The Year of the Rooster will soon give way to the Year of the Dog. China begins 2018 with the administration of President Xi Jinping entering its second term (2017 to 2022), following the 19th National Congress of the Communist Party of China (CPC) in October 2017. At the same time, China's 13th five-year plan (2016 to 2020) enters its core phase.
President Xi's October 18 2017 speech to the CPC Congress set out a clear vision of China's development priorities. The government is committed to continuing the reform and rebalancing objectives in the five-year plan and, at the same time, Xi indicated a shift in focus from the pace to the quality of growth. China is still targeting annual GDP growth above 6% in the three years to 2020, but has dropped the use of a long-term GDP goal. This provides more flexibility for the government to focus on the goals of continuous 'green development', tackling inequality, and cultivating home-grown innovation, emphasised in Xi's speech.
China will continue to prioritise supply-side reform, with a focus on reducing over-capacity and excessive leverage in the economy. To this end, a tight rein is being kept on wealth management products and other shadow finance vehicles, and controls on the property market are in place. Partial privatisation of many state-owned enterprises (SOEs) is envisaged in a move to a 'mixed-ownership' model, with foreign investment participation also sought. Various initiatives are being pursued to support national e-commerce and e-finance development, notably the Internet Plus action plan and the national big data strategy. At the same time, the 'Made in China 2025' strategy is directed at building key China industrial strengths in strategic sectors, including advanced IT, robotics, aerospace, new energy vehicles, new materials and medical devices. The overall objective of these initiatives, as set out in Xi's speech, is for China to become a 'fully modernised socialist state' by 2035 and a 'leading global power' by 2050.
At the centre of China's external economic strategy is the Belt and Road Initiative (BRI). This is an ambitious plan to more deeply integrate the economies of more than 60 countries across Eurasia, encompassing 63% of the world's population and 35% of global GDP, through more than $1 trillion in infrastructure investment. China is, since 2015, a net exporter of capital; in 2016 outbound direct investment of $183 billion greatly exceeded inbound direct investment of $131 billion. Chinese enterprises have moved quickly to seize BRI opportunities and, while outbound investment dipped somewhat in 2017 as the government sought to rein in some of the more speculative overseas investments, the regulators have facilitated BRI investments as officially 'encouraged'.
At the same time, to encourage greater inbound investment, the State Council's January 2017 Notice No. 5, and the subsequent August 2017 Notice No. 39, have set out a new range of 'opening up' measures. These include plans for a streamlined negative list of sectors for foreign investment, with various service and advanced manufacturing sectors to be liberalised and foreign involvement in Made in China 2025 to be encouraged. These are accompanied by measures to protect foreign intellectual property (IP) rights, ease visa processes, and make the regulatory environment for foreign enterprises simpler and more neutral vis-à-vis local firms. Further details of these policies are awaited, with progress likely be seen in the run up to the March 2018 session of the National People's Congress.
With these structural economic policies as a general context, in this seventh edition of China Looking Ahead, KPMG China's tax experts examine recent developments and explore what the Year of the Dog may bring for foreign investors in China, as well as for Chinese multinational enterprises (MNEs) investing overseas. It should be noted, however, that the content of this publication is not intended as predictions or forecasts of Chinese tax policies and should not be relied upon as such.
In the seventh edition of China Looking Ahead, two key themes come repeatedly to the fore throughout the chapters – the impact of digitalisation and technology, and China's repositioning of itself for a new stage in its economic development, both of which themes are intertwined.
The first chapter, VAT: a pathway to 2025, confronts both of these themes head-on. The chapter asserts that the digitalisation of economies, and the leveraging of new technologies in tax administration, will, in three major trends: (i) drive VAT and GST systems to morph into 'in substance' retail sales taxes; (ii) lead indirect taxes to be managed and administered nearly entirely through technology; and (iii) enable expansion of the tax base for indirect taxes. In the China context, these trends are turbo-charged by the extent to which mobile payments and e-platform commerce have come to dominate the Chinese economy, as well as by the rapid progress already made by the authorities with tax digitisation (e.g. online filing, electronic invoicing, automated invoice verification, etc.). China is well placed to move to the next steps of automated point of sale VAT collection and blockchain transaction chain authentication, and indeed the State Administration of Taxation (SAT) is already looking at the possibilities of the latter in detail. The chapter notes how aspects of China's VAT rules, in relation to financial services and digital economy consumer-to-consumer (C2C) activity, are much better primed for the future than other countries' more established VAT systems.
China's orientation to the future, and its reimagining of its tax policy for a new global role, are further considered in the chapters, China after BEPS, for now... and A thousand miles begins with a single step: tax challenges under the BRI. Since 2015, China has been a net capital exporter, and is experiencing both the challenges and opportunities that this brings. Chinese companies are increasingly running into tax disputes overseas, and SAT assistance in mutual agreement procedures (MAP) is increasingly invoked. This experience is filtering into policy thinking, with consideration being given to how best to collaborate with BRI countries to smooth tax frictions. In addition, policy options that could have created greater frictions for outbound and inbound investment, such as the expansion of permanent establishment (PE) rules through the multilateral instrument (MLI), have been quietly left aside. Work is underway on the enhancement of foreign tax relief for 'Go Out' Chinese enterprises, including consideration of a potential China participation exemption – this might better support 'Go Out' enterprises in the face of similar tax reform changes being pushed through in the US. At the same time, tax enforcement efforts for foreign business activity cross-border into China have not let up – indeed big data and information exchange are being leveraged to an ever greater degree in PE and treaty relief cases.
The pressure on foreign businesses remains particularly high in the transfer pricing (TP) space. The chapter, TP in China: all the data in the world, outlines how, after several years of extensive overhaul, culminating in the 2017 release of a new China TP framework, the Chinese tax authorities now have a very robust set of TP information and investigation/adjustment tools. They are using these to significant effect, as made clear in the many enforcement cases detailed in the chapter. Enforcement challenges also continue unabated in the mergers and acquisitions (M&A) space, and the chapter, Chasing deals: tax trying to keep pace with business in China, looks in particular at best practices for tackling the indirect offshore disposal rules.
The use of technology by the tax authorities to bring vast amounts of tax information on tap is the central focus of the chapters, Adding wings to a tiger: data in tax enforcement in China, and A brave new world in tax transparency: CRS in China, Hong Kong and Taiwan. The Chinese tax authorities have invested heavily in their data storage and processing capacity – big data analytics, married with a sophisticated risk-driven approach to audit targeting, promise an exponential increase in China enforcement tax effectiveness in the coming years. China's commencement of international automatic tax information exchanges, from 2018 onwards, will turbo-charge this process. It is, in particular, likely to lead to a sea-change in the individual income tax space. The chapter, This time it's personal: China IIT on the eve of a major revamp, outlines how enforcement is becoming increasingly robust, even in advance of this new swell of tax data coming on tap. The China customs authorities are becoming equally adept at leveraging data, taxpayer ratings and automated processes to great effect, as made clear in the chapter, All roads lead to...: new integration regime in China customs.
The rapid re-orientation of China's economy for the future is borne out in the chapter, One billion Chinese mobile phone users can't be wrong: tax and the digital economy. Continuing on the themes raised earlier in the chapter on VAT, the digital economy chapter explains how the breathtaking advance of China's digital economy has left the regulatory and tax authorities struggling to keep up, resulting in ambiguity in the taxation of the sharing economy, cloud services and other new business models. The digital economy advance also exposes how archaic certain aspects of the traditional tax administration have become in the face of new modes of economic organisation – the chapter notes some of the administrative innovations being made in other countries in this regard. The theme of reorienting China's future path is also at the core of the chapters, The future is green: EPT in China, and Better smart than lucky: China R&D incentives 2.0. Both chapters outline the steady progress being made in refining tax incentives for more innovative, and more ecological, economic growth.
These chapters are rounded off with a look at developments in Hong Kong and Taiwan. The digital economy is again to the fore in the chapter, Taiwan: tax goes digital. This details the recent adaptations of the VAT system to cover cross-border digital service supplies in Taiwan, and the planned new corporate tax digital nexus, alongside broader planned reforms to the imputation tax regime. The chapters, Hong Kong tax: let economy take the lead and Tax boosts for Hong Kong funds industry, outline Hong Kong's adherence to the MLI and roll out of TP rules, and explore the new and improved special regimes for aircraft leasing, corporate treasury centres, and PE funds.
2018 is the Year of the Dog in the Chinese zodiac, and a time for action. This certainly looks to be the case, across the spectrum, in the field of China taxation.
A special thanks to Conrad Turley at KPMG China for his contributions to the editing and compilation of this guide.
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Lewis Lu is the head of tax at KPMG China. He is based in Shanghai and specialises in the financial services and real estate industries. He specialises in formulating entry and exit strategies for these clients for the Chinese market and has assisted many foreign and domestic funds in structuring their investments in China. Lewis regularly undertakes tax due diligence and advisory engagements on M&A transactions. He also frequently assists foreign multinationals in discussing tax policy matters with the Chinese tax authorities.
Lewis is a frequent speaker at various international tax fora. He teaches international taxation for the master of taxation students at Fudan University.
He is a member of the Canadian and Ontario institutes of chartered accountants and is a fellow of the Hong Kong Institute of Certified Public Accountants.
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Khoonming Ho is the head of tax for KPMG Asia Pacific. He was the vice chairman and head of tax at KPMG China. Since 1993, Khoonming has been actively involved in advising foreign investors about their investments and operations in China. He has experience in advising on issues on investment and funding structures, repatriation and exit strategies, M&A and restructuring.
Khoonming has worked throughout China, including in Beijing, Shanghai and southern China, and has built strong relationships with tax officials at both local and state levels. He has also advised the budgetary affairs committee under the National People's Congress of China on post-WTO tax reform. Khoonming is also actively participating in various government consultation projects about the continuing VAT reforms.
He is a frequent speaker at tax seminars and workshops for clients and the public, and an active contributor to thought leadership on tax issues. Khoonming is a fellow of the Institute of Chartered Accountants in England and Wales (ICAEW), a member of the Chartered Institute of Taxation in the UK (CIOT), and a fellow of the Hong Kong Institute of Certified Public Accountants (HKICPA).