Checklist of hot China tax issues for MNEs in 2019

Technology implementation to manage individual income taxes – With the China individual income tax (IIT) reforms entering into full effect from January 2019, businesses are looking to implement technology solutions to help them efficiently manage the administrative burden of collecting employee information on IIT deduction eligibility. The reforms fundamentally change the basis upon which Chinese nationals, and their employers, account for, or withhold, IIT. Whereas previously Chinese nationals were typically taxed on their gross income, from January 2019 they will be assessed on their net income after taking into account a broad range of personal deductions. Foreign expatriates in China will also be affected, with new residency tests and modified rules on claiming various tax free allowances.

Employer duty of care for administering itemised deductions – New itemised deductions for a range of personal living expenses have been introduced under the IIT reform, with a view to improving the lives of working people. While the starting point in the implementation guidelines is that individual taxpayers are responsible for the accuracy of their claims, it is clear that employers will also have a duty of care in the administration of the itemised deduction claims. This will add considerably to employer administrative burdens, as they will need to verify certain claims and track deduction limits.

Manage communications with employees – Given the sweeping IIT reform changes, all employees, including both local-hires and foreign expatriates, are bound to have many queries. It is therefore important for companies to provide appropriate training to equip their HR personnel with relevant knowledge of the China IIT reform in order to handle queries, and manage the expectation of employees. To do so, companies will also need to review their current HR policies, determine how the IIT reform will impact them, and formulate appropriate changes to these policies, and corresponding administrative processes, in order to ensure compliance and optimal employee communication.

General anti-avoidance rules (GAAR) – A key objective of the IIT reform is to close loopholes and protect the integrity of the tax base. To this end, a GAAR has been introduced for IIT. This empowers the tax authorities to adjust tax assessments for individuals involved in tax avoidance transactions or arrangements. Together with the adoption of the latest big data technology to perform data analysis, the Chinese tax authorities are now well equipped to detect and take action in relation to non-compliant taxpayers. As such, it is important that employers review their remuneration reporting processes, as well as any existing dual employment arrangements (where applicable), to check their compliance with the updated IIT rules in order to manage risk of being asserted as non-compliant.

Increase in research and development (R&D) super deduction rate – 2018 saw the expansion of the 75% R&D expense super deduction rate, which had previously been limited to smaller enterprises, to all qualifying enterprises nationwide; many of these had previously been limited to a 50% super deduction. While this is certainly welcome, taxpayers should take care to ensure full compliance with the qualifying criteria, and retention of the requisite documentation, as the tax authorities have been strengthening their follow-up inspections.

CIT super deduction for R&D outsourced overseas – 2018 also saw a rule change, retroactive to January 2018, under which 80% of the amount of R&D activity-related payments made to an overseas service provider can now qualify for the super deduction. Companies who engage overseas subcontractors for R&D activities, due to lack of technical capacity or expertise in China, may benefit from this change and should review their existing arrangements.

Extension of loss carry-forward period – In 2018 it was also clarified that, for high and new technology enterprises (HNTE) and science and technology small and medium-sized enterprises (STSMEs), unused enterprise tax losses, incurred in the previous five years, are allowed to be carried forward for another five years. This includes losses incurred prior to the enterprises qualifying as a HNTE or STSME. In consequence, technology enterprises can now enjoy a relatively long tax loss carry-forward period (i.e. 10 years, vs the standard five years), which should encourage them to make upfront investment where necessary.

Large enterprise tax risk management – With the expanded list of large enterprises under the State Administration of Taxation's (SAT's) supervision, ever more large groups with multi-sector operations, and with cross-border activities, will be subject to tighter financial and tax information monitoring by the tax authorities. It is a critical time for all large groups to enhance the compliance effectiveness and efficiency of internal tax management functions. It is also an optimal time for deploying high-tech systems to identify, evaluate and control tax risks.

Value chain management – As many Chinese enterprises expand their operations into the upper and lower tiers of their industry value chains, they are facing more complicated tax compliance issues, but, at the same time, opening a path to tax efficient planning opportunities. Tax planning, whether directed at investment and financing structures, internal cash flow management need, or operational requirements, needs to reflect business objectives and business substance to mitigate tax risks.

US-China trade issues and China response – Since the beginning of 2018, the US government has announced a series of tariff measures directed at Chinese exports to the US. In response to the tariff measures, China has also implemented tariff measures of a similar scale and intensity, directed at products originating in the US. At the same time, the Chinese government announced several batches of tariff reduction measures covering pharmaceutical, automotive, consumer and industrial products. The overall average tariff rate on imports into China is set to see a reduction to 7.5% in 2019, as compared to 9.8% last year. This is in parallel with steady increases to Chinese goods export VAT refund rates to support Chinese exporters in the face of increased tariffs. The tariff measures have a potentially huge impact on import and export enterprises in both countries, particularly if the US proceeds with planned further tariff increases in early 2019. Enterprises need to review their compliance risks and, to the extent that the trade issues continue, plan strategically for their trading and supply chain arrangements.

Customs advance ruling regime – In 2018, China Customs introduced an advance ruling regime which steers customs inspections, reviews and validation processes away from post-import disputes, and towards a more targeted and clearly defined administrative process and improved efficiency on customs clearance. Enterprises should consider how they might make the best use of the new regime.

Pre-initial public offering (IPO) restructurings guidance – Well run capital markets are essential to the continuous and sustainable development of enterprises in China. The listing process, however, can be quite time consuming and challenging. Particularly in the context of stricter initial public offering (IPO) scrutiny and risk-oriented tax administration, undertaking pre-IPO restructurings in a compliant and efficient way is vital for a successful IPO. China has introduced various tax rules governing onshore and offshore corporate restructurings, which are generally required pre-IPO. The rules provide for certain preferential tax treatments, such as special (tax deferred) reorganisations under Circular 59, safe harbour rules under the Announcement 7 indirect disposal rules, etc. However, the interpretation and application of tax rules by the local tax authorities can be inconsistent between different locations in China. Consequently, it is very important for companies, at an early stage, to identify and resolve contentious issues, as well as practical uncertainties, through thorough tax planning and analysis, and consultation.

Cross-border non-trade charges (e.g. service fee, dividend, royalty, etc.) – The Chinese tax authorities have been reinforcing their post-filing investigation of contracts related to non-trade charges, utilising big data analytics and risk management-driven tax administration. At the same time, the 2018-issued Announcement 9 comprehensively updates tax guidance on the determination of beneficial owner for treaty relief purposes. This includes two major clarifications for accessing dividend tax treaty benefits: an extended scope for the safe harbour rule and the introduction of a new look-through rule under multi-tier holding structures. These facilitate overseas shareholders to access treaty relief on dividends, and should be examined by taxpayers to see if they can benefit.

New approach to transfer pricing compliance – A profit monitoring mechanism covering large MNEs and taxpayers with complex intercompany transactions was introduced in April 2018, to enhance the oversight of transfer pricing risk and compliance management. The mechanism, which was pioneered by the Jiangsu provincial tax bureau and is expected to be rolled-out nationwide, sets out a risk assessment framework that involves extensive data gathering by the tax authorities. Impacted taxpayers should ensure that they can keep pace with potentially increased data demands from the tax authorities and provide quality data that supports their transfer pricing arrangements. As the profit monitoring mechanism also incentivises taxpayers to engage continuously with the tax authorities, taxpayers should also consider their strategy in managing this interaction.

Mutual agreement procedure (MAP) and advance pricing arrangements (APAs) – In 2018, there has been an increase in efforts by the SAT to deal with outstanding MAP cases, and to make progress with pending APA cases at competent authority meetings between China and other countries. The enhanced APA process introduced by the 2016-issued Announcement 64 is also expected to contribute to more rapid APA programme outcomes. The increasing openness in the SAT's approach and the enhanced regulatory process offer opportunities for taxpayers to seek assistance from the SAT to resolve double taxation and achieve certainty with respect to their transfer pricing arrangements.

Offshore indirect transfers of Chinese taxable assets – The calculation of the tax cost base for offshore indirect transfers of Chinese assets remains an area of uncertainty, which is still determined in an inconsistent manner across tax districts in China. In some instances, the local Chinese tax bureaus may allow the full acquisition cost, for the purchase of the overseas company, to be deducted in determining the capital gain on disposal. However, in other cases, only the registered capital of the indirectly transferred China company can be deducted. Foreign investors investing into China, through purchase of an overseas company, therefore have to ensure that the seller reports and pays tax under the Announcement 7 indirect offshore disposal rules. Alternatively, they need to reserve the right to report the acquisition to the China tax authorities and obtain a tax indemnity against any potential withholding tax (WHT) liability from the seller's failure to pay the tax.

WHT deferral regime for dividend reinvestment in China – Issued in December 2017, Circular 88, introduced an incentive which defers the imposition of WHT on dividends paid out of China, provided that the amounts were reinvested in 'encouraged projects' in China. In September 2018, Circular 88 was replaced by Circular 102, which expanded the incentive to reinvestment in all sectors, not just encouraged sectors, except for those included in the negative lists for foreign investment. Foreign investors, especially multinational companies intending to make further investment in China, should monitor how these rules will be implemented.

E-commerce platform needs to be prepared for growing tax compliance responsibilities – The new China E-Commerce Law that enters into effect from January 2019 includes a provision to oblige all e-commerce platforms to report on the activities of traders and service providers to the tax authorities. While the implementation of this provision will very likely be relying on the finalisation of the new Tax Collection and Administration Law, which is still under drafting and is expected to be finalised in 2019, it nevertheless is expected to add to the tax compliance responsibilities of the platforms significantly in the near future. This development also coincides with the international trend, under which more countries are inclined to shift part of the tax reporting (and even tax withholding) responsibilities of the online traders to the platforms for the ease of administration and tax collection. Hence, whether the e-commerce platform is only conducting business domestically in China, or has expanded/will expand internationally, being prepared, whether in terms of platform IT infrastructure, or trader information collection and management policies and procedures, would be critical in the long-run.

New VAT legislation – Following the successful implementation in 2016 of the VAT reform pilot programme, the government is expected to commence the process for enacting formal VAT legislation during 2019 (and possibly into 2020). A key question will be the extent to which the government uses this opportunity to make changes to the VAT system, which may potentially include modifications to ensure closer alignment between the Chinese VAT system and OECD principles.