Abe Zhao - China Tax Advisory

"Chinese SME Taxpayer Incentive" Becoming More Important to MNCs in 2020

An income tax preferential program lesser-known to MNCs operating in China is the "SME Taxpayer Incentive" or the STI. The Chinese government granted tax relief to SMEs because they create the largest number of jobs in the domestic economy.

The STI was often considered less relevant for MNCs, which tend to conduct more significant operations in China than allowed by the STI. This situation has changed to some degree since 2019, when the Chinese central tax authorities and the Ministry of Finance jointly issued Bulletin 13 and considerably broadened the scope of SME for STI.

The expanded scope of SME described above means that while the larger taxpayers remain off-limit, more MNC's subsidiaries in China may qualify in 2020 given the potentially negative impact on the business performance of the ongoing Covid-19.

-19

http://ow.ly/qTSd50Bj9yC

"Chinese SME Taxpayer Incentive"​ Becoming More Important to some MNCs in 2020 An income tax preferential program lesser-known to MNCs operating in China is the "SME Taxpayer Incentive" or the STI. Compared with other preferential tax regimes in China, the STI imposes fewer qualification requirements in general.

2019 Chinese Permanent Establishment Case - Aggregation of Installation Service Contracts

The following summarizes a 2019 case reported by the Chinese central tax authorities concerning the aggregation of contracts, when determining the existence of service permanent establishment ("PE").

In this case, a Chinese company imported seven pieces of high-valued equipment from a Japanese MNC for approximately US$ 23 million under two sales contracts in June 2014. The Japanese MNC ("Seller") did not pay any Chinese enterprise income tax ("EIT") on the basis that the income from the equipment sale was not China-sourced and was not attributable to a Chinese PE. The Chinese tax authorities investigated the transactions and disagreed.



http://ow.ly/xUL250Bj9y4

2019 Chinese Permanent Establishment Case - Aggregation of Installation Service Contracts The following summarizes a 2019 case reported by the Chinese central tax authorities concerning the aggregation of contracts, when determining the existence of service permanent establishment ("PE"). In this case, a Chinese company imported seven pieces of high-valued equipment from a Japa...

Chinese VAT Credit Controversy for Importation of Equipment on Consignment

Since January 1, 2009, the Chinese VAT system has in principle allowed for VAT paid by a general VAT taxpayer during a purchase of equipment as a credit to offset its output VAT liabilities. However, the reality is more complex than the theory, and some Chinese subsidiaries of MNCs have experienced significant uncertainties on this issue in the context of cross-border contract manufacturing arrangements. Please refer to the article for details.



http://ow.ly/LdxM50Bj9xH

Chinese VAT Credit Controversy for Importation of Equipment on Consignment Since January 1, 2009, the Chinese VAT system has in principle allowed for VAT paid by a general VAT taxpayer during a purchase of equipment as a credit to offset its output VAT liabilities. However, the reality is more complex than the theory, and some Chinese subsidiaries of MNCs have experienced

Chinese tax considerations of capital reduction by foreign investment enterprises

When foreign investment enterprises ("FIEs") in China seek to repatriate excess cash accumulated in the PRC, the practical mechanisms included the remittance of tax-deductible payments such as royalties and service fees and non-deductible payments such as dividend, outbound loans, and capital reductions. For many years, the option of capital reduction was only feasible in principle but difficult in practice and success stories were rare.

The situation started to improve since towards the end of 2016 when the regulatory system for administering FIEs transitioned from an approval-based system to a recordal system. Over the last two years we have handled successful capital reductions in different locations such as Beijing, Hangzhou, etc. The corporate procedures aside (which are important on their own), a capital reduction in China does have tax implications to keep in mind, contrary to the common belief that it should be a tax-free transaction by nature.



http://ow.ly/3vYa50Bj9xi

Chinese tax considerations of capital reduction by foreign investment enterprises When foreign investment enterprises ("FIEs") in China seek to repatriate excess cash accumulated in the PRC, the practical mechanisms included the remittance of tax-deductible payments such as royalties and service fees and non-deductible payments such as dividend, outbound loans, and capi...

China Tax Litigation - A Paid-off Shareholder Loan Recast as a Dividend?

When a Chinese individual shareholder borrows money from an investee company, a Chinese tax examiner "may" deem any outstanding loan balance at the end of the year when the borrowing takes place as a dividend to the shareholder, unless the shareholder loan was used to benefit the business operation of the investee company. This is what the rule says.

What happens if a shareholder loan straddled the end of the borrowing year but was settled before the time of a tax audit? Can a paid-off loan still be recast as a dividend? The tax authorities and two courts in the Anhui province believed so.

http://ow.ly/sGeH50Bj9wF

China Tax Litigation -Shareholder loan recast as a dividend The following summarizes a tax case in which shareholder loans were recast as dividends for the purpose of Chinese individual income tax despite that the loans were already paid off at the time of the tax audit. Both the tax authorities and the courts stick to a mechanical interpretation of the Chin

Chinese Tax Adjustment Risks for Pricing in Unrelated Party Transactions

Do the Chinese tax authorities have the ability to adjust the price of a commercial transaction between unrelated parties for tax purposes? That was the core issue in a tax litigation that happened in Northwestern China.

The result of the case was favorable to the taxpayer. When reaching such a conclusion, one of the courts specifically denied the legal authority of the two tax letter rulings that were issued by the central tax administration (aka the STA) and were cited by the local tax officials as supporting evidence.

http://ow.ly/xgoA50Bj9ws

Chinese Court Case on Tax Adjustment for Pricing in Unrelated Party Transactions The article below summarizes a tax controversy litigation that happened in the Xinjiang region (Western China). The case was centered on the tax authorities' ability to adjust the price of a commercial transaction between unrelated parties for tax purposes, and the result of the case was favorable t

How is the China-US Income Tax Treaty Relief Affected When the US Shareholder is a Pass-through Entity?

Some US-headquartered multinationals use US LLCs to hold equity investments in China for various reasons. Does such a structure affect the access of the US shareholders to benefits under the US-China income tax treaty if the Chinese equity interests are sold in the future? A recent case reported by the Chinese central tax authorities, in which the direct US shareholder was an S corporation, shed light on this question.

http://ow.ly/2mXo50Bj9wc

An S Corp Denied Access to the China-US Income Tax Treaty Relief for Capital Gains In a recent case reported in China, a US shareholder was denied treaty relief from the Chinese capital gains due to its status as a US S Corp. The Chinese company ("ChinaCo") was listed in the Shenzhen stock exchange in the PRC.

MNC Won Chinese Tax Treaty Position with Derivative Benefits Test

The article describes a recent Chinese tax audit case on treaty qualification. It was one of the few known cases where an MNC taxpayer relied on a technical argument similar to the "derivative benefits" provision in a typical US LOB article (also referenced in the OECD BEPS Action Plan 6) to score a major victory in a PRC audit on dividend withholding tax.

http://ow.ly/VVkm50Bj9w1

MNC Won Chinese Tax Treaty Position with Derivative Benefits Test The following is a recent Chinese tax audit case on treaty qualification. It was one of the few known cases where an MNC taxpayer relied on a technical argument similar to the "derivative benefits" provision in a typical US LOB article (also referenced in the OECD BEPS Action Plan 6) to score a majo

Can the Statute of Limitations in China be Suspended if the Taxpayer provides a Reasonable Cause?

A case was reported in Southern China about the application of the statute of limitations (SOL) provisions. Even though the taxpayer launched the case after the SOL expired, the Chinese court ruled that the lawsuit was still valid because the taxpayer provided a reasonable cause for not meeting the statutory time limit. It ruled that the time spent by the buyer in figuring out the correct court should be deducted when deciding whether the SOL was satisfied.

http://ow.ly/Hsub50Bj9vy

China Tax Update - Statute of Limitations for Chinese Tax Litigation Suspended Due to a Reasonable Cause A case was reported in Southern China about the application of the statute of limitations (SOL) provisions in the PRC. Even though the taxpayer launched the case after the expiration of the time bar, the court ruled that the lawsuit was still valid because the taxpayer provided a reasonable cause fo

Using the Statute of Limitations (SOL) to Win a Chinese Tax Audit

Audit cases in China often trace back to historical periods from a long time ago so the Statute of limitations (SOL) is important. It is used by both Chinese taxpayers and the Chinese tax authorities as a powerful argument in tax controversy matters. Depending on the nature of the issues, different SOL rules apply. In the case below, the taxpayer relied on the SOL to win an audit without debating the technical details in the Chinese courts.

http://ow.ly/Lhs250Bj9vp

Using the Statute of Limitations (SOL) to Win a Chinese Tax Audit The following is a tax case in which a Chinese taxpayer used the Statute of Limitation ("SOL") provision to win an audit. The case shows that SOL can be a powerful argument for taxpayers in some Chinese tax audit defense situations.

Chinese Land Appreciation Tax Controversy in Real Estate Sales

Chinese real estate assets have appreciated significantly in the past 15 years. Thanks to the booming market, any seller that disposes of Chinese immovable properties (including land rights) acquired from 10 years ago will likely realize material gains.

A business transferor of Chinese real estate needs to pay Land Appreciation Tax (LAT), and this can be very significant in amount. As LAT technically does not apply in equity deals and should arise only when Chinese real estate assets are disposed of directly, some corporate sellers sought to convert asset deals into equity deals when the target assets mainly consist of real estate. Is this a feasible approach?

http://ow.ly/IUVK50Bj9v8

Chinese Land Appreciation Tax Controversy in Real Estate Sales Chinese real estate assets have appreciated significantly in the past 15 years. Thanks to the booming market, any seller that disposes of Chinese immovable properties (including land rights) acquired from 10 years ago will likely realize material gains.

Managing Double Taxation Risks for Outbound Royalties in China

When a Chinese company pays a royalty to an overseas enterprise that is a related party, it is well recognized that the income tax deduction of the royalty payment may be challenged sometimes due to transfer pricing reasons. However, even if the Chinse company and the overseas enterprise are unrelated, the royalty may still face Chinese double taxation risks in certain situations. The cause of the problem is not transfer pricing, but the lack of coordination between the tax and the customs authorities in the PRC.

http://ow.ly/VDMz50Bj9uE

Managing Double Taxation Risks for Outbound Royalties in China When a Chinese company pays a royalty to an overseas enterprise that is a related party, income tax deduction of the royalty payment may be challenged due to transfer pricing reasons. However, even if the Chinse company and the overseas enterprise are unrelated, the royalty may still face Chinese do

Tax Risks of Valuation Adjustment in Chinese M&A

Valuation adjustment mechanism (VAM) is sometimes used in Chinese M&A transactions, due to the asymmetrical state of information between the parties. In an equity deal, a common practice of VAM specifies the financial performance of the target for a future period. If the financial performance of the target falls short, the buyer is compensated by the seller in cash or equity, and vice versa.

If the seller makes a payment due to the VAM, the purchase price is reduced. Can the seller get a refund for the overpaid portion of the income tax that was previously based on the original purchase price?

http://ow.ly/MgUZ50Bj9uc

Tax Risks of Valuation Adjustment in Chinese M&A Valuation adjustment mechanism (VAM) is sometimes used in Chinese M&A transactions, due to the asymmetrical state of information between the transaction parties. In an equity deal, a common practice of VAM specifies the financial performance of the target for a period of time in the future (e.

China Tax Update - Changchun Tax Audit Collected $7 million of Tax By Valuation Adjustment in Equity Sale.

A tax valuation case was reported in Changchun, China, in which the local tax officials collected $7 million of income tax by increasing the transaction value of an equity sale under the cost method. The case shows that while the general trend in China for tax valuation is that the tax authorities tend to prefer the income method to the cost method, it is not always the case. The tax examiners will choose the method that gives them the best tax outcome. The recommended approach for the MNC taxpayers is to use a combination of the income method and the cost method to derive a more defensible valuation position.

http://ow.ly/mlHm50Bj9th

China Tax Update - Changchun Tax Audit Collected $7 million of Tax By Valuation Adjustment in Equity Sale. The Chinese transfer pricing (TP) regulations contain three main tax valuation methods for asset transfers among related parties: (1) the cost method; (2) the income method; and (3) the market method. The cost method values an asset based on the costs of creating a similar asset under the current ma

China Tax Update - Tax Controversy on the Western Region Incentive

Attached is a brief recapture of recent tax litigation concerning the Western Region Tax Incentive (Western Incentive) in Southern China. While the issue in controversy pertains to the Western Incentive specifically, it can arise in the context of another Chinese tax incentive that is based on an encouraged industry catalogue. So the case potentially has wider applicability.

http://ow.ly/1Kti50Bj9qn

China Tax Update - Tax Controversy on the Western Region Incentive The following is a brief recapture of recent tax litigation concerning the Western Region Tax Incentive (Western Incentive). While the issue in controversy pertains to the Western Incentive specifically, it can arise in the context of another Chinese tax incentive that is based on an encouraged indu

Chinese Tax Adjustment Risks for Pricing in Unrelated Party Transactions

Do the Chinese tax authorities have the ability to adjust the price of a commercial transaction between unrelated parties for tax purposes? That was the core issue in a tax litigation that happened in Northwestern China.

The result of the case was favorable to the taxpayer. When reaching such a conclusion, one of the courts specifically denied the legal authority of the two tax letter rulings that were issued by the central tax administration (aka the STA) and were cited by the local tax officials as supporting evidence.

https://www.linkedin.com/pulse/chinese-court-case-tax-adjustment-unrelated-party-abe

Chinese Court Case on Tax Adjustment for Pricing in Unrelated Party Transactions The article below summarizes a tax controversy litigation that happened in the Xinjiang region (Western China). The case was centered on the tax authorities' ability to adjust the price of a commercial transaction between unrelated parties for tax purposes, and the result of the case was favorable t

PRC Tax Loss Planning by Chinese Subsidiaries of MNCs in 2020

The current COVID-19 pandemic is expected to pose financial challenges to Chinese subsidiaries of MNCs in 2020, and many entities will incur losses this year. When planning for the PRC tax loss, Chinese businesses should keep some important technical aspects in mind.

https://www.linkedin.com/pulse/considerations-tax-losses-chinese-subsidiaries-mncs-abe

Considerations for tax losses by Chinese subsidiaries of MNCs in 2020 The current COVID-19 pandemic is expected to pose financial challenges to many Chinese subsidiaries of MNCs in 2020. From a Chinese standpoint, the following technical considerations should be kept in mind by MNCs' tax planners.

How is the China-US Income Tax Treaty Relief Affected When the US Shareholder is a Pass-through Entity?

Some US-headquartered multinationals use US LLCs to hold equity investments in China for various reasons. Does such a structure affect the access of the US shareholders to benefits under the US-China income tax treaty if the Chinese equity interests are sold in the future? A recent case reported by the Chinese central tax authorities, in which the direct US shareholder was an S corporation, shed light on this question.

https://www.linkedin.com/pulse/corp-denied-access-china-us-income-tax-treaty-relief-abe

An S Corp Denied Access to the China-US Income Tax Treaty Relief for Capital Gains In a recent case reported in China, a US shareholder was denied treaty relief from the Chinese capital gains due to its status as a US S Corp. The Chinese company ("ChinaCo") was listed in the Shenzhen stock exchange in the PRC.

MNC Won Chinese Tax Treaty Position with Derivative Benefits Test

The article describes a recent Chinese tax audit case on treaty qualification. It was one of the few known cases where an MNC taxpayer relied on a technical argument similar to the "derivative benefits" provision in a typical US LOB article (also referenced in the OECD BEPS Action Plan 6) to score a major victory in a PRC audit on dividend withholding tax.

https://www.linkedin.com/pulse/china-tax-audit-update-mnc-won-treaty-position-test-abe

MNC Won Chinese Tax Treaty Position with Derivative Benefits Test The following is a recent Chinese tax audit case on treaty qualification. It was one of the few known cases where an MNC taxpayer relied on a technical argument similar to the "derivative benefits" provision in a typical US LOB article (also referenced in the OECD BEPS Action Plan 6) to score a majo

Can the Statute of Limitations in China be Suspended if the Taxpayer provides a Reasonable Cause?

A case was reported in Southern China about the application of the statute of limitations (SOL) provisions. Even though the taxpayer launched the case after the SOL expired, the Chinese court ruled that the lawsuit was still valid because the taxpayer provided a reasonable cause for not meeting the statutory time limit. It ruled that the time spent by the buyer in figuring out the correct court should be deducted when deciding whether the SOL was satisfied.

https://www.linkedin.com/pulse/china-tax-update-statute-limitations-chinese-due-abe

China Tax Update - Statute of Limitations for Chinese Tax Litigation Suspended Due to a Reasonable Cause A case was reported in Southern China about the application of the statute of limitations (SOL) provisions in the PRC. Even though the taxpayer launched the case after the expiration of the time bar, the court ruled that the lawsuit was still valid because the taxpayer provided a reasonable cause fo

Tax Risks of Valuation Adjustment in Chinese M&A

Valuation adjustment mechanism (VAM) is sometimes used in Chinese M&A transactions, due to the asymmetrical state of information between the parties. In an equity deal, a common practice of VAM specifies the financial performance of the target for a future period. If the financial performance of the target falls short, the buyer is compensated by the seller in cash or equity, and vice versa.

If the seller makes a payment due to the VAM, the purchase price is reduced. Can the seller get a refund for the overpaid portion of the income tax that was previously based on the original purchase price?

https://www.linkedin.com/pulse/tax-risks-valuation-adjustment-chinese-ma-abe

Tax Risks of Valuation Adjustment in Chinese M&A Valuation adjustment mechanism (VAM) is sometimes used in Chinese M&A transactions, due to the asymmetrical state of information between the transaction parties. In an equity deal, a common practice of VAM specifies the financial performance of the target for a period of time in the future (e.

Managing Double Taxation Risks for Outbound Royalties in China

When a Chinese company pays a royalty to an overseas enterprise that is a related party, it is well recognized that the income tax deduction of the royalty payment may be challenged sometimes due to transfer pricing reasons. However, even if the Chinse company and the overseas enterprise are unrelated, the royalty may still face Chinese double taxation risks in certain situations. The cause of the problem is not transfer pricing, but the lack of coordination between the tax and the customs authorities in the PRC.

https://www.linkedin.com/pulse/double-taxation-risks-outbound-royalties-china-abe

Managing Double Taxation Risks for Outbound Royalties in China When a Chinese company pays a royalty to an overseas enterprise that is a related party, income tax deduction of the royalty payment may be challenged due to transfer pricing reasons. However, even if the Chinse company and the overseas enterprise are unrelated, the royalty may still face Chinese do

Chinese Land Appreciation Tax Controversy in Real Estate Sales

Chinese real estate assets have appreciated significantly in the past 15 years. Thanks to the booming market, any seller that disposes of Chinese immovable properties (including land rights) acquired from 10 years ago will likely realize material gains.

A business transferor of Chinese real estate needs to pay Land Appreciation Tax (LAT), and this can be very significant in amount. As LAT technically does not apply in equity deals and should arise only when Chinese real estate assets are disposed of directly, some corporate sellers sought to convert asset deals into equity deals when the target assets mainly consist of real estate. Is this a feasible approach?

https://www.linkedin.com/pulse/land-appreciation-tax-consideration-equity-deals-real-abe

Chinese Land Appreciation Tax Controversy in Real Estate Sales Chinese real estate assets have appreciated significantly in the past 15 years. Thanks to the booming market, any seller that disposes of Chinese immovable properties (including land rights) acquired from 10 years ago will likely realize material gains.

Chinese Transfer Pricing Audit on a Semiconductor Company

A Chinese transfer pricing audit case was recently reported in Wuxi, Jiangsu province, against a PRC semiconductor group. Several important aspects of the case reflect the current tax enforcement trend in China and are summarized in the article below.

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Chinese Transfer Pricing Audit on a Semiconductor Company A Chinese transfer pricing audit case that was recently reported in Wuxi, Jiangsu province, against a PRC semiconductor group. Taxpayer was a medium-sized Chinese company headquartered in the city of Wuxi.

Current Status of Chinese MAP Program

In December, the OECD released a stage 1 MAP peer review report for China. The review was intended to assess China’s implementation of the BEPS Action 14 Minimum Standard and was partly conducted through questionnaires completed by China, the competent authorities of 18 other countries, and selected MNC taxpayers. The attached article summarizes the latest status of the Chinese MAP program based on the comments received.

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https://www.linkedin.com/pulse/status-chinese-map-program-abe-zhao/?published=t

Status of Chinese MAP Program In December 2019, the OECD released a stage 1 MAP peer review report for China. The review was intended to assess China’s implementation of the BEPS Action 14 Minimum Standard and was partly conducted through questionnaires completed by China, the competent authorities of 18 other countries ("peer...

Recent Litigation on Fiscal/Tax Incentive Deal with Local Chinese Government

MNCs often conduct location studies when making new investments in China and one factor to consider is the incentives offered by the governments in-charge of the investment projects. Recently a litigation case was reported in Anhui province (central China) concerning the fulfillment of commitment regarding incentives that were previously agreed upon by the local government. Although the incentives were documented in an investment agreement between the government and the taxpayer, the local government subsequently argued that they lack legal basis. Details are provided below.

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https://www.linkedin.com/pulse/recent-litigation-fiscaltax-incentive-deal-local-chinese-abe-zhao/?published=t

Recent Litigation on Fiscal/Tax Incentive Deal with Local Chinese Government MNCs often conduct location studies when making new investments in China and one factor to consider is the incentives offered by the governments in-charge of the investment projects. Recently a litigation case was reported in Anhui province (central China) concerning the fulfillment of commitment re

Chinese Permanent Establishment Risks from Short-Term Travelers

The following summarizes a recent tax investigation case of Permanent Establishment (“PE”) in Beijing, China. The case serves to clarify on the common misunderstanding and illustrates the Chinese PE risks caused by frequent international travelers, even though each traveling individual stayed in the PRC for a short period of time only.

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Chinese Permanent Establishment Risks from Short-Term Travelers The following summarizes a recent tax investigation case of Permanent Establishment (“PE”) in Beijing, China. The case serves to clarify on the common misunderstanding and illustrates the Chinese PE risks caused by frequent international travelers, even though each traveling individual stayed in...

New Transfer Pricing Investigation in Ningbo, China

A Sino-Japanese joint venture in Ningbo, Zhejiang Province of China was selected for transfer pricing audit because of its low profitability in historical periods. The local PRC tax authorities asserted that the rapid expansion of sales by the taxpayer during the audit period suggested the products possessed good competitive advantages and growth potential in the market, and hence more profits should have been reported. Details are below.

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https://www.linkedin.com/pulse/new-transfer-pricing-investigation-ningbo-china-abe

New Transfer Pricing Investigation in Ningbo, China With respect to Chinese transfer pricing (TP) enforcement practices, the following summarizes a recent anti-avoidance investigation in Ningbo, Zhejiang Province. The taxpayer was a joint venture ("JV") between a Chinese company and a Japanese MNC.

Recent Chinese Indirect Transfer Case in the City of Hefei

A recent indirect transfer case was reported in the city of Hefei, Anhui Province, which is in Central China. In this case, the Hefei tax authorities determined that the indirect sale of a Chinese WFOE by the Seller did not meet the business purpose requirement and should be disregarded under China's tax regulations. Therefore, the Seller was asked to pay Chinese income tax on gains attributable to its pro rata share in the Chinese WFOE.

The case suggests that the Chinese tax authorities continue to enforce the indirect transfer rules vigorously. More details are in the attachment.

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Recent Chinese Indirect Transfer Case in the City of Hefei A recent indirect transfer case was reported in the city of Hefei, Anhui Province, which is in Central China. The transaction took the form of equity transfer, and the share purchase agreement ("SPA") was signed by the parties in August 2018.