Worldwide Tax News
China Releases Guidance on Special Tax Investigations, Adjustments, and Mutual Agreement Procedures
China's State Administration of Taxation has published Announcement No. 6/2017 on the administrative rules regarding special tax investigations, adjustments, and mutual agreement procedures. The Announcement integrates, updates, and replaces certain past guidance, including taking into account the results of the BEPS project. In general, it does not introduce new rules, but rather confirms and expands upon past rules and procedures followed by the tax authorities
Announcement 6 sets out the scope of special tax investigations in relation to transfer pricing, thin capitalization, controlled foreign companies, and general anti-avoidance rules. In particular, the Announcement notes that tax authorities will focus on enterprises with certain characteristics for the purpose of conducting special investigations, including:
- Enterprises with a significant volume or numerous types of related party transactions;
- Enterprises with continuous losses, low profitability, or a fluctuating pattern of profits/ losses;
- Enterprises with profitability lower than their industry standard;
- Enterprises whose profitability does not match their functional/risk profile or whose revenues do not match their shared costs;
- Enterprises engaging in transaction with low or no tax jurisdictions (tax havens);
- Enterprises that fail to prepare contemporaneous documentation or disclose related-party transactions;
- Enterprises whose related party debt-to-equity ratio exceeds the allowed ratio (5:1 for financial institutions and 2:1 in all other cases);
- Enterprises controlled by Chinese residents in low tax jurisdictions (less than 12.5% rate) that have not distributed profits; and
- Enterprises engaged in tax planning schemes or arrangements without a reasonable commercial purpose.
The Announcement provides a number of requirements with regard to the comparability analysis. This includes that the analysis should generally cover the following five areas:
- Characteristics of assets/services involved in the transaction, including the physical characteristics, quality, and quantity of tangible assets; characteristics and scope of services; and transactional forms, terms, scope, and expected returns for intangible assets;
- Functions performed, risks assumed, and assets used by parties to the transactions;
- Contractual terms, including quantity, price, conditions of delivery, terms of after-sale services, right to modify, terminate or renew, etc.;
- Economic circumstances, including industry profiles, geographic locations, market scale, market segment, market share, etc.; and
- Business strategy, including strategies for innovation and development, business diversification, risk avoidance, etc.
Some specific factors the tax authorities will give greater focus to include:
- The impact of group synergies;
- The impact of location specific advantages, such as location savings, market premium, and other relevant geographical factors;
- The parties' ability to execute a contract, the actual conduct in executing a contract, and the reliability of the terms of a contract; and
- Comparable factors when using the comparable uncontrolled price method in pricing transfers of financial assets, including equity transfers.
In performing comparability analysis, it is clarified that the tax authority may use non-public information, but should prioritize the use of public information. In addition, when selecting the tested party for a transaction, the simpler party in terms of function/risk should be selected instead of just selecting the Chinese party.
With regard to transfer pricing methods, acceptable methods include:
- The comparable uncontrolled price method;
- The cost-plus method;
- The resale price method;
- The profit split method;
- The transactional net margin method; and
- Other methods that conform to the arm’s length principle.
Other acceptable methods include valuation methods (cost, market, and income) and other methods that can appropriately reflect the principle that profits should be taxed where economic activity takes place and where value is created.
Announcement 6 gives specific focus to transactions involving intangible assets. This includes that for the allocation of benefits of intangible assets among related parties, the determination must be based on the economic activities and value contribution of each party. In determining the allocation, the following factors will be taken into account:
- The functions performed for the development, enhancement, maintenance, protection, exploitation, and promotion of the intangibles (DEMPEP - extra P for promotion as compared with OECD DEMPE guidance);
- The risks assumed; and
- The contribution of capital, manpower, and other resources.
In determining the benefits, an overall analysis of the global business operations of the group should be performed. This includes taking into account the interaction between the intangibles and other global business functions, assets and risks, market premium, cost savings and other regional factors, and value creation factors resulting from synergies within the group.
The Announcement also provides that adjustments should be made to royalties paid to related parties in the following circumstances:
- The value of the intangibles has changed substantially;
- There should have been an adjustment as per normal business practice under the license agreement;
- The functions performed, risks assumed, and assets used by the related parties have changed during the use of the intangibles; or
- The licensee has contributed to the DEMPEP of the intangibles, but has not been compensated.
In addition, when royalties are paid to a related low-function entity that has only contributed funds to the development of the intangibles, the payment will only be partially deductible (a financing return). If no contribution to the development has been made by the low-function entity, no deduction for the payment will be allowed.
While the tax authorities have traditionally focused on outbound payment transactions, the intangible assets rules are to be applied for inbound transactions as well.
Announcement 6 also gives specific focus to transactions involving service fees. This includes that for service fees to be considered at arm's length, the service must provide a direct or indirect economic benefit to the service recipient, the price must reflect the fair price for transactions between unrelated parties in same/similar circumstances, and the service must be one that an independent party would be willing to pay for or perform itself.
Specific cases where service fees will not be considered at arm's length and subject to special adjustment include:
- The services are already supplied by a third party or carried out by the taxpayer itself (duplicated);
- The services are for the control, management and supervision of the taxpayer in order to protect the interests of the taxpayer's direct or indirect investors;
- Although the taxpayer received additional benefits due to services being provided in its group by related parties, no specific services were provided to the taxpayer itself;
- Compensation for the services was already paid through another related-party transaction;
- The services are not relevant to the taxpayer's functions, risks, or business activities; or
- Any other case where the taxpayer did not receive any direct or indirect economic benefits from the service.
In addition, the deduction of service fees may be subject to a special adjustment in full in any case when paid to related parties that have not performed any functions, borne any risks, nor carried out any substantive activities.
As with intangible asset transactions, the tax authorities will also give focus to inbound service fee transactions in addition to the traditional focus on outbound transactions.
The Announcement provides that enterprises may make MAP applications to avoid or eliminate double taxation arising from a special tax adjustment. MAP is to be handled in accordance with the relevant provision of applicable tax treaties China has entered into, including that the application should be made within the time limit specified by the relevant treaty. Applications are to be made directly to the SAT when relating to special tax adjustments, with the provincial level tax authorities generally responsible for delivering notices to the applicants and monitoring/implementing the collection or refund, as the case may be, after the MAP negotiations are concluded. MAP applications may be denied in certain cases, including if the enterprise is currently undergoing a special tax investigation or has not yet paid any tax due resulting from a special adjustment.
Other specific rules clarified/confirmed by Announcement 6 include that:
- Loss-making companies with limited functions/risks, such as toll/contract manufacturers and distributors, must prepare transfer pricing documentation (Local file) regardless of meeting documentation preparation thresholds set out in Announcement 42/2016 (previous coverage);
- When an enterprises makes a self-adjustment for transfer pricing purposes, the self-adjustment does not prevent the tax authorities from initiating a special investigation or from making a subsequent adjustment if deemed necessary;
- When an enterprise requests confirmation from the authorities on principles and methods applied for transfer pricing, special investigation procedures may be triggered; and
- When conducting a special tax investigation, information may be requested from all relevant parties, even if not related.
Announcement No. 6/2017 is effective from 1 May 2017.
New Zealand Publishes Special Report on GST and Services Connected with Land
New Zealand Inland Revenue's Policy and Strategy group has published a special report on changes regarding goods and services tax (GST) and services connected with land as introduced in the Taxation (Annual Rates for 2016-2017, Closely Held Companies, and Remedial Matters) Act 2017, which received Royal assent on 30 March 2017 (previous coverage). The changes apply GST (15%) to a wider range of services, particularly professional services, supplied to non-residents who are outside of New Zealand and which closely relate to land in New Zealand. When these services are provided in relation to land outside New Zealand (whether to residents or to non-residents), they are not charged with GST (zero-rated).
Click the following link for the Special report: GST and services connected with land. The new rules apply from 1 April 2017.
Update - Saudi Arabia Cuts Oil and Gas Corporate Tax Rate
As previously reported, Saudi Arabia has cut the corporate tax for upstream oil and gas producers from 85% to 50%, primarily for the benefit of Saudi oil giant Aramco. The reduction is effected through Royal Decree No. A/135 of 22 March 2017, which provides for a reduction in the rate based on the amount of capital investment:
- less than SAR 225 billion - 85% (no reduction)
- between SAR 225 billion and 300 billion - 75%
- between SAR 300 billion and 375 billion - 65%
- more than SAR 375 billion - 50%
The rates apply from 1 January 2017.
UK Updates Guidance for New VAT Flat Rate Scheme for Limited Cost Businesses
UK HMRC has updated guidance for the new VAT flat rate scheme for limited cost businesses. The new scheme, announced as part of Autumn Statement 2016 (previous coverage), provides for a 16.5% VAT flat rate on turnover of small businesses in any sector if the cost of goods inclusive of VAT is less than either:
- 2% of turnover; or
- GBP 1,000 per year (if costs exceed 2% of turnover).
For small businesses meeting the limited cost conditions, the new 16.5% flat rate must be applied from 1 April 2017. For small businesses not meeting the limited cost conditions, the existing flat rates by sector continue to apply, which range from 4% to 14.5%.
Iceland Publishes Fiscal Plan for 2018-2020 including VAT Reforms
The Iceland Ministry of Finance and Economic Affairs has published an English language overview of the five-year fiscal plan for 2018-2020 presented to parliament on 31 March 2017. With regard to tax system reform, the plan notes that the main upcoming changes will focus on amending the value added tax (VAT) system and canceling concessions. Particular VAT reforms include:
- Classifying most types of tourism services under the general VAT bracket (24%) while keeping restaurant services under the reduced bracket (11%) - effective 1 July 2018 or 15 months after the announcement is made; and
- Reducing the general VAT bracket from 24% to 22.5% - effective 1 January 2019.
Other plans include lowering payroll taxes (if conditions warrant it), doubling the carbon tax, and continuing work on the design of a comprehensive green tax system.
UK Corporate Interest Restriction Draft Guidance
UK HMRC has published draft guidance for comment on the new corporate interest restriction, which limits the amount of interest and other financing amounts that a company may deduct in computing its profits for Corporation Tax purposes using a recommended fixed ratio rule (30% of EBITDA) or an optional group ratio rule (previous coverage). The restriction is included in the Finance Bill 2017, and although the Bill has not yet been passed, the restriction is to apply from 1 April 2017.
Click the following link for the draft guidance, which is the first tranche, with further guidance to be published the end of May. Comments are due by 31 July 2017.
Protocol to Tax Treaty between Belgium and Moldova Signed
On 30 March 2017, officials from Belgium and Moldova reportedly signed an amending protocol to the pending 2008 income and capital tax treaty between the two countries. Both the treaty and the amending protocol will enter into force after the ratification instruments are exchanged, and once in force and effective, will replace the 1987 tax treaty between Belgium and the former Soviet Union, which still applies in respect of Belgium and Moldova.
French Government Approves Protocol to Tax Treaty With Portugal
On 30 March 2017, the French government approved for ratification the pending protocol to the 1971 income tax treaty with Portugal, with the bill for ratification currently before the French Senate. The protocol, signed 25 August 2016, will enter into force on the first day of the month following the exchange of the ratification instruments.
Tax Treaty between Ghana and Singapore Signed
On 31 March 2017, officials from Ghana and Singapore signed an income tax treaty. The treaty is the first of its kind between the two countries.
The treaty covers Ghana income tax and Singapore income tax.
The treaty includes the provision that a permanent establishment will be deemed constituted when an enterprise furnishes services within a Contracting State through employees or other engaged personnel for the same or connected project for a period or periods aggregating more than 183 days within any 12-month period.
- Dividends - 7%
- Interest - 7%
- Royalties - 7%
- Service fees (managerial, technical, or consultancy) - 10%
The following capital gains derived by a resident of one Contracting State may be taxed by the other State:
- Gains from the alienation of immovable property situated in the other State; and
- Gains from the alienation of movable property forming part of the business property of a permanent establishment in the other State.
Gains from the alienation of other property by a resident of a Contracting State may only be taxed by that State.
Article 22 (Miscellaneous Rules Applicable to Certain Offshore Activities) provides that a permanent establishment will be deemed constituted where an enterprise carries on offshore activities in connection with the exploration or exploitation of the seabed and subsoil and their natural resources situated in a Contracting State, if such activities continue for a period or periods aggregating more than 90 days within any 12-month period. Substantially similar activities carried on by an associated enterprise in a Contracting State are included in determining if the 90-day threshold is exceeded.
Article 22 also provides that gains derived by a resident of a Contracting State may be taxed by the other State if derived from the alienation of exploration or exploitation rights; or the alienation of shares (or comparable instruments) deriving their value or the greater part of their value directly or indirectly from such rights.
Both countries apply the credit method for the elimination of double taxation. In addition, for dividends received by a Ghana resident company that holds at least 10% of the paying company's capital, Ghana will also provide a credit for the Singapore tax payable by the company in respect of the profits out of which the dividends are paid.
A provision is also included for a tax sparing credit for tax that has been reduced or exempted by a Contracting State in order to promote its economic development.
The treaty will enter into force once the ratification instruments are exchanged. For Ghana, it will apply from 1 January of the year following its entry into force. For Singapore, it will apply in respect of withholding taxes from 1 January of the year following its entry into force and for other taxes from 1 January of the second year following its entry into force.
TIEA between Mauritius and South Korea to Enter into Force
The tax information exchange agreement between Mauritius and South Korea will enter into force on 13 April 2017. The agreement, signed 11 August 2016, is the first of its kind between the two countries and applies for criminal tax matters on the date of its entry into force and applies for other matters for taxable periods beginning on or after 1 January 2018. Where there is no taxable period, it applies for other matters from the date of its entry into force.