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TAX & FINANCE: Profit level monitoring of cross-border related party transactions The priority of China's anti-tax avoidance work in the future
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Profit level monitoring of cross-border related party transactions
The priority of China's anti-tax avoidance work in the future

By Kelvin Lee, PwC Tianjin

BT 201812 tax 01跨境交易相关方的利润水平监测
中国未来反避税工作的重点

最近国家税务总局(SAT)强调,中国近期反避税工作的总体原则是在确保稳定的同时寻求改善,优先考虑的是跨境利润水平监测。江苏省已推出利润水平监测试点系统,预计将逐步扩展到其他省市。建议在中国运营的跨国集团在实施合理的转让定价政策的基础上,加强转让定价风险防范和预警系统,积极管理税收合规,降低风险。

国家税务总局还在税收政策简报中澄清了未来反避税工作的详细计划:

加强对跨境交易的相关方的利润水平监测,建立统一的统计标准和拥有风险评估体系的跨国企业,实施“全球整合”,利润水平监测体系至关重要; 了解跨国集团的整体运营情况; 按风险等级对其进行排名; 为每个企业制定转让定价风险和合规档案; 并从国家,行业,财政年度,交易类型和纳税人等方面进行风险评估,实现跨国公司转让定价管理水平的全面提升。

Recently the State Administration of Taxation (SAT) emphasized that the general principle of China's anti-tax avoidance work in the near future is to seek improvement while ensuring stability, and the priority will be cross-border profit level monitoring. A pilot system for profit level monitoring has been rolled out in Jiangsu Province, which is anticipated to be gradually expanded to other provinces or municipalities. It is recommended that multinational groups operating in China strengthen their transfer pricing risk prevention and early warning system based on the implementation of reasonable transfer pricing policies, so as to actively manage tax compliance and mitigate risks.

BT 201812 tax 02Background

Since the 18th National Congress of the Communist Party of China (CPC), the SAT has continuously promoted the development of a fair and modern international tax system, and actively implemented the requirements of the Central Committee of the CPC and the State Council on optimizing the business environment and promoting the reform to “streamline administration, delegate power, strengthen regulation and improve services”. An area of significant public concern is the gradual evolution of anti-tax avoidance concepts to strengthen cross-border profit level monitoring and administration.
 

As early as 2015, the SAT has been proactively making arrangements to adapt to the changes in the domestic and international economic environments. In the China Advance Pricing Arrangement Annual Report issued in 2015, the SAT clearly stated in the foreword that it would establish a three-pillar anti-tax avoidance administration system with a balanced approach for “administration, service and investigation” and put the administration of cross-border related party transactions in a prominent position.
 

On 17 March 2017, the SAT promulgated the Administrative Measures for Special Tax Investigation and Adjustment and Mutual Agreement Procedures (Public Notice No. 6 [2017] of the SAT, hereinafter referred to as “Public Notice No. 6”), which stipulates that “taking a risk-oriented approach, tax authorities shall build and develop a tracking system to monitor the profitability of enterprises and their related-party transactions.”

Recently, officials in charge of anti-tax avoidance from the SAT International Taxation Department made a systematic summary of the future direction of China's anti-tax avoidance when attending the China Tax Policy Briefing jointly organized by the SAT and the Korean Embassy in China:
 

For a certain period of time to come, the general principle of China's anti-tax avoidance work is to seek improvement while ensuring stability. By sticking to the priority of cross-border profit level monitoring, it is imperative to build a more comprehensive three-pillar anti-tax avoidance administration system with a balanced approach for “administration, service and investigation”, constantly consolidate the institutional foundation, enhance the talent development mechanism, deepen international tax cooperation, promote the modernisation of taxation in the new era with high quality, and add momentum to the formation of a new landscape in all-around opening up.

On the basis of maintaining the rigidity of “investigation”, China’s anti-tax avoidance work will focus more on the flexible “administration” and “service”, and help multinational enterprises reduce transfer pricing risks by promoting communication and cooperation between tax authorities and enterprises.

BT 201812 tax 03Specific Measures

The SAT also clarified the detailed plan for future anti-tax avoidance work at the above-mentioned tax policy briefing:

To strengthen the profit level monitoring of cross-border related party transactions, it is critical to establish a “globally-integrated” profit level monitoring system for multinational enterprises with a unified statistics standard and risk evaluation system; to conduct panoramic scanning and risk testing on single enterprises from the global, national and provincial levels to understand the overall operation profile of multinational groups; to rank them by risk level and compliance willingness; to develop transfer pricing risk and compliance files for each enterprise; and to carry out risk assessment from the dimensions of nationality, industry, fiscal year, transaction type and taxpayer so as to achieve a comprehensive upgrade of the transfer pricing management level of multinational enterprises.
 

Since 2015, many provincial administrations of international taxation have started pioneering work in relation to the monitoring of cross-border tax sources, by leveraging information systems under the concept that “priority should be given to the administration of cross-border related party transactions”. Among them, a representative example is the Jiangsu Provincial Tax Bureau’s initiative to monitor and control multinational enterprises’ profit level.
 

In April 2018, the Jiangsu Provincial Tax Bureau held presentations to local taxpayers on multinational enterprise profit level monitoring and administration in several cities in Jiangsu Province. During the presentations, Jiangsu Provincial Tax Bureau said that the Bureau had selected 150 enterprises with large amounts of related party transactions, complicated related party businesses and typical targeted related party transactions as the first batch of key monitoring targets in the province. Subsequent to these presentations, local tax authorities have compiled internal statistics, requested the selected enterprises, provided additional data and developed an analytics database which contains key information of the 150 enterprises during the period of 2008-2016 (e.g., information in transfer pricing contemporaneous documentation). By leveraging the database, Jiangsu Tax Bureau plans to introduce a big data analytics platform to realize dynamic monitoring of multinational enterprises’ profit levels, with core tools of risk assessment and compliance assessment.
 

The dynamic monitoring of multinational enterprises’ profit level by the Jiangsu Provincial Tax Bureau mainly includes the following aspects:

1. Widely collect tax return information (including country-by-country reports, etc.), transfer pricing documentation (including master file, local file and special issue file), annual reports of listed companies, data exchanged between governmental organs, information from commercial databases, internationally exchanged information, public information (e.g., from enterprise websites, securities analyst reports, industry association reports, news reports), information collected from taxpayers’ response to tax authorities’ risk assessment requests, and information related to potentially comparable domestic companies;
 

2. Set 39 qualitative risk indicators by reference of similar concepts proposed by the Base Erosion and Profit Shifting (BEPS) initiatives by G20 and the Organisation for Economic Co-operation and Development (OECD), and conduct quantitative risk assessment mainly based on value chain analysis so as to comprehensively evaluate the related party transaction tax risks of single enterprises;
 

3. Assess the enterprises’ tax compliance level from six quantified perspectives including the degree of aggressiveness of a group's global tax planning, the quality of related party transactions reporting, the quality of transfer pricing documentation preparation, the internal control system of related party transactions taxation, the performance of related party transactions responses, and the willingness of enterprises’ management to actively communicate;
 

4. Classify the assessed enterprises into different administration levels based on their degrees of tax base erosion risk and types of compliance willingness by utilizing an administration level classification model; and
 

5. Build an administration framework based on risk classification with the consideration of administration resources in tax authorities; adopt different countermeasures for enterprises with different administration levels to guide and promote enterprises’ active compliance.
 

Our observations

The SAT has taken the monitoring of multinational enterprises’ profit level as the priority of anti-tax avoidance work in China in the future, with the pilot programme already being rolled out to begin collecting basic data of taxpayers in Beijing, Sichuan, Jiangsu, Ningbo, Shenzhen, and other places. In view of this fact, we recommend that not only single enterprises but also multinational groups with large amounts of cross-border related party transactions get prepared to be included into the expanding scope of provincial and even national monitoring of multinational enterprises’ profit level, and manage risk prevention and early warning in the following aspects:
 

1. Re-examine and evaluate the potential risks of transfer pricing policies at the group level based on an in-depth understanding of the framework of BEPS rules, and identify potential conflicts and double taxation exposures between China tax authorities and other competent tax authorities;
 

2. Develop relevant risk warning systems with consideration on how the China tax authorities established and adjusted the risk monitoring indicators, and construct information management platforms to realize the end-to-end management on formulation and adjustment of transfer pricing policies, financial forecast, actual financial performance (including segmented financial performance) and comparable data;
 

3. Enhance the regular monitoring on the implementation of transfer pricing policies to ensure consistency between the implementation results and pricing policies, and effectively identify and control potential risks by data monitoring; and
 

4. Maintain communication with the local in-charge tax authorities, keep in tune and up to date with the latest trends of transfer pricing administration, and ensure entities meet all necessary obligations by adhering to legislative requirements or apply for advance pricing arrangements to obtain stable expectations for the coming years.
 

Last but not least, the trend of using more data tools in tax authorities’ monitoring will require tax practitioners in corporations to collect or process huge amounts of data frequently. As a result of this, an urgent task confronted by corporations is to upgrade current manual processing methods, so as to fulfill the demand for robust, systematic, accurate and real-time data. Management should consider building appropriate data analytics methods that suit the company’s needs, and digitalizing information from daily operations, which will efficiently and effectively facilitate the company’s reporting and management requirements. Moreover, digital thinking can also allow management to analyze the company’s transfer pricing information instantaneously, comprehensively, and in a multi-dimensional manner, and thus more accurately manage transfer pricing risks under the rapidly changing international economy.

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