derived by a Hong Kong investor from the disposal of shares in a Mainland company, provided that the shares sold are less than 25% of the shareholding of the Mainland company and the assets of the Mainland company are not comprised mainly of immoveable property situated on the Mainland. However, the implementation of this exemption is subject to the interpretation of the tax authorities in the Mainland.

Given the fact that there is no tax on gains from the sale of capital assets in Hong Kong, this article would effectively give a unilateral benefit to Hong Kong taxpayers. Although the exemption only applies to the sale of a minority interest in a Mainland company, it should still provide a relief for certain Hong Kong investors.

INCOME FROM EMPLOYMENT 

Under the new arrangement, there is a change in the basis period for counting the number of days of presence in the Mainland for Hong Kong employees frequently visiting the Mainland from a calendar year to any 12-month period.

1.4 DTA WITH LUXEMBOURG
This is a comprehensive avoidance of double taxation arrangement signed between HKSAR government and Luxembourg on 2 November 2007 and it takes into effect on 1 April 2008 in HK side whereas it takes into effect on 1 January 2008 in Luxembourg side.

The following areas are covered in this new DTA:

1.41 WITHHOLDING TAX RATE ON DIVIDEND RECEIVED:
There are the major areas to be entitled to the tax benefit on dividend received and royalty income received if certain criteria are satisfied:
(i) the withholding tax rate on the dividend is normally significantly reduced from 10% to zero;
(ii) the withholding tax rate on the royalty income is reduced from 5.25% to 3%.

1.42 CAPITAL GAINS (¡§CG¡¨)
According to DTA – HK/Luxembourg, CG derived by a HK company through the disposal of shares in a Luxembourg company is not subject to tax regardless of the amount of shareholding. Unless the disposal of a real property holding company in which more than 50% of the asset value of this Luxembourg company, which is arisen from immovable property located in Luxembourg. In which case, the CG is subject to tax.

1.43 DEFINITION OF RESIDENTS
According to IRO of Hong Kong, there is no concept of residence, so Hong Kong side has to follow the definition of resident construed in article 4 to define the term of ¡§resident ¡¨ under the DTA – HK / Luxembourg.

In fact, the definition of resident in this DTA is similar to those in DTA between HK with PRC, Belgium and Thailand.

For dual residency encountered by persons other than an individual, the concept of residency will be taken into consideration with reference to the place of effective management.

1.44 PERMANENT ESTABLISHMENTS FOR SERVICE-RENDERED PROJECTS
Under the DTA – HK / Luxembourg, a permanent establishment (¡§PE¡¨) will be concluded to set up if a HK company renders service in Luxembourg for a connected project for the total more than 180-service days within any twelve months period.

1.45 WE PROVIDE SERVICES FOR TAX PLANNING.
We can provide the related tax planning services to those clients which has investment in Hong Kong, Luxembourg and other countries in which is the member of European Union. If you have problem regarding the group structure or intend to restructure your group of companies to minimize your tax liabilities, please feel free to contact us.

1.5 DTA WITH VIETNAM
This is a comprehensive avoidance of double taxation arrangement signed between HKSAR government and Vietnam on 16 December 2008 and it takes into effect on 1 April 2009 in Hong Kong side whereas it takes into effect on 1 January 2009 in Vietnam side. According to the DTA, it adopts the concept of permanent establishment. Take the provision of service by an enterprise as an example, the period in which the enterprise provides service longer than 180 days in any 12-month period, the enterprise is regarded as having a permanent establishment in that contracting side.

1.51 UNDER THE AGREEMENT, TAX TREATMENTS ON DIVIDENDS, INTERESTS AND ROYALTY ARE SUMMARIZED AS FOLLOWS 
There are the major areas to be entitled to the tax benefit on dividend received and royalty income received if certain criteria are satisfied:
(i) the withholding tax rate on the dividend is normally subject to 10% under the DTA;
(ii) the withholding tax rate on the interest is 10% whereas it is tax free if payable to the government of HKSAR or recognized institutions
(iii) the lower withholding tax rate on the royalty.
1.52 CAPITAL GAINS TAX EXEMPTION UNDER DTA (“CG”)
According to DTA – HK/Vietnam, CG derived by a HK resident through the disposal of shares in a Vietnam company less than the prescribed amount, and to the Vietnam company in which holds more than 50% of the immovable asset value physically located in Vietnam. In which case, the CG is NOT subject to tax.

1.53 HONG KONG EMPLOYEE CAN BE EXEMPT FROM TAX 
For expatriates working in Vietnam, General speaking,the income tax rate subject to the employment income is 20%. Under the DTA, if they do not spend longer than 183-day in any 12-month period in any calendar year in Vietnam. The employment income is tax free if fulfilling certain criteria.
If you have problem regarding the tax planning or intend to minimize your tax liabilities, please feel free to contact us.

1.6 DTA WITH BRUNEI
Recently, Hong Kong signs the comprehensive double tax agreements (“CDTA”) with Burnei, Indonesia and the Netherlands and which have also incorporated the latest clause of international standards on exchange of information (“EOI”).

Such CDTAs will become effective and enforceable after the completion of ratification procedures for both sides involved in those respective CDTAs. For CDTAs signed between Hong Kong with Brunei, and Indonesia respectively, in Hong Kong side, for the year of assessment concern commencing from 1 April in the calendar year followed immediately that in which the CDTAs become enforceable.

The CDTA with the Netherlands becomes effective in Hong Kong for any year of assessment commencing from 1 April 2011 and onwards.

In Brunei, CDTA becomes effective for any year of assessments commencing from 1 January in the calendar year immediately followed that in which the agreement comes into effect.

Under different CDTA between Hong Kong and Brunei, Indonesia and the Netherlands respectively, there are different withholding tax rates on those passive income including the dividend, interest and royalty.

There is no withholding tax on dividends subject to CDTA between Brunei and Hong Kong whereas it can enjoy the lower rate for interest if the recipient is a financial institute and also enjoy 5% tax rate on the royalty payment.

There is lower rate of withholding tax (5%) on dividends subject to CDTA between Indonesia and Hong Kong if it fulfills the certain level of shareholding whereas it can enjoy the 10% tax rate for interest and also enjoy 5% tax rate on the royalty payment.

There is no withholding tax on dividends subject to CDTA between the Netherlands and Hong Kong if the recipient is a qualifying person and at holding the prescribed level of shareholding on the paying company whereas it can enjoy zero tax rate for interest and also enjoy lower tax rate on the royalty payment. Under such agreement, it is an ideal one in which provides a set of more preferential tax rates on those passive incomes.

1.61 WE PROVIDE SERVICES FOR TAX PLANNING.
We can provide the related tax planning services to those clients which has investment in Hong Kong, Brunei, Indonesia and the Netherlands. If you have problem regarding the group structure or intend to restructure your group of companies to minimize your tax liabilities, please feel free to contact us.

1.7 DTA WITH INDONESIA
Recently, Hong Kong signs the comprehensive double tax agreements (“CDTA”) with Burnei, Indonesia and the Netherlands and which have also incorporated the latest clause of international standards on exchange of information (“EOI”).
Such CDTAs will become effective and enforceable after the completion of ratification procedures for both sides involved in those respective CDTAs. For CDTAs signed between Hong Kong with Brunei, and Indonesia respectively, in Hong Kong side, for the year of assessment concern commencing from 1 April in the calendar year followed immediately that in which the CDTAs become enforceable.
The CDTA with the Netherlands becomes effective in Hong Kong for any year of assessment commencing from 1 April 2011 and onwards.
In Brunei, CDTA becomes effective for any year of assessments commencing from 1 January in the calendar year immediately followed that in which the agreement comes into effect.
Under different CDTAs between Hong Kong and Brunei, Indonesia and the Netherlands respectively, there are different withholding tax rates on those passive incomes including the dividend, interest and royalty.
There is no withholding tax on dividends subject to CDTA between Brunei and Hong Kong whereas it can enjoy the lower rate for interest if the recipient is a financial institute and also enjoy 5% tax rate on the royalty payment.
There is lower rate of withholding tax (5%) on dividends subject to CDTA between Indonesia and Hong Kong if it fulfills the certain level of shareholding whereas it can enjoy the 10% tax rate for interest and also enjoy 5% tax rate on the royalty payment.
There is no withholding tax on dividends subject to CDTA between the Netherlands and Hong Kong if the recipient is a qualifying person and at holding the prescribed level of shareholding on the paying company whereas it can enjoy zero tax rate for interest and also enjoy lower tax rate on the royalty payment. The agreement is an ideal agreement in which provides a set of more favourable tax rates on those passive incomes.

1.71 WE PROVIDE SERVICES FOR TAX PLANNING.
We can provide the related tax planning services to those clients which has investment in Hong Kong, Brunei, Indonesia and the Netherlands. If you have problem regarding the group structure or intend to restructure your group of companies to minimize your tax liabilities, please feel free to contact us. 

1.8 DTA WITH THE NETHERLANDS
Recently, Hong Kong signs the comprehensive double tax agreements (“CDTA”) with Burnei, Indonesia and the Netherlands and which have also incorporated the latest clause of international standards on exchange of information (“EOI”).
Such CDTAs will become effective and enforceable after the completion of ratification procedures for both sides involved in those respective CDTAs. For CDTAs signed between Hong Kong with Brunei, and Indonesia respectively, in Hong Kong side, for the year of assessment concern commencing from 1 April in the calendar year followed immediately that in which the CDTAs become enforceable.
The CDTA with the Netherlands becomes effective in Hong Kong for any year of assessment commencing from 1 April 2011 and onwards.
In Brunei, CDTA becomes effective for any year of assessments commencing from 1 January in the calendar year immediately followed that in which the agreement comes into effect.
Under different CDTAs between Hong Kong and Brunei, Indonesia and the Netherlands respectively, there are different withholding tax rates on those passive income including the dividend, interest and royalty.
There is no withholding tax on dividends subject to CDTA between Brunei and Hong Kong whereas it can enjoy the lower rate for interest if the recipient is a financial institute and also enjoy 5% tax rate on the royalty payment.
There is lower rate of withholding tax (5%) on dividends subject to CDTA between Indonesia and Hong Kong if it fulfills the certain level of shareholding whereas it can enjoy the 10% tax rate for interest and also enjoy 5% tax rate on the royalty payment.
There is no withholding tax on dividends subject to CDTA between the Netherlands and Hong Kong if the recipient is a qualifying person and at holding the prescribed level of shareholding on the paying company whereas it can enjoy zero tax rate for interest and also enjoy lower tax rate on the royalty payment. The agreement is an ideal agreement in which provides a set of more favourable tax rates on those passive incomes.

1.81 WE PROVIDE SERVICES FOR TAX PLANNING.
We can provide the related tax planning services to those clients which has investment in Hong Kong, Brunei, Indonesia and the Netherlands. If you have problem regarding the group structure or intend to restructure your group of companies to minimize your tax liabilities, please feel free to contact us.

2. HONG KONG TAX PLANNING

The territorial concept has been adopted subject to the tax in Hong Kong. Only those profits which are derived from Hong Kong are liable to Hong Kong profits tax. There are some examples in where the profits derived by a Hong Kong company may be treated as offshore sourced and non-taxable in Hong Kong. There are different types of taxes imposed on different types of incomes.

2.1 TAX PLANNING FOR TRADING PROFITS
A Hong Kong company sends employees / executives to meet with overseas suppliers and customers to negotiate and conclude the terms of the purchase and sale contracts. It may be possible to claim that the trading profits so derived are non-taxable in Hong Kong.
2.2 TAX PLANNING FOR MANUFACTURING PROFITS
A Hong Kong manufacturing business enters into a processing or assembly arrangement with a Mainland entity. The Hong Kong manufacturing business will provide the raw materials, technical know-how, management, training and supervision provided by the HK entity. It may be possible to follow the decision of court cases to be entitled apportionment of profit to be exempt from being taxable in Hong Kong. A 50:50 apportionment can be made.

2.3 TAX PLANNING FOR SERVICE INCOME
A Hong Kong company provides services partly in Hong Kong and partly outside Hong Kong. It may be possible to claim that part of the service income as those attributable to the services rendered outside Hong Kong are exempt from being taxable from Hong Kong profits tax. IRD looks at the locality of services rendered to generate or derive such an income.

2.4 TAX PLANNING FOR E-COMMERCE INCOME
Recently, e-commerce is a form of business to be increasingly popular in our world. Taxpayers set up their own websites to carry on businesses to engage in the trading of goods, antiques, and different variety of commodities or the provision of services. Some tax issues are triggered even if their websites are set up overseas. Moreover, certain receipts derived from such e-commerce businesses by non-residents are still taxable under IRO. Some important considerations have to look at as to determine whether these incomes are taxable.

2.5 TAX PLANNING FOR MISCELLANEOUS INCOME
Different tax treatments and planning ideas for different varieties of income including royalty, interest income, cross-border land transportation income and service income derived from e-commerce.

2.6 STAMP DUTY TAX PLANNING IN HONG KONG
Stamp duty is a kind of tax which is charged on the documents as evidence for certain kinds of transaction instead of the transactions themselves. In Hong Kong, stamp duty is encountered in respect of the sale or lease of interests in Hong Kong land, buildings and the transfer of shares of HK companies. Moreover, the range of instruments subject to stamp duty is wide and thus professional advice should be sought on every transaction which involves Hong Kong property or shares.

Stamp duty on a conveyance on sale of land and buildings are charged at progressive rates ranging from 0.75% to 3.75% based on the consideration

The rate of stamp duty on an agreement for lease depends on the period of lease- 0.25% of the rent for 1 year or less, 0.5% of the annual average rent lease terms for 1 – 3 years, and 1% for periods in excess of 3 years.

The tax rate for transfers of shares is 0.2% of the consideration (0.1 % each for buyer and seller).

Stamp duty is charged on the market value of a transaction if this is greater than the actual consideration. Consideration includes debts waived and assigned. The principal exemption is for transfers of shares between associated corporations and fulfills the 2 year-period criteria.

Accordingly, stamp duty planning could be implemented to mitigate the stamp duty liabilities on different cases and circumstances.

3. TAXATION IN THE MAINLAND CHINA

3.1 SETTING UP BUSINESS IN PRC
The most direct way to enter the China market is to set up local presence. There are various forms of investment vehicles available to suit different business objectives and operations. Other than financial institutions, a foreign company still cannot set up a branch office in China at the moment. Setting up a representative office has been the simplest way to get into China and gain on-the-market experience. If your investment involves a Chinese partner, you should probably go for setting up either a Sino-foreign equity joint venture or a cooperative joint venture. Otherwise, a wholly foreign-owned enterprise will allow you greater management control and flexibility. The setting up of a foreign-invested shareholding company is another relatively new option.

Normally a foreign investment enterprise (“FIE”) is set up for a specialized purpose with a specific business scope. Apart from the traditional production FIEs, foreign investors may now also set up trading FIEs, service FIEs, wholesale and retail FIEs, etc. If your group has already established a number of FIEs and is poised to make further investments in China, you may consider establishing China holding company to centralize management, provide shared services, consolidate the distribution of goods produced by your FIEs in China and pre-market certain imported products. Upon having paid up its registered capital according to the approved schedule, your FIE may also expand its geographical coverage by setting up branches.

FORMS OF BUSINESS SET UP IN PRC

1. IMPORT PROCESSING ARRANGEMENT (IPA)

  • The HK business sold the raw materials to the Mainland entity, the latter processed the raw materials into the finished goods to HK business;
  • There was no processing agreement between the HK business and Mainland entity.

2. OUTWARDS PROCESSING AGREEMENT (OPA)

  • The HK company entered into a processing agreement with a Mainland entity. The mainland business provides factory premises, land, and labour.
  • While HK business provides raw materials technical know-how, management, supervision, production skills, design and traning, etc, and
  • The business will pay a processing fee to the PRC entity

3. FOREIGN INVESTMENT ENTERPRISES (FIEs)

  • The foreign investment enterprises include the enterprises in which the foreign entity must at least holds 25% interests of the total equity interests;
  • Can be sub-classified into joint venture forms such as co-operative operation, equity and as sets and then the wholly owned foreign enterprises.

4. SINO-FOREIGN COOPERATIVE OR EQUITY JOINT VENTURE (EJV OR CJV)

  • has Chinese entity as the business partners;
  • has different categories; distinguish from each other in terms of equity joint venture and co-operative joint venture forms;

5. WHOLLY OWNED FOREIGN ENTERPRISES (WOFE)

  • is subject to business tax on 3% to 20% of the turnover;
  • enterprise income tax by using 25% (a flat rate);
  • has autonomy on the labour recruitment and general administration;
  • has no any Chinese entity as business partner;
  • has to meet the huge registered capital requirements and distribute the profits to various reserves.

6. REPRESENTATION OFFICE (R.O.)
Functions include:

  • provide the business liaison;
  • introduction of new production or promotional services;
  • conducting market research and development; and
  • technology information exchange.

All of above are related to non-direct business activities, R.O. is subject to both enterprise income tax (FEIT) and business tax (BT) respectively.

7. THE INDUSTRIAL AND COMMERCIAL INDIVIDUAL BUSINESS UNITS.

    It is the business unit which is engaged in the scope of business including industries, construction, transportation and logistics, food and beverage and mechanical repairs and services rendered and so on. The tax is calculated on annual basis, the tax payable is worked out when the annual turnover or total income of the business unit is deducted from the related costs and expenses incurred, and the losses brought forwards to get the assessable amount. In the light of the foregoing, the IIT amount is calculated on annual basis and prepaid every month. The taxpayer has to pay each monthly tax prepayment within 7 days after the preceding month end.
3.2 TAX ADMINISTRATION SYSTEM IN PRC
In PRC, the tax authorities are divided into 2 levels. They include states and local tax bureau and the rates they adopted are also different. Their organizational chart can simply be summarized below:

DIFFERENT CATEGORIES OF TAX IN PRC 

Recently, there are more than 20 different categories of tax encountered in the daily business matter and daily life in PRC. Generally speaking, the following taxes below are mostly hit by the most businesspersons who carry on business in PRC.

1. ENTERPRISE INCOME TAX (EIT)

  • Subject to Foreign enterprise investment made in PRC (25%);
  • Is considered as gross profit X deemed rate X tax rate;
  • Subject to income sourced in PRC

2. BUSINESS TAX (BT) 

  • For the service providers who provided the service inside PRC, PRC sourced income is derived from or arise;
  • Amount of tax payable is generally equal to 3% to 20% of the gross income;
  • It is also applicable to business transactions transfer of immovable / intangible property in PRC;
  • Pay 100% of the tax amount to the local government;
  • It is not recoverable but is deductible in calcculations of the income tax purpose.

3. VALUE-ADDED TAX (EXPORT AND IMPORT VAT TAX)

  • It is subject to the activities of the selling and purchases of goods, commodities incurred in PRC;
  • It is considered on the invoiced amount in the related invoices issued by the eligible issuing units;
  • The tax rate is different for the import and export invoices;
  • The tax payer can be divided into 2 categories: general tax payer and small scale VAT taxpayer, therefore tax rates applicable to them are different.

4. INDIVUDAL INCOME TAX
We look at the expatriates working in PRC including the HK permanent residents:

  • Apply to individual who have a domicile or PE in PRC;
  • Calculate the number of days staying in PRC;
  • Day of arrivals, date of departure, and within multiple entry within one day; and
  • Different treatments for expatriates from different countries which have or have no tax treaty with PRC.
  • A chief representative or expatriate working in the PRC for a project is deemed to have a PE in PRC, is excluded from the limitation of 90/ 183 days rule.
  • IIT is charged on the rates ranging from 5 to 45%.
3.3 NEW TREND OF THE NEW COMPANY INCOME TAX (CIT) LAW DEVELOPMENT
3.31 CHANGES ON TAX RATES AND THE DEDUCTIBILITY OF EXPENSES ITEMS: 

Compared with the old CIT law, the new CIT law which is effective from 1 January 2008, include the following changes as follows:

  1. The new tax rate becomes a flat rate of 25% on the taxable income after tax adjustments and a lower tax rate is enacted to impose on qualified small and thin- profit companies (20%) and qualified high/new technological enterprise (15%) without the geographical limitations;
  2. The effective rates start from 1 January 2008; and the changes in the expenses hit in the income statement include;
  3. The allowable amount of charitable donations raise up to the ceiling of 12% of annual accounting profit;
  4. The salaries are allowed to be fully deductible on the condition that they are reasonably incurred in the course of the ordinary business;
  5. The advertising and promotion expenses are deductible up to the ceiling of 15% of the total sales; and
  6. The employee education expenses are deductible up to the ceiling of 2.5% of the total salaries.

3.32 IMPOSITION OF THE WITHHOLDING TAX ON DIVIDENDS, INTEREST AND ROYALTY PAYMENTS 

Before the repatriation of profits from the FIE in PRC to the holding companies in the home countries, the withholding tax will be imposed on the following payments such as dividends, interests and royalty payments effective from 1 January 2007. Accordingly, a sophisticated planning in selecting the country in which the immediate holding company is incorporated is essential to mitigate the tax burden.

3.33 ELIMINATION OF THE PREVIOUS PREFERENTIAL TREATMENTS 

Under the new CIT law system, the old tax holidays will be eliminated or started to be utilized by certain enterprises:
– Manufacturing enterprise;
– Double intensive enterprise;
– Export-oriented enterprise;
– High-New-Technology enterprise in High-Tech Zone.

So Existing enterprise previously entitled to the higher (such as 33%) CIT rate will be entitled to the new rate (25%);

If the existing enterprise which previously entitled to, but not yet start to utilize the tax holiday due to the continuing losses, the tax holiday will be regarded to commence from the year when the new CIT law takes effect until the end of the tax holiday period.

New enterprise established before 16 March 2007 (then day when the announcement of the new CIT law); so we called the “old enterprise”, can still enjoy the same grandfather treatments as the existing enterprise;

Once the new enterprise established after 16 March 2007, (then day when the announcement of the new CIT law); so we called the “new enterprise”, no longer enjoy any grandfather treatments, new rule is applicable from 1 January 2008.

3.4 THIN CAPITALIZATION RULES
These are the rules set up to govern the related party loans and control the ratio of debt -to -equity subject to foreign investment enterprise (“FIE”) in order to maintain the reasonable deductibility of loan interest and the availability of sufficient capital funds from those foreign investors.

Article 46 of new CIT law mentions that interest expenses related to the related party loans do not meet the stipulated debt-to-equity ratio are not deductible; The criteria of arm-length debts is applicable.

Accordingly, careful tax planning idea should be made in this regard to make sure that the interest expense incurred in respect of the related party loan can be fully deductible and thus the risk of the possibility of the tax adjustment raised by the PRC Tax Bureau can be minimized.

According to the Caishui [2008] No. 121, both the Ministry of finance and the State Administration of Taxation (SAT) have recently issued ¡§Notice regarding the Tax-deductibility policy of interest payment to related parties¡¨, it highlights the standard ratio thresholds to allow the extent of deductibility of interest expenses if the debt to the capital structure (DER) of these enterprises can fulfils the following ratio:

(i) For financial enterprise: 5:1
(ii) For non-financial enterprise and all other enterprises: 2:1

In alternative, if the enterprise is currently engaged in both financial and non-financial business at a mix, the amount of the actual interest expenses incurred in respect of the related parties shall be separately considered and calculated for 2 different categories of businesses under a reasonable basis approach.

The interest expenses may be deductible if the enterprise can adopt the arm-length principles for such financing and also produce a detailed supportive documentation to show that the effective tax rate of the borrower is not higher than that of the domestic related party that receive the interest.

Regardless of the whether the deductibility of the interest expense, in the recipient¡¦s perspective, the interest income derived from the related party is subject to the Company Income Tax (CIT) Regime. 

3.5 TRANSFER PRICING DOCUMENTATION RULES

The contemporaneous transfer pricing (“TP”) issue becomes one of the most critical concerns to enterprise with multi-national and cross-border operational business. Generally speaking, TP issue becomes crucial focus of the tax authorities on those multi-national corporations. In particular, PRC tax authorities will mainly focuses on the area so-called “RELATED PARTY TRANSACTIONS”.

Recently, the State Administration of Taxation (“SAT”) in PRC takes tight enforcement on TP documentation subject to Foreign Investment Enterprise (“FIE”) and a set of detailed documentation requirement will be taken effect in the near future in parallel to the implementation of the newly revised Company Income Tax Law (“CIT”) which is effective from 1 January 2008.

According to Article 109, of Chapter 6 of CIT, parties are defined as related parties if

  1. In respect of financing, business purpose, sales and purchase of goods in which parties have direct or indirect control relationship;
  2. Have directly or indirectly been controlled by a common third party;
  3. In terms of benefit side, have other relationship.

According to Article 110 of Chapter 6 of CIT law, parties without any relationship should make use of arm-length principle to carry out business transactions with the other parties. 

3.51 THE CONTEMPORANEOUS TRANSFER PRICING DOCUMENTATION REQUIREMENTS 

In order to meet the more stringent TP documentation requirements of the revised new CIT law, the following forms will be applicable.

Form Name
1 The summary of related party relationship by type
2 The summary of the related party transactions by type
3 The summary of both purchase and sales transactions
4 The summary of the related party services transactions
5 The summary of related party financing transactions
6 The summary of the intangible assets
7 The summary of fixed assets
8 The summary of outbound investment
9 The summary of outbound payments

3.52 SERIOUS CONSEQUENCE IF NON-COMPLIANCE WITH THE CONTEMPORANEOUS TRANSFER PRICING DOCUMENTATION (“TPD”) REQUIREMENTS 

If a taxpayer fails to comply and maintain the contemporary TPD, Consequently, the taxpayer may be deemed to subject to CIT liabilities by  the Chinese tax authority. The taxpayer is also subject to a special tax adjustment including the additional tax payment, the interest levy, tax penalty and the risk of other tax issues.

It is anticipated that the interest levy is calculated based on the benchmark bank loan interest rate set by the People’s Bank of China.

3.53 TRANSFER PRICING ISSUES

 In carrying on business in the Mainland China, to most multi-national companies (“MNC”), their group goal to achieve the tax saving is to shift the group profit to those subsidiaries incorporated in some countries with low tax jurisdictions, one of the common practices is to implement careful tax planning – the adoption of transfer pricing methods.

The appropriate adoption of transfer pricing results in tax saving legitimately whereas the abuse of transfer pricing causes the alert of tax authorities and raises the issue of tax anti-avoidance measures, accordingly, certain tax adjustments are needed by the tax authority. The pricing policy in a transaction is a crucially important issue to management and thus how to technically make the commercial transaction feasible and on arm-length basis is always headache to MNC.

In respect of the issues of transfer pricing, there are 5 guidelines regarding the definition and its application promulgated by OECD (“Organization for Economic Co-operative and Development”) in 1995, the former conventions, it suggested that the tax authorities and the taxpayers should adopt the normal commercial basis. According to the Article 9 of OECD convention 1995 – the adoption of the arm-length transaction principle, it recommends taxpayer to set the prices comparable those adopted in these normal commercial transactions.

What’re the arm-length transactions?

There are neither any clear nor standardized definitions to explain the term “arm-length transactions”, but in the real-life market environment, these must be the consequences under the normal perfect competition.

Pursuant to the guideline OECD 1979, the am-length transactions principle should be involved the following factors:

(i)          the transaction analysis

(ii)        comparison and similarity:

(iii)       the private agreement arrangement;

(iv)      the feature of open market;

(v)        the feature of subjectivity; and

(vi)      functional analysis.

3.54 METHODS TO ASCERTAIN THE ARM-LENGTH TRANSACTIONS

There are six traditional methods to work out the arm-length transactions regarding the appropriateness of prices adopted in related party transactions under the transfer pricing issues:

According to Article 111 of Chapter 6 of CIT law, there are six traditional methods to work out the arm-length transactions regarding the appropriateness of prices adopted in related party transactions under the transfer pricing issues:

(i)          Comparable uncontrolled prices (known as CUP),

It is the method in which non-related uncontrolled parties have set the prices adopted based on the similar and comparable transactions basis to deal with the others.

(ii)        Resell price method (known as RPM);

The related party has purchased goods and then sold them to un-related party, the pricing policy is set when the selling price used less the gross profit derived from a transaction with similar nature transaction

(iii)       Cost-plus pricing methods (known as CPP);

It is the pricing method in which the cost incurred is marked-up with the necessary related expenses and profit-margin at the appropriate basis to work out the selling price.

(iv)      Transaction profit methods;

Among these non-related uncontrolled parties, they set the selling price to carry out business transactions with the others, so the net profit margin adopted in setting their selling prices is the norm in this pricing method.

(v)        Profit split method; and

It is the pricing method in which the combined profit or loss of the group of related parties is allocated to the individual related party on reasonable and appropriate basis.

(vi)      Other methods corresponding to the independent transactions basis.

In China, new CIT law became effective in January 2008, some important issues regarding the transfer pricing are:

Pursuant to Article 114 of Chapter 6 of CIT law, – the “connected information”

(i)          The provision of the contemporaneous information regarding the pricing setting criteria, expenses allocated criteria and their basis of calculation in the related party transactions;

(ii)        The provision of the contemporaneous information regarding the selling pricing information (transfer of interest) or the final selling pricing information (transfer of interest) of the related party transactions are involved in property, royalty fee in respect of intellectual property, and service fee, etc;

(iii)        When a related party is involved in a tax investigation case, other related party transactions dealt with it should provide the comparable information and profit margin information for such a tax investigation purpose;

(iv)      Other information in connection with the related party information.

Pursuant to Article 123 of Chapter 6 of CIT law, the enterprise has carried out transactions with its related party neither on independent transaction basis or without the appropriate commercial purpose, the tax authority has the right to make tax adjustments within the subsequent 10 tax financial years from the first tax financial year in which the enterprises had started to carry out such business transactions.

3.55 ADVANCED PRICING AGREEMENT (“APA”)

It is a tax arrangement in which the taxpayer is entered into a compromise agreement with tax authority concern regarding the pricing policy to be selected and adopted before adopted those in the related party transactions. Upon the application and get the confirmation from the tax authority concern, those pricing policies adopted are unanimously agreed not to be involved as tax evasion or the element of anti-tax avoidance. Such practice aims to avoid the tax adjustment made by the tax authority upon the transactions dealt with related parties.

(i)         Unilateral Advanced Pricing Agreement

The taxpayer has entered into a compromise arrangement with ONLY one tax authority concern regarding the pricing policies to be selected and adopted before adopted those in the related party transactions.

(ii)       Bilateral Advanced Pricing Agreement

The taxpayer has entered into a compromise arrangement with TWO tax authorities located in two different countries concern regarding the pricing policies to be selected and adopted before adopted those in the related party transactions. This can avoids the double taxation in two different countries in an excessive amount.

(iii)     Multi-lateral Advanced Pricing Agreement

The taxpayer has entered into a compromise arrangement with tax authorities located in THREE OR MORE different countries concern regarding the pricing policy to be selected and adopted before adopted those in the related party transactions. This can avoid the double taxation in three different countries in greater extent. As it is involved more complicated issues, it is observed that not many successful cases are found worldwide.

3.6 CONTROLLED FOREIGN CORPORATION (CFC) RULES
The PRC tax authority MAY make tax adjustments on the taxable income by adopting the reasonable approach if enterprises have made arrangements to deduct their taxable income WITH NO any reasonable commercial substances or grounds.

According to Article 45 of the CITL, the provisions of CFC rules set out is so general: it mentions that foreign companies (the subsidiary of the PRC resident company) are incorporated in low-tax jurisdictions but operationally controlled by the PRC resident enterprise, the profit sharing attributable to the resident enterprise shall be reported as taxable income in PRC IF the profit is not properly distributed without the reasonable commercial grounds. Thus undistributed profits derived by CFCs located in those low-tax jurisdictions MAY be taxed in PRC as deemed distributions.

Under the Article 47 of CITL, the term “Control” is defined as “the Chinese resident enterprise which directly or indirectly holds more than 10% of the total voting shares and together holds more than 50% of the shares of the foreign enterprise.