The Year of the Sheep, now drawing to a close, has been a signature year both economically and fiscally for China. China had surpassed the US as the world's largest economy, in purchasing power parity terms, in 2014. It had similarly become the world's largest recipient of foreign direct investment (FDI), also overtaking the US, in that year. Remarkably, while China takes the top position as a recipient of FDI, Chinese outbound direct investment (ODI) is projected to overtake FDI for 2015 as a whole, making China a net exporter of capital. Projections further show China overtaking the US in ODI terms to become the world's premier source of ODI within a short few years. There is no doubt that China is becoming ever more central to the global economic order. Nevertheless, as the Chinese government seeks to shift her economy from reliance on investments, exports and heavy industries to a more consumption and service sector-driven model, the pace of economic expansion in China will ease off before picking up again. In the meantime, the government will go to every length to safeguard her tax revenues.
It is also particularly timely that the G20/OECD Base Erosion and Profit Shifting (BEPS) project should now enter into its implementation phase. This happens just as China assumes its role as the 2016 host of both the G20 summit and the OECD's Forum on Tax Administration. China's State Administration of Taxation (SAT) has taken a lead role in the BEPS process, contributing substantially to the final shape of the proposals. Senior SAT officials have also indicated repeatedly how seriously they take China's responsibilities to ensure that the new BEPS rules are rolled out nationally.
Even before the finalisation of the BEPS deliverables, China started to incorporate some of the ideas contained in the BEPS programme proposals into its domestic tax regulations. This was especially so after President Xi Jinping's November 2014 address to the G20 Leaders' Summit in Australia, at which he pledged China's support for global cooperation on tax reform. These changes are set to continue into 2016 and beyond.
And at the Fifth Plenary Session of the 18th Chinese Communist Party (CCP) Central Committee on October 26 to 29 2015, the Chinese leadership proposed the outline of the country's 13th Five-Year Plan for economic and social development, which will cover the years 2016 to 2020. The Plan, once fully elaborated by subordinate government bodies, is expected to include key measures on real estate, consumption and environmental taxation. It is also expected to include the revision of the Individual Income Tax (IIT) Law and the restructuring of the way in which tax revenues and collection responsibilities are shared between the central and local governments. These reforms will be made alongside the finalisation of the transition of the indirect tax system from Business Tax (BT) to VAT which is due to complete in 2016.
Against this backdrop, in this fifth edition of China – Looking Ahead, KPMG China's tax experts examine recent developments and explore what the Year of the Monkey may bring for foreign investors in China and 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.
The chapter, China at the forefront of global BEPS implementation, maps the final BEPS 2015 deliverables against the items in the SAT's tax policy agenda . The chapter details the alignment of the China anti-treaty shopping provisions with the BEPS deliverables as well as the revised controlled foreign company (CFC) rules. The chapter also discusses how the SAT may look to rigorously enforce the permanent establishment (PE) rules in line with the BEPS proposals. This development may well have a significant impact on the existing operating structures of MNEs doing business in China.
More specifically, the chapter, China's new Transfer Pricing Guidelines and BEPS, discusses a raft of changes to transfer pricing (TP) rules. These changes are contained in the SAT's exposure draft of the guidelines on special tax adjustments. Alongside BEPS-related updating of TP rules, the draft calls for the introduction of a new TP methodology, that is, the Value Contribution Apportionment Method (VCAM). VCAM would seek to allocate profits to China with reference to a MNE's global value chain including assets, costs, sales, and employees. The use of VCAM would generally require the preparation of value chain analysis which needs to be included in the local file TP documentation of a MNE's Chinese subsidiary.
The BEPS-related tax changes will have a pervasive effect on many aspects of Chinese taxation. One example is M&A transactions, as made clear in the chapter, A New Era for M&A Tax in China. Alongside the BEPS-related changes to anti-tax treaty abuse provisions, other significant measures to consider include the much relaxed, and far more useful, restructuring tax relief rules and the challenging changes to the indirect offshore disposal rules as set out in the SAT's Announcement 7.
The Chinese tax authorities are also changing their approach to administering the tax law. The chapter, FATCA and CRS: the Changing Landscape of Fiscal Disclosure, considers the challenges that the introduction of new automatic cross-border tax information exchange systems are bringing to global financial institutions with operations in Hong Kong and China.
The chapter, New Challenges to Tax Risk Management in China, considers how new rules are transferring the responsibility for the interpretation and application of tax law from the tax authorities to the taxpayers. The changes include the provisions on tax deductions, and conditions for eligibility for treaty benefits and tax incentives. Tax authorities are rapidly relinquishing the power for pre-approvals of tax treatments, while redoubling efforts and resources to "follow up" on filed returns and to conduct post-filing audits. Going forward, tax authorities will have access to far more tax information and will have more technologies and resources to conduct data analysis. Under these circumstances, the changes may drive tax authorities and taxpayers to work more closely together in future to manage tax processes and risks, with more emphasis on tax internal controls and compliance agreements.
Casting an eye even further into the future, the chapter, Indirect Taxes in China – 2020 and Beyond!, considers how the China indirect tax landscape may evolve subsequent to the completion of the continuing BT to VAT reforms. Possibilities considered include:
the expansion of the VAT base;
the modernisation of rules and systems to better capture cross-border dealings in intangibles and services; and
the deployment of data analytics by the tax authorities to enhance VAT administration.
In addition, the chapter, Strengthening of Administration and Enforcement of IIT Law in China, considers the heightened enforcement efforts for high-income earners and equity compensation schemes. The chapter, Moving up the Value Chain – Greater Access to R&D Incentives, takes a timely look at the newly updated Chinese innovation tax provisions and considers how they fare in the global competitive landscape of technology incentives. The chapter, New Customs Opportunities and Risks in China, considers:
the changing customs duty implications for e-commerce enterprises;
the impact of the new free trade zones: and
China's growing network of free trade agreements.
The publication concludes with an overview of Hong Kong's latest and future developments in tax incentive and treaty network enhancements in the chapter, Hong Kong Looks to the Future, and a review of the opportunities offered by Taiwan: An Innovative Centre with Attractive Investment Options.
As will be clear to the readers of this edition of China – Looking Ahead, as predicted in the last edition, the Year of the Sheep has been anything but docile in terms of tax changes. The Year of the Monkey looks set to be even more animated.
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Khoonming Ho is the tax partner in charge of China and Hong Kong SAR. 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).