Legal flash Shanghai – 2014 special edition – Update on tax regulations 2014

In 2014, China continued to develop its taxation system affecting domestic and crossborder transactions. This “Legal Flash – Special Edition 2014” highlights the most significant tax updates of the year. Please see our monthly legal flashes for more information and analysis here.

Taking a step-forward on anti-avoidance provisions, the State Administration of Taxation (“SAT”) released Decree No. 32 to introduce the Administrative Measures on the General Anti-Avoidance Rule (“GAAR”) (Trial). Before this, China only had general principles for the application of GAAR, which left the procedures and standards related to GAAR cases to the discretion of local tax authorities. The measures, based on the substance-over-form principle, give detailed guidelines for applying the GAAR in China, specifying the scope, characteristics, adjustment methods and investigation procedures; it comes into force on February 1, 2015.

This is a positive response from the Chinese government to the OECD/G20’s Base Erosion and Profit Shifting (“BEPS”) Action Plan. It has announced that the measures do not focus on domestic transactions, so we expect the Chinese tax authorities will take a more active stance on combating international tax evasion in the near futur e.

Regarding the international framework, in the past few years China has been working with other countries on amending double taxation treaties (“DTT”) to facilitate international transactions and investment, especially the DTT signed with developed countries in the 1980s. The remarkable milestones for 2014 in this area are as follows:

The amended China-UK DTT became effective on December 13, 2013, and applies to income generated in China since January 1, 2014.

The amended China-Belgium DTT became effective on December 29, 2013, and applies to income generated in China since January 1, 2014.

The amended China-Netherlands DTT became effective on August 31, 2014, and applies to income generated in China since January 1, 2015.

The amended China-Switzerland DTT became effective on November 15, 2014, and applies to income generated in China since January 1, 2015.

The amended China-Germany DTT was signed on March 28, 2014, but is not yeteffective.

The amended China-Russia DTT was signed on October 13, 2014, but is not yet effective.

The new China-Ecuador DTT became effective on March 6, 2014, and applies to income generated in China since January 1, 2015.

China and Liechtenstein signed an agreement for the exchange of information relating to taxes on January 27, 2014, which is not yet effective.

A significant change in all the amended DTT reduces the withholding tax rate  on dividends from 10% to 5%, if the beneficial owner is a company holding directly at least 25% of the capital of the company distributing them. The Chinese gover nment is expected to gradually amend its DTT network in the near future and introduce a similar provision in all DTT. This change reduces significantly the advantages of indirect investment in China through Hong Kong or Singapore. Foreign countries, especi ally developed countries, may need to reassess the pros and cons of indirect investment through Hong Kong or Singapore when determining their corporate structure.

All the amended DTT extend the period for creating a construction permanent establishment (“PE”) from more than 6 months to more than 12 months (except the amended China-Russia DTT, which  keeps the period of more than 18  months) and change the period for creating a service PE from more than 6 months in any 12-month period (and more than 18 months in the China-Russia DTT) to more than 183 days in any 12-month period. This last change is more favorable with regard to PE exposure for residents in those countries  providing services in China, as the Chinese authorities interpreted this threshold restrictively under the former DTT wording, considering one day of presence the same as a full month.

The amended China-Russia DTT and the new China-Ecuador DTT also introduce a limitation of benefits clause.

Regarding transfer pricing practices, the SAT released Announcement [2014] No. 54 concerning Issues related to Monitoring and Administration of Special Tax Adjustments, effective August 29, 2014.

Under this announcement, multinational companies should (i) examine and review their transfer pricing policies to avoid being identified as a target for self -adjustments by the tax authorities through their monitoring and administration methods, and (ii) keep up to date documentation and other transfer pricing related documents ready for tax authorities’ requests, to avoid a 5% mark-up on the interest charged on taxes resulting from self-adjustments.

On December 5, 2014, the SAT also issued the China Advance Pricing Agree ment Annual Report for 2013, which covers the statistics on China’s advance pricing agreements (“APA”) for January 1, 2005, to December 31, 2013. This is the fifth year that the SAT has issued the APA Annual Report to introduce the China APA system, proced ures and implementation. An analysis of the statistics show taxpayers’ increasing inclination to use APA as a way to reduce double taxation risks in the case of tax reassessment.

China has also adopted several measures relating to enterprise income tax (“EIT”) administration, affecting both resident and non-resident enterprises.

Regarding resident enterprises, the SAT released Announcement [2014] No. 38 on Reporting Overseas Investment and Income by Resident  Enterprises,  effective September 1, 2014. Resident enterprises are now required to report to the tax authorities direct or indirect equity holdings of 10% or more in foreign enterprises, as well as any change that causes the holding percentage to go above or below the 10% threshold. The report must be filed with the EIT prepayment declaration during the period in which the transaction occurs. The announcement aims to further regulate the information (form and content) resident enterprises must provide on overseas investments and income, so the Chinese tax authorities can access complete and systematic information to help them administer and collect EIT.

The SAT also released Caishui [2014] No. 75 and Announcement [2014] No. 64 concerning EIT policies on accelerated depreciation of fixed assets, effective retroactively to January 1, 2014.

It also issued the 2014 version of the EIT Annual Declaration Form, to be used by resident enterprises for their EIT annual declaration and settlement for tax year 2014.

Regarding non-resident enterprises, the SAT issued Announcement [2014] No. 24 on determining beneficial owner status under entrusted investment structures (i.e., investment in China by hiring services of a foreign individual or  organization  that formally invests on behalf of the non-resident).

The SAT also released Caishui [2014] No.79, under which, starting November 17, 20 14, EIT exemption applies to qualified investors generating capital gains from domestic share transfers.

In addition, the SAT released Provisional Measures on Tax Administration on Non – Resident Enterprises Engaging in International Transportation Services (Announcement [2014] No.37), addressing EIT administration only. These international transportation services include transport of passengers, goods and mail into and out of  Chinese domestic ports, using self-owned or rented ships, aircrafts and containers, as well as ancillary services, such as loading and unloading, and warehousing. Non -resident enterprises operating bareboat charter and dry-leasing aircrafts or renting containers fall outside the scope of these services. In addition to addressing tax registration issues, the measures also clarify that non-resident enterprises can benefit from the DTT related to their international transportation services’ income, if applicable.

Regarding individual income  tax administration, on December 7, 2014, the SAT released Announcement [2014] No. 67 on the Administrative Measures for Individual Income Tax  on Capital Gains from Equity Transfer,  effective January  1, 2015. The measures provide more comprehensive and clearer guidelines on capital gain tax relating to individuals transferring non-listed equity of entities established in China.

In 2014, progress was made on the VAT pilot reform, which was one of the most significant tax updates for 2012 and 2013. As part of the main new developments, Caishui [2014] No. 43 included telecommunication services under the scope of the VAT pilot reform effective June 1, 2014, classifying them into two categories: basic telecommunication services, subject to 11% VAT, and value -added telecommunication services, subject to 6% VAT. In addition, under Announcement [2014] No. 42 concerning several VAT issues related to international freight forwarding services, forwarders indirectly providing these services are eligible for VAT exemption. Due to the change in the scope of the VAT pilot reform in the past two years, the SAT issued Bulletin [2014] No. 11 on Administrative Measures for Applying the Tax Refund (exemption) for Taxable Services Subject to Zero VAT Rate and Announcement [2014] No. 49 on Administrative Measures for VAT Exemption on Crossborder Taxable Services; these replace the former measures.

Finally, on November 17, 2014, China initiated a pilot program linking the Shanghai and Hong Kong stock exchanges, providing many preferential tax treatments under Caishui [2014] No. 81.