According to news posted on the OECD website on 24 January 2017, the Platform for Collaboration on Tax – a joint initiative of the IMF, OECD, UN and World Bank Group – has developed a draft toolkit designed to assist developing countries to administer their transfer pricing (TP) policies. The Platform’s toolkit attempts to address the ways in which developing countries can overcome a lack of data on "comparables“ for the market prices for goods and services transferred between members of multinational corporations. Public feedback is now being sought on the draft toolkit.
The toolkit is part of a series of reports by the Platform to help countries with limitations in their capacity to design or administer strong tax systems. Previous reports have included discussions of tax incentives and external support for building tax capacity in developing countries. Helping developing countries build strong and credible transfer pricing regimes is an important part of the Platform's effort to increase the capacity of developing countries to apply the principles of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, and protect their tax bases from aggressive tax planning by multinational corporations.
The draft TP toolkit (A Toolkit for Addressing Difficulties in Accessing Comparables Data for Transfer Pricing Analyses) offers advice on making the best use of data that exists and options for monitoring the behaviour of multinational corporations in situations in which no data is available. The draft puts the search for potential comparables in context, emphasising the importance of accurately defining the transaction to ensure the subsequent search for comparables is as efficient and effective as possible. Guidance on accurately defining the transaction, an addition to Chapter 1 of the OECD TP Guidelines, was one of the principal outputs contained in the OECD’s October 2015 final BEPS TP report. The draft sets out sources of potential comparables data and practical tools such as step-by-step screening templates. To address situations where there is a systemic lack of comparables data, the draft considers potential policy options such as the development of safe harbours.
In addition, since the pricing of transactions in the extractive industries is an issue of particular relevance to many low-income countries, the draft toolkit also addresses the information gaps on prices of minerals sold in an intermediate form. The supplementary material on minerals pricing (Addressing the Information Gaps on Prices of Minerals Sold in an Intermediate Form) provides a systematic process that could be used by tax administrations to map the transformation chain for a particular mineral, identify key traded products and establish common industry pricing practices. Detailed case studies demonstrating the process are then provided for copper, gold, thermal coal and iron ore.
The Platform partners now seek comments by 21 February from interested stakeholders on the draft toolkit, including the supplementary material on minerals pricing, with the aim of finalising it in the coming months.
On 1 February 2017, OECD released documents setting standards and processes for peer review of the adoption of the BEPS minimum standards applicable under BEPS Action 13 on country-by-country reporting (CBCR) and BEPS Action 5 on the compulsory spontaneous exchange of information on tax rulings. These are two of the four BEPS minimum standards, all of which are subject to peer review for there to be timely and accurate implementation; the other two are in relation to the BEPS Action 14 work on the mutual agreement procedure and the BEPS Action 6 treaty anti-abuse provisions. All jurisdictions that are members of the “inclusive framework” on BEPS (96 jurisdictions as at Jan 2016) have committed to implementing the minimum standards and participating in the peer reviews, including China.
The documents released will form the basis on which the peer review processes will be undertaken. These include:
In addition, an additional news item on the OECD website notes that the Mutual Agreement Procedure (MAP) peer review and monitoring process under Action 14 of the BEPS Action Plan was launched in December 2016 with the first peer reviews of Belgium, Canada, the Netherlands, Switzerland, the United Kingdom and the United States, now well underway.
The peer review process is conducted in two stages. Under Stage 1, implementation of the Action 14 minimum standard is evaluated for Inclusive Framework members, according to the schedule of review. Stage 2 focuses on monitoring the follow-up of the recommendations resulting from jurisdictions' Stage 1 report.
The OECD is now gathering input for the Stage 1 peer reviews of Austria, France, Germany, Italy, Liechtenstein, Luxembourg and Sweden, and invites taxpayers to submit input on specific issues relating to access to MAP, clarity and availability of MAP guidance and the timely implementation of MAP agreements for each of these jurisdictions using the taxpayer input questionnaire. The questionnaire shall be completed and returned by 27 February 2017 at the latest.
On 12 January 2017 the People’s Bank of China (PBOC) issued PBOC Circular  No. 9, which makes important changes to the regulations determining how much leverage Chinese enterprises, including foreign invested enterprises (FIEs), can take on through cross-border borrowing into China. The changes alter the maximum debt-equity ratio achievable through cross-border borrowing and so make the existing Chinese tax thin capitalization rules, and other tax rules impacting on international borrowing, potentially more relevant for a greater number of companies.
In short, prior to 2016 China required newly established FIEs to fix, as part of the pre-approval registration process, a total investment capital amount (TIC - the sum of total debt and equity foreseeably needed by the FIE) and a registered capital (RC) amount (i.e. equity). The debt financing ceiling for the FIE was the residual difference between the TIC and the RC notified to the authorities. The maximum permissible debt-equity ratio (with RC standing for equity) ranged from debt-equity of 3:7 for FIEs with a TIC of less than USD3 million, 1:1 for TIC between USD3 to 10 million, 1.5:1 for TIC from USD10 to 30 million, and 2:1 for TIC exceeding USD30 million. The operation of the debt limitation, and its adjustment, was highly bureaucratic, and the repayment of certain loans (specifically mid-term and long term debt) could potentially “exhaust” part of the debt capacity of an FIE, permanently lowering its maximum debt-equity ratio.
From May 2016, PBOC Circular  No. 132 introduced, alongside the above-mentioned “borrowing gap” system, a new, more flexible approach to regulating cross-border borrowing, termed the macro-prudential (MP) financing management system. This applies to all enterprises in China, domestically-owned as well as FIEs, and covers financial institutions but not real estate enterprises. Specifically, for enterprises, the upper limit of the risk-weighted balance of cross-border financing will be the product of their net assets, a cross-border financing leverage ratio and a MP adjustment parameter. For banks, it will be the product of their tier-one capital, a cross-border financing leverage ratio and a MP adjustment parameter. For non-banking financial institutions, it will be the product of capital (paid-in capital or capital stock + capital reserve), a cross-border financing leverage ratio and a macro-prudential adjustment parameter. The leverage ratio is set at 1 for enterprises and non-banking financial institutions, and 0.8 for banking financial institutions.
In relation to FIEs, these can either remain with the borrowing gap system, or opt into the MP financing management system. The latter requires them to monitor that their risk-weighted balance of cross-border borrowing does not exceed a cap linked to their net assets. All relevant borrowing contracts and payments, and all financial accounting information relevant to calculate the net assets of the FIE, need to be filed with the PBOC or the SAFE on an ongoing basis. This is so that the latter have sufficient information to hand to ensure that the FIE is not in breach of the cap.
The cap is determined by multiplying FIE net assets by a debt-equity leverage ratio, initially set at 1:1 by Circular 132 and now changed to 2:1 by Circular 9. The calculation of the risk-weighted balance of cross-border borrowing is adjusted upwards where the debts are short term (i.e. multiply by 1.5) and where the borrowings are in foreign currency (i.e. multiply by 1.5). This new system, while it does involve the additional compliance burden of dealing with increased filings with PBOC and SAFE, may allow some FIEs, particularly those with TIC of less than USD10 million, and those borrowing cross-border in RMB, greater headroom for leverage compared with the old system.
Where an FIE finances its long term borrowing requirement with foreigncurrency borrowings, it can support a debt-equity ratio (taking net assets asequity) of 1.33:1, which is better than the debt-equity 3:7 and 1:1 ratiosapplying to FIEs with TIC of less than 10 million under current rules, and this iseven before taking the difference between registered capital and net assetsinto account. The permissible ratio rises to 2:1 where borrowing is inRMB. Furthermore, net assets, as the basis for the leverage limitationcalculation, may be greater than RC for many companies, particularly wherethey have accumulated profits over many years. Depending on the level ofaccumulated earnings and the currency of borrowing, the new rules might alsobe better for some FIEs with TIC of greater than USD10 million. The new rulesalso resolve the earlier problem of debt capacity being “exhausted”, and FIEsopting into the new system can “unlock” the restrictions previously createdwhere debt capacity was exhausted – in practice this may be one of the mostsignificant and useful developments as many large companies had run out ofquota.
Some FIEs may consequently seek to finance themselves to a greater degreefrom cross-border debt, as interest is generally tax deductible (subject to thincapitalization rules) and may be subject to lower tax rates on receipt by alending related party overseas. Withholding tax (WHT) of 10% is applied tooutbound payments of interest under domestic law, but China’s increasinglyimproved treaty network is allowing for ever lower WHT rates with treatyrelief. However, it is noted that VAT at 6% (plus local charges) applies tointerest payments and there is, at present, no VAT input credit for this.
China’s tax thin capitalization rules apply a 2:1 debt-equity ratio (the equitycalculation is similar to net assets); where an enterprise’s leverage exceeds thislevel interest tax deductions may be disallowed. For interest on excess debt tocontinue to be treated as tax deductible, transfer pricing support may benecessary. Up to now, due to the regulatory limitations on leverage, China’sthin capitalization rules have been generally less of an issue forenterprises. Going forward, with potential for greater levels of leverage forFIEs, the thin cap rules may become of greater relevance and require greatermonitoring and compliance effort. This would particularly be the case if Chinaloosens gearing restrictions further by continuing to raise the MP financingmanagement borrowing cap calculation leverage ratio, or lower the foreigncurrency borrowing balance risk adjustment ratio. We would note that, for themoment, it does not appear that China will adopt the OECD BEPS Action 4EBITDA-based interest deduction limitation, so the focus will remain on debtequityratios.
It might be added that, beyond FIEs, the MP financing management system isalso relevant for financial institutions and for domestically owned enterprises,but it is applied in a different manner which would need separate regulatory andtax evaluation. It might also be noted that the practical application of Chineseforex rules has recently become a problematic area, with reported difficultiesarising in repatriating cash from China to make loan principal and interest, aswell as dividend payments – adaptation by companies to the new cross-borderfinancing opportunities will clearly also take related concerns on-board.
As highlighted in KPMG China Tax Weekly Update (Issue 18, May 2016), the Resource Tax reform has been rolled out across China since 1 July 2016. The reform expands the scope of Resource Tax collection as well as transitioning it from a volume basis tax to a price basis tax. The main objectives of the reform are to regularise the interaction between the nationally legislated Resource Taxes and local government resource fees and to establish a more fair, reasonable, and efficient Resource Tax system.
To complement this, on 4 February 2017, the State Administration of Taxation and the Ministry of Land and Resources jointly issued Announcement  No. 2 (“Announcement 2”), which further clarifies certain collection and administration issues for implementing the preferential polices that were set out in Cai Shui  No. 53 and No. 54. Announcement 2 came into force on the date of issuance.
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On 25 January 2017, the China Certified Tax Agents Association (CCTAA) issued Zhong Shui Xie Fa  No. 4 (“Circular 4”). This releases trial practicing rules for tax firms carrying out the four tax services, including: (i). agency service of application for enjoying preferential tax policy; (ii). tax planning service; (iii). compliance review for special tax treatment in capital transaction; and (iv). attestation service for recognition of high-tech enterprise. All the four rules have come into force since the date of issuance.
The four services outlined are services which the SAT has stated, in tax guidance, may/must be provided by certified tax practitioners to taxpayers in order to help the latter meet their tax compliance obligations. The CCTAA guidance explains how certified tax practitioners should go about doing these work items.
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