China's Year of the Monkey will soon give way to the Year of the Rooster, which will see the closing of another economically and fiscally progressive chapter in China's ongoing development.
Throughout the past year, a lot of groundwork has been laid for a series of key fiscal policy advances, which are anticipated to come to fruition in 2017. This chimes with the characterisation of the Year of the Rooster as being a period that calls for confident and courageous action.
Since 2014, China has overtaken the US as the world's largest economy in purchasing power parity terms. It has continued its steady expansion with a GDP growth of 6.7% in the first three quarters of 2016. Chinese outbound direct investment (ODI) overtook foreign direct investment (FDI) in 2015, with ODI at $146 billion and FDI at $136 billion, making China a net exporter of capital. This trend accelerated in 2016, with ODI for the first six months alone standing at $99 billion and projected to hit a record $170 billion for the whole year. This outbound push by Chinese multinational enterprises (MNEs), alongside the substantial acquisitions of foreign brands and technology, is seen as integral to the retooling of China's economy towards a service, consumption, and high-tech industry-driven model. This transition towards wholesale economic transformation is now having a perceptible effect on Chinese tax policy.
An overarching framework for Chinese fiscal reform was provided in the 15th chapter of the 13th Five Year Plan for Socio-Economic Development, which was issued in March 2016.
During 2016, many of the plan's objectives have been put into effect, including the finalisation of the business tax (BT) to VAT reforms, resource tax reforms, and the issuance of a draft of the planned environmental protection tax.
In 2017 and beyond, substantial reforms are planned to the Individual Income Tax (IIT) Law, real estate taxation, and consumption taxation. This is alongside a restructuring of the way in which tax revenues and collection responsibilities are shared between the central and local governments within China, and a move to put tax regulations and guidance on a statutory basis, further formalising and reinforcing Chinese tax law.
While China makes these major changes in 2016 and 2017, it is also transposing most of the G20/OECD BEPS agenda into Chinese tax regulations and guidance. In 2016, the China State Administration of Taxation (SAT) put mechanisms in place to enable Chinese participation in the OECD's common reporting standard (CRS) for the automatic exchange of information (AEOI), which goes live in China from 2018. The fact that China is at the forefront of implementing these measures should come as no surprise. China's hosting of the G20 and the Forum on Tax Administration (FTA) in 2016 saw the SAT and China's Ministry of Finance (MOF) take leading roles in driving forward the global tax reforms.
In this, the 6th edition of China – Looking Ahead, these recent developments will be examined by KPMG China's tax experts as they explore what the Year of the Rooster may bring for foreign investors in China, and for Chinese 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.
The first chapter, BEPS in China – multi-track developments, breaks down the development of China's cross-border taxation policies and practices into three dimensions. The chapter looks at the steps already taken to embed the 2015 BEPS deliverables into Chinese law, alongside efforts to roll out other global cooperative initiatives, such as the OECD's CRS. It discusses in detail how Chinese enforcement of cross-border tax rules is becoming more vigorous, driven by the exchange of information and the use of big data analysis. At the same time, the chapter also highlights other notable developments, including the first significant tax court cases and the increased use of private tax rulings, which could allow taxpayers to gain greater tax certainty over time. Lastly, the chapter discusses the rapid development of China's external tax policy, looking at the rigorous enforcement of controlled foreign corporation (CFC) rules and how the tax authorities assist Chinese MNEs in their tax disputes overseas through the use of the mutual agreement procedure (MAP). This outline of China's external tax policy is rounded out with a summary of China's efforts to improve its tax treaty network, particularly with the One Belt, One Road project countries, and its assistance to developing countries to improve their tax capacity. This builds on a key commitment among all nations that attended the FTA meeting, held in Beijing in May 2016.
At the core of the BEPS initiative is a radical overhaul of transfer pricing (TP) rules. Another chapter in this guide, China transfer pricing – first mover on BEPS, captures the key changes in China's TP regulations during the past year. In 2016, the SAT clarified China's TP documentation requirements and the administrative procedures for advance pricing agreements (APAs), thus implementing China's BEPS TP documentation commitments. At the same time, the new SAT circulars support the use of China's long-standing TP practices. These practices have been successfully embedded by the SAT into the updated BEPS TP guidance in the course of the BEPS process.
Although much attention has been focussed on policy development in the direct tax space, the most significant China tax policy change of 2016 was in indirect taxation, with the transition from BT to VAT being completed. Through BEPS, China may be increasingly taking a leading role in global direct tax reform, but it may be leading the world to an even more profound extent with the updated VAT rules and administration regime. Other countries may, in time, adopt some of the innovative features from the upgraded Chinese VAT system. In this regard, the chapter, Post VAT reform in China – what's next?, sets out a number of key world-leading dimensions of China's new VAT system.
Moving from a policy-led focus to a more practice-driven focus, the chapter, M&A tax in China – practical challenges, provides a step-by-step walk through the merger and acquisition (M&A) tax due diligence and structuring processes. It highlights pitfalls for the unwary and offers best practice advice to conclude a successful transaction in the context of heightened enforcement by the Chinese tax authorities.
Increasing tax enforcement effectiveness is indeed the overarching narrative of the chapter China tax – big data and beyond. The chapter considers how more efficient and effective tax authority work is being driven by the better use of big data analysis and tax information pooling, in part from overseas exchange of information sources. Improved data analysis is being combined with more effective arrangements for collaboration between tax authorities throughout China, and further supported by initiatives for enhanced taxpayer-tax authority collaboration, such as the One Thousand Enterprises initiative.
The theme of improving tax policies to drive economic transformation, alongside more data-driven and rigorous tax enforcement approaches, is also present in other chapters. The chapter, IIT in China – moving with the times, details the new preferential tax regime for staff equity incentives, which is designed to help align management and staff incentives and efforts. At the same time, the chapter details how the authorities are making greater use of data and analytics in IIT enforcement.
Similarly, the chapter, China Customs – pushing the boundaries, clarifies how the new framework for cross-border e-commerce into China has been designed to stimulate the further development of China's already burgeoning digital economy. In parallel, the chapter highlights how far more detailed customs reporting, particularly on royalties and related party transactions, and the use of taxpayer risk ratings, are driving more targeted customs enforcement.
Equally, the chapter, Tax to the aid of innovation and entrepreneurship in China, details how continued refinements to Chinese innovation incentives are accompanied by increasingly finely tuned compliance requirements.
These chapters are rounded off with a look at developments in specific industries and locations. China's crucial healthcare system reforms, a key focus of the 13th Five Year Plan, and their tax implications are explored in the chapter Challenges of the two invoices system for China's pharmaceutical industry.
The chapter, Hong Kong: A tax boost to the international investment hub, highlights enhancements to Hong Kong's tax regime through clarifications made on the taxation of reorganisations and the operation of the corporate treasury centre regime. The improvements were made at the same time as Hong Kong made moves to start adopting BEPS changes.
Finally, the chapter, Taiwan: tax changes towards growth and progress, looks at how Taiwan is becoming more attractive as an investment hub, with its steady expansion of double tax agreements and a tougher, BEPS-driven, upgrade to its anti-avoidance rules.
On the whole, it can be seen that many of the reforms in the Year of the Monkey involved China getting ready for significant changes in the Year of the Rooster and beyond.
For companies operating in China, the following themes will be explored throughout the chapters:
The BEPS TP rules and documentation should be largely in place by the end of 2016: how will the new rules work and be applied when the new TP reporting requirements enter into effect from 2017?
The VAT reforms were rolled out in mid-2016: how will they fare in practice as businesses get used to them in 2017?
The OECD BEPS multilateral instrument was concluded in November 2016: how will it change China's tax treaty network and what will be the implications for taxpayers?
The CRS implementation guidance has been issued in draft for public consultation in 2016: when CRS is implemented from 2018, will the Chinese tax authorities be in a position to effectively use the mass of new tax information they receive?
Big data analysis has been put at the centre of China's new tax enforcement approach, with new systems (e.g. Golden Tax III, etc.) being rolled out in 2016: now that the new systems are in place, what will they be able to achieve in 2017 and beyond?
Quite significantly, 2017 is the Year of the Red Fire Rooster. This means that it will be a period of meaningful advancements that can provide a clear picture of how the future will unfold. Given the rapid pace of developments in China's tax system, this is certainly to be hoped for in the coming year.
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Khoonming Ho is the vice chairman and head of tax at KPMG China, as well as the head of tax for KPMG Asia Pacific. Since 1993, Khoonming has been actively involved in advising foreign investors about their investments and operations in China. He has experience in advising 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 ongoing 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).