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World Tax Advisor Connecting you globally. 22 July 2016 China introduces CbC reporting and master file/local file requirements On 29 June 2016, China...
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World Tax Advisor Connecting you globally. 22 July 2016

China introduces CbC reporting and master file/local file requirements On 29 June 2016, China’s State Administration of Taxation (SAT) issued rules (Bulletin 42) that introduce new transfer pricing reporting and documentation requirements. The rules, which generally are in alignment with the three-tiered framework for transfer pricing documentation found in the final report on action 13 of the OECD BEPS project, are designed to improve the reporting of related party transactions and contemporaneous documentation. Bulletin 42 applies retroactively as from 1 January 2016. Notably, while Bulletin 42 generally adopts the OECD approach, it also requires a technical analysis and consideration of positions that are familiar to the China market. Requirements that were signaled in the September 2015 discussion draft revisions to Circular 2 (the main framework for China’s transfer pricing and anti-abuse rules), including countryby-country (CbC) reporting, the master and local files, the special issue file and value chain analysis, also are covered in Bulletin 42 (for prior coverage, see the China tax alert, 21 September 2015). A special issue file will need to be prepared for cost sharing arrangements (CSAs) and in certain thin capitalization cases. URL: http://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-alert-china-21-september-2015.pdf

Circular 2 covers areas such as transfer pricing adjustments, CSAs, controlled foreign companies, thin capitalization and the general anti-avoidance rule. Bulletin 42, however, addresses only the reporting of related party transactions and the preparation of contemporaneous documentation; it replaces the transfer pricing documentation rules in Circular 2 (chapters 2 and 3, and articles 74 and 89) and repeals other related guidance (Circular 114). The SAT will be issuing additional rules to complete the planned overhaul of Circular 2. Bulletin 42 covers issues that have been the focus of the Chinese tax authorities for a number of years, addressing practical issues they have encountered and laying a new landscape for transfer pricing practice and management in China. Additionally, the implementation of BEPS action 13 represents a dramatic shift in China’s policies and is a milestone in the “internationalization” of the country’s transfer pricing practices. Related party relationships and transactions Bulletin 42 revises the related party relationship definitions in Circular 2 to ensure that relationships between individuals are taken into account when considering the relationship between two parties. Two parties will be considered to be related if they have “other substantial common interests.” There are changes to reflect public comments on the rules in respect of relationships involving directors on boards and senior management personnel. In addition, the new rules recognize that related party relationships may change, and that relationships should be recognized during the periods in which they exist. The types of covered related party transactions are updated from the Circular 2 definitions to more comprehensively cover the types of transactions that take place between related parties, thus expanding the potential coverage of special tax adjustments. The final rules effectively are unchanged from those signaled in the September 2015 discussion draft, and cover tangible and intangible assets, financial assets (e.g. equity investment), financing transactions (e.g. cash pooling, guarantee fees and all kinds of interest accrued on advances and deferred payments) and service transactions. Reporting of related party transactions Bulletin 42 includes the formal templates and filing instructions for the Annual Related Party Transactions Reporting Forms (“New Forms”), including the CbC reporting form. The New Forms replace the previous nine forms, and increase the total number of forms to 14. Overall, the information disclosure requirement is increased. The New Forms will take more time to complete, given the increase in the number of forms and the amount of information required. The design of the forms reflects the enhanced requirements of the tax authorities on disclosure, especially for related party relationships and transactions, while at the same time attempting to streamline the preparation and reduce uncertainty in the filing process. The inclusion of the CbC form also shows how China has adopted the requirements of BEPS action 13, and lays the foundation for future CbC information exchanges. Taxpayers will need to pay close attention when preparing the forms to ensure consistency across all of the forms, as well as with the transfer pricing documentation, audit report and other associated documents. World Tax Advisor 22 July 2016

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CbC reporting The SAT has included the CbC form in the reporting forms for related party transactions, and seems to require taxpayers to provide both Chinese and English versions. Consistent with the treatment in the discussion draft, a CbC form will be required for the following taxpayers: • •

A China resident enterprise that is the ultimate parent of a multinational enterprise group that has consolidated revenue greater than RMB 5.5 billion in the previous fiscal year; or A China resident enterprise that is designated by the multinational group to be the filing entity (consistent with the secondary filing mechanism provided in the BEPS action 13 report).

Bulletin 42 includes a number of definitions for the purpose of determining the group parent and member entities; these definitions are consistent with those in the recommendations under BEPS action 13. Of interest to some taxpayers, the rules also partially or entirely exempt Chinese enterprises from the filing requirement if the information relates to “national security.” There are provisions that allow the Chinese tax authorities to request copies of CbC reports from overseas tax authorities, as well as provisions to require the information from local entities if the overseas tax authorities do not provide the information. Submission deadline The filing deadline for the New Forms generally should be the same as the date the annual enterprise tax return is due, i.e. 31 May of the following year. Contemporaneous documentation A major focus of the feedback on the discussion draft was the framework for transfer pricing documentation. Overall, the requirements for the master and local files are similar to those signaled in the discussion draft, with revisions to the thresholds for preparation; the requirement for the special issue file for service transactions has been removed, although the analysis for service transactions now is required to be incorporated into the local file, along with information regarding equity transfers. Of particular note, the new rules retain the detailed disclosure requirements from the discussion draft, meaning that the value chain analysis, location-specific advantages and other matters of concern to the SAT will need to be addressed. It has been confirmed that transactions with related parties in Hong Kong, Macau and Taiwan will be considered cross-border related party transactions. The deadlines for preparing the documentation have been revised (see the table below). The following table compares the requirements of Bulletin 42 and Circular 2 for the preparation of the contemporaneous documentation:

World Tax Advisor 22 July 2016

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© 2016. For information, contact Deloitte Touche Tohmatsu Limited.

Item Circular 2 (Chapter 3) Report structure China country file only Threshold for preparation





The annual sum of related party purchases and sales exceeds RMB 200 million (for toll manufacturing activities, the amount is calculated based on the import/export customs declaration prices); or The annual sum of other related party transactions exceeds RMB 40 million (for related party financing, the amount is calculated based on the interest received/paid)

The value of related party transactions under a CSA or advance pricing agreement (APA) is not taken into account in determining the annual sum of related party transactions

Bulletin 42 Three-part framework: master file, local file, special issue file Master file: •



An enterprise has transactions with overseas related parties during the year and the ultimate holding company of the group in which the enterprise is a member, which consolidates the enterprise into its financial statements, has prepared a master file; or An enterprise has related party transactions exceeding an aggregate of RMB 1 billion during the year

Local file: •





The annual sum of related party purchases/sales exceeds RMB 200 million (for toll manufacturing activities, the amount is calculated based on the import/export customs declaration prices); The annual sum of related party purchases/sales of financial assets or intangible assets exceeds RMB 100 million; or The annual sum of other related party transactions exceeds RMB 40 million

The value of related party transactions under an APA will not be taken into account in determining the annual sum of related party transactions Special issue file: • •

Exempt from preparation

• •

Related party transactions covered under an APA; or The foreign shareholding percentage is lower than 50% and related party transactions are carried out only among domestic parties





World Tax Advisor 22 July 2016

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An enterprise enters or implements a CSA; or An enterprise with a related party debtto-equity ratio exceeding the threshold (i.e. 2:1 for nonfinancial entities and 5:1 for financial entities) wishes to demonstrate that its related party financing is in compliance with the arm’s length principle If the related party transactions of the enterprise are only between the enterprise and its domestic related parties, the enterprise may be exempt from the preparation of the master file, local file and special issue file requirements Related party transactions that are covered under an APA may be exempt from the preparation of the local file and special issue file requirements © 2016. For information, contact Deloitte Touche Tohmatsu Limited.

Item Circular 2 (Chapter 3) Report structure China country file only Deadline for preparation

31 May of the following year

Deadline for submission

Within 20 days of a request by the tax authorities

Bulletin 42 Three-part framework: master file, local file, special issue file • Master file: Within 12 months of the fiscal year end of the group’s ultimate holding company • Local file and special issue file: By 30 June of the following year Within 30 days of a request by the tax authorities

Comments Bulletin 42 will require multinational enterprises to invest more time and resources to comply with China’s contemporaneous documentation and reporting requirements. In particular, in the absence of a consistent threshold or filing requirement for the master file from the OECD, China’s regulations may be different from the rules in other countries. Difficulties could arise where a foreign parent company is not required to prepare a master file in the country where it is located, while its Chinese subsidiary is required to prepare a master file according to Chinese domestic law. Additionally, Bulletin 42 requests taxpayers to provide some sensitive and complicated information in the New Forms and in the contemporaneous documentation. The depth and scope of the content that needs to be analyzed has increased significantly. Taxpayers should take early action to ensure they are prepared for this change and communicate with related parties so that information can be collected on time. Furthermore, given the increased disclosure requirements, and collaboration and information sharing between tax authorities, taxpayers will need to improve the efficiency of information collection, control compliance costs and maintain consistency with the transfer pricing information disclosed globally. It is worth noting that the multilateral convention on mutual assistance in tax collection entered into force for China on 1 February 2016 and will apply as from 1 January 2017. More than 130 countries will be able to exchange tax information with China by that time. Additionally, on 12 May 2016, the SAT signed the CbC multilateral competent authority agreement for the automatic exchange of CbC reports for multinational enterprise groups. Some countries are drafting or have announced national regulations for CbC reports. Therefore, multinational enterprise groups will face more stringent information transparency and compliance requirements. The OECD recently published additional guidance on filing requirements for CbC reports that makes suggestions on several outstanding issues, including the filing of CbC reports during the transition period and the effects of exchange rate fluctuations on the filing threshold (for prior coverage, see the global transfer pricing alert, 1 July 2016). Taxpayers should monitor whether the additional guidance will cause any changes to the filing regulations in the different countries in which they operate. URL: http://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-global-transfer-pricing-alert-16-023-1-july2016.pdf

Overall, the information required to be disclosed through the reporting of related party transactions and contemporaneous documentation will be more transparent, and the information exchange between tax authorities of different jurisdictions should be more extensive and efficient. This will enable the Chinese tax authorities to obtain more control over taxpayer information for the purpose of risk assessment and the determination of tax audit targets, and will allow the SAT to participate more actively in global anti-tax avoidance actions. —

Eunice Kuo (Shanghai) Partner Deloitte China [email protected]

World Tax Advisor 22 July 2016

Liantang He (Beijing) Partner Deloitte China [email protected]

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World Tax Advisor 22 July 2016

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© 2016. For information, contact Deloitte Touche Tohmatsu Limited.

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