China: SAT’s formal assessment on service fees and royalty payments

Khoonming Ho		Lewis Lu

In an area of immediate importance to taxpayers, the State Administration of Taxation (SAT) recently instructed tax bureaus across the country to survey and report back in September regarding companies in their jurisdictions which have made service fee or royalty payments to related parties between the years 2004 and 2013; these years are eligible for potential tax adjustments since the statute of limitations for transfer pricing audits is 10 years. In addition, the SAT urged tax bureaus to formally begin registering transfer pricing audits now of companies which engaged in such transactions deemed to be especially suspicious. In terms of focus, the SAT is paying particular attention to a number of specific issues, for example royalty payments made to:

• entities in "tax haven" jurisdictions; and

• overseas related parties with few or no functions, and which are therefore perceived to have little economic substance.

Also, cases where the Chinese taxpayer may have made significant contributions to the value of the intangibles, or where the intangibles may have eroded in value since initially being licensed, are receiving close scrutiny.

With regard to services, the SAT is focusing attention to those which:

• relate to shareholder activities;

• relate to supervision by the group headquarters;

• may be duplicative to ones that the Chinese service recipient can or is also performing in-house or are already provided by third parties;

• may be irrelevant to the Chinese service recipient given its functional and risk profile or business operations; or

• for which the remuneration is already reflected in other transactions.

Against this background, the issuance of internal directives to actively scrutinise related party service and royalty payments from the SAT's perspective is likely a logical step to take. As a result, it is expected that a significant number of transfer pricing audits with focus on royalties and service fees will be conducted across the country.

For taxpayers, this is an area of immediate concern and action to manage the tax risks arising from service fee and royalty payments. It is recommended that companies review relevant documentation to ensure adequate evidence is in place and assess areas of potential controversy.

Khoonming Ho (khoonming.ho@kpmg.com)

KPMG, China and Hong Kong SAR

Tel: +86 (10) 8508 7082

Lewis Lu (lewis.lu@kpmg.com)

KPMG, Central China

Tel: +86 (21) 2212 3421