Aoba Newsletter | China
Member NewsDecember 7, 2016 - Aoba CPA Limited
Insight into the New Policy on Refining the Filing of Related Party Transactions and Administration of Contemporaneous Transfer Pricing Documentation
On 29th June 2016, the State Administration of Taxation (“the SAT”) issued the “Public Notice on Matters Regarding Refining the Filing of Related Party Transactions and Administration of Contemporaneous Transfer Pricing Documentation” (SAT Public Notice  No.42, hereinafter referred to as “the Notice 42”). The “Implementation Measures of Special Tax Adjustments (Trial Version)” (Guoshuifa  No.2) was first released in China in 2009. Since then, China has been actively participating in the formulation of the international tax regulations, especially the in-depth participation in the Base Erosion Profit Shifting (“BEPS”) Action Plan. The “Implementation Measures of Special Tax Adjustments (Discussion Draft)” was subsequently released in September 2015, which was an overall revision of the Guoshuifa  No.2 by integrating with the BEPS Action Plan. The newly released Notice 42 is a further revision by refining the chapters on the Filing of Related Party Transactions and the Administration of Contemporaneous Transfer Pricing Documentation based on the Discussion Draft.
New contents added to the Notice 42 were stemming from the SAT’s years of practical experience in anti-tax evasion, which include adding the transfer of financial assets as a new category of related party transaction, adding the requirement to file a Country-by-Country Report, the Contemporaneous Transfer Pricing Documentation has increased from a one-set file to a three-set file, while the Related Party Transactions Return (“the RPT Return”) has increased from 9 forms to 12 forms. Therefore the release of Notice 42 will impact the multinational enterprises significantly as:
1. With the addition of many complicated forms and reports, the workload of preparing the RPT Return increases a lot. Considering the complexity of the forms, it’s likely that the enterprises would need to seek professional assistance for its preparation;
2. Contents such as value chain analysis, the disclosure of related party equity transfer and etc. are required to be included in the Transfer Pricing Documentation, which increase the difficulty in preparing the analytic data. Thus, it would be difficult for enterprises to prepare the Transfer Pricing Documentation without professional help.
The Notice 42 has made detail provisions in respect of the reporting entity for RPT filing, the definition of a related party relationship and a related party transaction, the requirement for the filing of Country-by-Country Report, as well as the type, content, preparation requirement and time limitation of preparing the Contemporaneous Transfer Pricing Documentation.
1. Clarify the reporting entity of Related Party Transaction filing
A tax resident enterprise that pays Enterprise Income Tax according to its financial records and a non-tax resident enterprise that has an establishment or a place of business in China and is assessed Enterprise Income Tax based on its actual accounts should, at the time of submitting its annual Enterprise Income Tax return, report related party transactions based on its dealings with related parties.
2. Amend the definition of a Related Party Relationship (“the RPR”)
1) For the determination of RPR constituted by shareholding, it’s now required to aggregate,in the calculation, the shares of a same enterprise held by two or more natural persons, who are spouses, related by lineal consanguinity, siblings, or in other custodianship/family maintenance relationships.
2) For the determination of RPR constituted by debt financing, a calculation formula on total debt to paid-in capital ratio has been specified.
3) For the determination of RPR constituted by the appointment of directors or senior management, the Notice 42 further clarifies the term senior management to include secretaries of the board of directors of listed companies, managers, deputy managers, financial controllers and other personnel specified in the company’s articles of association
4) The Notice 42 also provides that two natural persons who are spouses, related by lineal consanguinity, siblings, or in other custodianship/family maintenance relationships have constituted RPR with one party and the other party respectively by way of shareholding, debt financing, granting of proprietary rights essential for operation, exercising control or appointment of directors or senior officers, etc., the two parties would constitute RPR. For instance, if the husband constituted a RPR with Enterprise A while the wife constituted a RPR with Enterprise B, then there is a RPR constituted between Enterprise A and B.
5) A related party relationship should be recognized for the period during which it exists, in the event it changes during the fiscal year. For instance, if Company A held 50% shares of Company B during the period from 1st January, 2015 to 31st March, 2015, and subsequently sold 30% shares of Company B to Company C on 1st April, 2015, which Company C held till 31st December, 2015, then Company A would constitute RPR with Company B from 1st January, 2015 to 31st March, 2015, while Company C would constitute RPR with Company B from 1st April, 2015 to 31st December, 2015.
6) It rules out constitution of RPR by way of shareholding by the State or association through assignment of directors or senior management by the state-owned assets management authorities.
3. New category of related party transaction
The Notice 42 adds one new category of related party transaction, i.e. the transfer of financial assets. Financial assets here refer to account receivables, notes receivables, other receivables, equity investments, debt investments, derivative financial assets and etc.
4. Reporting entity and content of Country-by-Country Report (“CbC Report”)
The CbC Report is an important part of BEPS’s Action Plan No.13, Transfer Pricing Documentation and Country-by-Country Reporting. Hence in the Notice 42, the CbC Report is added as an appendix to the Related Party Transactions Return, which together are to be submitted during the annual filing of the Enterprise Income Tax Return.
1) The tax resident enterprise should file the CbC Report, if either of the following criteria
a) The resident enterprise is the ultimate holding company of a group of multinational enterprises (“the MNE”) with the consolidated group income of over RMB5.5 billion as per the consolidated financial statements for the financial year immediately preceding the reporting year. The ultimate holding company is a company that is capable of consolidating all group companies’ financial statements and its result can not be included in other companies’ consolidated financial statements. The group companies should include any entity: i) whose financial results are included in the MNE’s consolidated financial statements; ii) whose shares are held within the MNE and its financial results should be included in the MNE’s consolidated financial statements if the equity interest of the MNE were to be traded on a public securities exchange; iii) which is not included in the MNE’s consolidated financial statements merely due to its business scale or materiality; iv) which is a permanent establishment that prepares its accounts and financial statements independently.
b) The resident enterprise that is assigned to file the CbC Report by the MNE.
2) The MNE’s global incomes, tax liabilities and business operations are disclosed on a country by country basis in the CbC Report via the following three forms “Distribution of Incomes, Tax iabilities and Business Operations by Country”, “List of the MNE’s Group Companies” and “Additional Statement”.
3) If the ultimate holding company of the MNE is a Chinese tax resident and its information relates to national security, its obligation to file the CbC Report could be partially or fully exempted as prescribed by the relevant laws and regulations.
4) The CbC Report should be completed in both Chinese and English. The Chinese tax authority may exchange the CbC Report in English with other tax regimes in accordance to the treaty/agreement/arrangement concluded.
5) Tax authorities can request a company to provide a copy of the CbC Report in the course of a special tax investigation, if:
a) The MNE has not filed the CbC Report to any other countries;
b) The MNE has filed the CbC Report to another country, but China does not have any arrangement in place to exchange the CbC Report with that country; and
c) The MNE has filed the CbC Report to another country which China has an arrangement in place to exchange the CbC Report, but the exchange of CbC Report has not been successful.
5. New requirements of Transfer Pricing Documentation (“TP Documentation”)
The TP Documentation now includes 3 sets of files, namely master file, local file and special issue file. If an enterprise meets the criteria for the preparation of any of the above files, the corresponding TP Documentation should be prepared. Thus, it’s possible that an enterprise may be required to prepare more than one set of TP Documentation file.
1) Any enterprise that meets either of the following criteria should prepare a master file:
a) The enterprise has cross-border related party transactions during the year and the MNE group to which the ultimate holding company has consolidated its financial results has prepared a master file; or Aoba Newsletter - China
b) The enterprise has related party transactions with the total amount over RMB one billion during the year. The master file aims to provide an overview of the global business operation of the MNE group to which the ultimate holding company belongs.
2) Any enterprise that conducts related party transactions in exceed of the following criteria during a fiscal year should prepare a local file:
a) over RMB200 million for transfer of tangible assets (for contract processing business, the amount is calculated based on the import/export price recorded in customs)
b) over RMB100 million for transfer of financial assets
c) over RMB100 million for transfer of intangible assets
d) over RMB40 million for other related party transactions
3) The Notice 42 emphasizes on the comprehensiveness, accuracy and completeness for the information disclosure in local file. The information concerned includes:
a) Corporate organization structure, management structure, business description, operation strategy, financial data, information related to corporate restructuring, transfer of intangible assets and etc.;
b) General information on related parties and changes in related party relationships;
c) Information on related party transactions including transaction details, work flows and the key factors influencing pricing and etc.;
d) Flows of business, logistic and capital of related party transactions, values contributed by special regional factors, and profits allocation principle and result within the MNE group value chain and etc.;
e) Information on outbound investment, share transfer and provision of services among related parties;
f) Any advance pricing arrangement and other tax rulings made by foreign tax authorities which are directly related to the related party transactions;
g) Factors considered in comparability analysis, information related to the functions performed, risk assumed, assets used by the comparable companies; and
h) Selection and application of transfer pricing methods.
4) An enterprise that concluded or participated in cost sharing agreements should prepare a special issue file.
5) An enterprise with a related party debt-to-equity ratio in excess of the standard rate should prepare special issue file for thin capitalization to demonstrate that it complies with the arm’s length principle.
6) An enterprise that has an existing advance pricing arrangement can choose not to prepare local file and special issue file related to the advance pricing arrangement, and the amounts of related party transactions relevant to the advance pricing arrangement can be excluded when calculating the threshold for requirement to prepare the local file as stated in Part 5 2).
7) An enterprise that only has related party transactions with related parties in China is exempted from the preparation of master file, local file and special issue file.
8) Master file should be completed within 12 months from the financial year end date of the MNE’s ultimate holding company; local file and special issue file should be completed by 30th June of the following year after the year which the related party transaction incurred. Contemporaneous TP Documentation should be submitted within 30 days after requested by the tax authorities.
9) The TP Documentation should be retained for 10 years since the completion date as required by the tax authority.
6. Application of the Notice 42
The Notice 42 comes into effect from 2016 fiscal year and onwards, and at the same time, Chapter 2, Chapter 3, Article 74 and Article 89 of the “Implementation Measures of Special Tax Adjustments (Trial Version)” (Guoshuifa  No.2) and the “People’s Republic of China Enterprise Annual Reporting Forms for Related Party Transactions” (Guoshuifa  No.114) are annulled.
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