BEPS – what will it mean for China?
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BEPS – what will it mean for China?

The OECD’s action plan for multilateral cooperation to address tax base erosion and profit shifting (BEPS), published on July 19 2013, inaugurates a global collaborative effort to modernise the international tax system. The plan describes 15 proposed actions, identifies expected outputs and establishes the anticipated timeframe. Abe Zhao, Leonard Zhang and David Chamberlain of KPMG China comment on the implications of BEPS for China.

As a key partner of the OECD, China is expected to monitor the progress of this OECD initiative closely and roll out new regulations corresponding to certain BEPS action items over the coming months. These new rules and tax enforcement practices will have significant international tax and transfer pricing implications for multinational companies (MNCs) operating in China.

Multinational companies are encouraged to conduct tax health-checks immediately to identify potential weaknesses, and take measures to rectify these areas.

Action plan on BEPS

The BEPS Action Plan sets forth an ambitious timeframe for reaching consensus on changes and modifications necessary to modernise the international tax system. The plan identifies 15 action items to address the issues of aggressive tax planning by some MNCs. Completion of the actions is planned over the next two-and-a-half years, with some of the more consensus-driven items to be finished by December 2015.

The 15 actions are summarised below:

1) Address the tax challenges of the digital economy

This action includes identifying the main difficulties that the digital economy poses for the application of existing international tax rules and developing detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.

2) Neutralise the effects of hybrid mismatch arrangements

This includes developing model treaty provisions and recommendations for the design of domestic rules to neutralise the effect (for example, double non-taxation, double deductions and long-term deferral) of hybrid instruments/entities.

3) Strengthen CFC rules

This includes developing recommendations regarding the design of controlled foreign corporation (CFC) rules.

4) Limit base erosion through interest deductions and other financial payments

This includes developing recommendations for best practices in the design of rules to prevent base erosion through interest expenses, for example, the use of related-party and third-party debts to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.

5) Counter harmful tax practices more effectively, taking into account transparency and substance

This includes revamping the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime.

6) Prevent treaty abuse

This includes developing model treaty provisions and recommendations for the design of domestic rules to prevent the granting of treaty benefits in inappropriate situations.

7) Prevent the artificial avoidance of PE status

This includes developing changes to the definition of permanent establishment (PE) to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions.

8) Assure that transfer pricing outcomes are in line with value creation – intangibles

This consists of developing rules to prevent BEPS by moving intangibles among group members including:

  • adopting a broader, clearer definition of intangibles;

  • ensuring that profits associated with the transfer of intangibles are related to value creation;

  • developing special rules for hard-to-value intangibles; and

  • updating guidance on cost contribution arrangements.

9) Assure that transfer pricing outcomes are in line with value creation – risks and capital

This includes developing rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members including adopting rules to prevent inappropriate returns from accruing to entities solely on the basis of provision of capital or contractual assumption of risks.

10) Assure that transfer pricing outcomes are in line with value creation – other high-risk transactions

This includes developing rules to prevent BEPS by engaging in transactions that would not, or would occur only rarely between third parties including:

  • adopting re-characterisation rules;

  • clarifying the application of transfer pricing methods in global value chains; and

  • protecting against payments such as management fees and head office expenses.

11) Establish methodologies to collect and analyse data on BEPS and the actions to address it

This includes developing recommendations on the indicators of the scale and economic impact of BEPS and ensuring that tools are available to assess effectiveness and impact of measures to address BEPS.

12) Require taxpayers to disclose their aggressive tax planning arrangements

This includes developing recommendations for the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses, and drawing on experiences of the increasing number of countries that have such rules.

13) Re-examine transfer pricing documentation

This includes developing rules regarding transfer pricing documentation to enhance transparency, including a requirement that multinational entities provide all "relevant governments" with information on global allocation of income, economic activity and taxes paid among countries in accordance with a common template.

14) Make dispute resolution mechanisms more effective

This includes developing solutions to address obstacles that prevent countries from solving treaty-related disputes under Mutual Agreement Procedures (MAP), including the absence of arbitration provisions and denial of access to MAP in certain cases.

15) Develop a multilateral instrument

This includes analysing tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement BEPS measures and amend existing bilateral treaties.

Chinese tax implications

The BEPS Action Plan may have a far reaching impact on international taxation and transfer pricing in China. The State Administration of Taxation (SAT) has kept a close watch on the development of the project and is contemplating major regulatory changes to adopt key elements of it. And even before the release of new BEPS-related circulars, local Chinese tax officials may refer to the action plan as an unofficial source of guidance when evaluating the tax and transfer pricing aspects of cross-border transactions. It is important for MNCs to keep the BEPS issues in mind when structuring international transactions.

Based on our experience and communications with the SAT, the BEPS Action Plan may impact the these tax areas in China:

Deductible outbound payments

Many MNCs have established internal lending platforms, intangible property holding companies or shared service centres outside China that make charges to their Chinese affiliates. Payments such as interest, royalties and service fees reduce the Chinese corporate income tax (CIT) base through deduction and are subject to lower rates of taxation or no taxation outside China through the participation in special foreign tax regimes. The BEPS Action Plan will prompt Chinese tax authorities to increasingly scrutinise payments that receive double non-taxation treatment. This could have both tax and cash flow ramifications for MNCs with these arrangements.

Historically, hybrid loans have not been used extensively in financing Chinese operations, partly due to the restrictions on registering non-conventional debt instruments with the Chinese foreign exchange authorities. Recently, the SAT has informally indicated that a cross-border payment from China that is not taxed in a foreign jurisdiction because of a mismatch in characterisation should not receive a deduction in China. If such a tax position is taken in practice, the regulatory authority is likely to be China's General Anti-Avoidance Principle (GAAR).

Contractual allocation of risks

Chinese entities performing functions that are seen as creating non-routine value (for example, certain R&D, brand building or market-penetrating activities), but which are allocated routine returns due to risks being removed by contract terms (for example, related-party contract manufacturing, distribution or contract R&D), could face further challenges to their transfer pricing under the BEPS environment. Chinese tax authorities will focus more on the actual functions in China that are entitled to a portion of the residual profits in the entire value chain. Business activities that create potentially valuable intangibles for taxpayers in China are likely to receive heavy scrutiny.

For example, if the Chinese subsidiaries of a MNC participate materially in marketing campaigns in China and incur significant marketing expenses, Chinese tax authorities in some situations may argue that these marketing activities generate valuable intangible assets and at least part of the intangible assets belongs to the Chinese entities that physically carry out the marketing functions. This result is not changed by the fact that the Chinese entities may have been fully compensated by an overseas affiliate for the provision of marketing services, because the Chinese tax authorities' argument is that the amount of the compensation is not commensurate with the value of such marketing services.

In such a case, Chinese tax authorities may ignore the purported characterisation of the Chinese subsidiaries that entitles them to routine profits only and adjust the profits of the Chinese entities upwards based on the presumption that they own non-routine intangibles. This situation is more likely to happen when the MNC operates in highly profitable industries in China (for example, automobile and pharmaceutical) and a significant amount of the profits relating to Chinese sales has been allocated to overseas affiliates based on a contractual allocation of risks.

Commercial substance

Transactions between Chinese subsidiaries and offshore entities, which appear to be light on substance, are likely to receive more attention. Backed by the BEPS Action Plan, Chinese tax authorities are likely to continue the rigorous implementation of the existing anti-avoidance rules on beneficial ownership and indirect transfers, which already place heavy emphasis on commercial substance. Specifically, a foreign company seeking benefits under the dividend, interest, royalty and capital gains articles of an income tax treaty that China is a party to will need to possess enough commercial substance in the residence jurisdiction. Such physical substance is embodied in the form of personnel presence, asset utilisation, risk taking and independent decision making. Similarly, when a foreign company that owns an equity interest in a Chinese company is transferred, the foreign company usually needs to own sufficient commercial substance in the residence jurisdiction for its corporate existence to be respected by Chinese tax authorities.

On the transfer pricing front, the SAT will be increasingly intolerant of profit allocations without physical substance. For example, if a Chinese company renders services to an offshore affiliate based on a cost-plus mark-up, while the service recipient retains the residual profit from a separate overseas contract, but has little physical substance in the residence jurisdiction, the transaction is vulnerable to Chinese tax challenges from a substance standpoint. This may put many existing principal structures and supply chain arrangements at risk.

Value creation

The statement in the Action Plan regarding value creation which reads, "measures… beyond the arm's-length principle, may be required," suggests some uncertainty as to how taxpayers should determine their transfer pricing. Taxpayers with unusual related-party transactions or transactions flows, or with transactions involving intangibles or unusually large scale, may be at greater risk of scrutiny or even potentially novel methods of adjustment under audit by the Chinese tax authorities. Senior officials from the SAT have suggested informally that China may consider a formulary allocation method in special situations to allocate profits in intercompany transactions if a traditional OCED transfer pricing methodology does not yield a result that reflects value creation by the Chinese entities properly relative to their foreign counterparts.

With the principle of value creation as support, Chinese tax officials may conduct even closer examinations of head-office expense allocations and deny tax deductions for these items equivalent to management fees in nature according to the implementation rule of the Chinese CIT law. When Chinese companies pay service fees or royalties to overseas affiliates, it is more important than ever before to have documentation ready supporting that the payment is not stewardship in nature; instead, these payments generate direct and tangible value to the Chinese payors.

Chinese tax officials will also continue to advocate an expansive view of value creation that includes location-specific advantages (LSAs) such as location savings and market premium to justify greater profit allocation into China. Chinese tax authorities indicated many times before that many MNCs have been able to reap greater profits in China than their home countries because of unique characteristics of the Chinese market. On the one hand, business operation costs in China are generally lower than in developed countries and therefore many MNCs in China derive location savings. On the other hand, due to a lack of competition that often exists in more mature markets as well as the immense purchasing power that originates from a rising middle class, many MNCs have been able to sell products at higher prices in China than in their home countries; this excess pricing represents market premium. Both location savings and market premium translate to super profits for MNCs. It is the view of the SAT that the Chinese market creates value for the MNCs that leads to these super profits, and that at least a portion of such excess profits should be subject to Chinese taxation. The BEPS Action Plan lends further theoretical support to this position of the Chinese tax authorities.

Permanent establishment

Chinese tax authorities are likely to intensify tax audit efforts on the Chinese taxable presence of non-resident companies, that is, PE in the tax treaty context. Regulation in recent years, such as SAT Directive 19 and Guoshuifa 2009-124, require foreign companies to register onshore projects or service activities with the Chinese tax authorities and submit recordal filings with the in-charge Chinese state tax bureaus if these companies wish to take a tax position of no-PE in China based on the relevant income tax treaties. We expect that these tax reporting and registration requirements will be enforced more rigorously going forward.

China will also pay more attention to PE issues in cross-border e-commerce transactions, and leverage from the guidance in the latest OECD model treaty commentary. For instance, when conducting e-commerce in China, many foreign companies have to place servers in China to maintain fast and stable data transmission across the Chinese border. The servers may be owned by the foreign companies or may be leased from third parties. If the server plays an instrumental role in facilitating and executing e-commerce transactions, Chinese tax authorities may argue that the server represents a fixed place of business for the foreign company and constitutes a taxable presence in China. If so, profits attributable to the server would be subject to Chinese CIT.

Finally, Chinese tax authorities are likely to use the concept of agency PE as a weapon to target MNCs that have not established extensive manufacturing or distribution bases in China, but mainly employ local agents to complete the direct importation of high-margin products into China. The initial targets of tax investigation are likely to be companies selling luxury consumer-goods brands in China. If a foreign company engages a dependent agent to perform significant portions of commercial negotiation in China, regardless of whether the agent signs the contracts on behalf of the foreign companies or whether the contracts are signed within China, the tax authorities could argue that the foreign companies have an agency PE in China. If that is the case, the tax authorities may use a formulary method to allocate a portion of the foreign company's profits to this PE for Chinese CIT purposes, as traditional transfer pricing methods may be ineffective in achieving the intended tax outcome.

Information collection

To increase the amount of information Chinese tax officials will have to identify audit targets and carry out tax examinations, the tax authorities will roll out additional tax recordal filing and disclosure requirements to increase transparency of the tax planning arrangements of MNCs and put more pressure on taxpayers to report tax positions or face a penalty. The SAT is designing new tax reporting forms as a part of the annual tax return package for companies and is referring to other tax compliance forms in the world to design its own reporting system.

On the international front, the SAT will increase its participation in information exchange with their overseas counterparts to uncover aggressive tax planning practices. China has signed income tax treaties with more than 100 jurisdictions and tax information exchange agreements with at least 10 others. All of these treaties or agreements allow the Chinese tax authorities to obtain information from their counterparties concerning foreign taxpayers. Recently, China became the 56th signatory to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. The convention allows China to exchange information automatically or spontaneously with other signatories and conduct simultaneous tax examinations on a MNC both within and outside China. This easy access to a MNC's tax-related information from another foreign jurisdiction creates a new deterrent for any tax arrangement whose feasibility depends on its lack of full visibility to Chinese tax authorities.

BEPS and tax administration reform

The release of the BEPS Action Plan provides Chinese tax authorities with a theoretical basis to launch extensive reforms within China's international tax administration. The SAT plans to issue a number of new circulars over the coming months in areas such as anti-avoidance, transfer pricing, PE determination, place of effective management (POEM) and CFCs. These initiatives are generally consistent with the BEPS Action Plan.

In response, MNCs should immediately conduct a health check on their existing arrangements, identify potential weaknesses according to the BEPS Action Plan and take steps to make improvements. This includes movement of functions, assets and personnel within the group, development of legal, tax and transfer pricing documentation as support, and preparation of internal controls and working guidelines to mitigate Chinese tax risks. With adequate preparations, MNCs will be able to adapt to the new tax landscape created by BEPS without causing unwarranted disruptions in business operation or incurring excessive amounts of tax costs during the transition.




Abe Zhao

Tax Partner

KPMG China

8th Floor, Tower E2, Oriental Plaza

1 East Chang An Avenue

Beijing 100738, China

Tel: + 86 10 8508 7096

Fax: + 86 10 8518 5111


Abe Zhao serves as KPMG China's international tax leader and has considerable experience of cross-border tax consulting. His specialty area is in advising on international tax structures. He has assisted a number of US, European and Australian multinational clients in the agricultural, construction and engineering, real estate, pharmaceutical, telecommunications, and entertainment sectors in tax planning engagements.

Serving both China inbound and outbound clients, Abe has extensive experience in international M&A and post-M&A integration; financing and intangible licensing/transfer arrangements; repatriation and exit planning; the design and development of international tax efficient supply chains; tax structuring for inbound and outbound private equity investment; foreign tax credit computation and analysis; transfer pricing controversy and documentation; and cost sharing arrangements.

He is a frequent speaker at seminars and forums and regularly contributes to academic journals on tax subjects.

Abe received his bachelor of business degree from the People's University of China, a masters in economics from the University of Virginia, and a masters in accountancy from the University of Georgia. He is a licensed US certified public accountant (CPA), and has received certified management accountant (CMA) and certified financial manager (CFM) certifications from the Institute of Management Accountants.




Leonard Zhang

Tax Partner

KPMG China

8th Floor, Tower E2, Oriental Plaza

1 East Chang An Avenue

Beijing 100738, China

Tel: +86 10 8508 7511

Fax: + 86 10 8518 5111


Leonard Zhang joined KPMG China's Beijing office from the economic and valuation services (EVS) practice in KPMG's Silicon Valley office in the US where he has worked on both transfer pricing and valuation projects for a variety of clients in different industries. He has significant experience in financial modelling, financial statement analysis, and performing quantitative and statistical analyses.

Leonard's past transfer pricing experience includes preparing global documentation and planning studies for the intercompany transfer of tangible goods, intangible properties, and services. He participated in a number of unilateral and bi-lateral advance pricing agreement (APA) projects, including some US-Japan APA projects. He assisted many technology companies in shifting their technology intellectual property (IP) as well as their advertising and marketing intangibles offshore. His previous engagements involved using a variety of innovative valuation techniques and profit split models to support the IP migration structure and the result.

Since joining KPMG China in December 2008, Leonard has led a number of transfer pricing planning, transfer pricing audit defence, APA, and tax-efficient supply chain management projects. He helped his clients defend their transfer pricing positions successfully; he also assisted his clients in reviewing the effectiveness of their supply chain management from a transfer pricing perspective and implementing the supply chain restructuring models he proposed.




David Chamberlain

Tax Director

KPMG China

8th Floor, Tower E2, Oriental Plaza

1 East Chang An Avenue

Beijing 100738, China

Tel: +86 10 8508 7056

Fax: + 86 10 8518 5111


David Chamberlain is a director in KPMG China's tax transfer pricing practice. Based in Beijing, David brings about 20 years of transfer pricing experience from both the government and the private sector in the US. David joined KPMG China in July 2012. Previously, David specialised in dispute resolution services from the Silicon Valley office of KPMG US.

Before joining KPMG, David was a team leader with the Advance Pricing Agreement (APA) Program within the US Internal Revenue Service (IRS). At the IRS, David negotiated APAs with taxpayers ranging from small businesses to billion-dollar multinationals in a wide variety of industries, dealing with numerous countries throughout Asia and Europe.

Before joining the IRS, David spent many years as a transfer pricing and international tax adviser with a primary focus on structuring tax-efficient global transfer pricing arrangements for high technology companies.

David has negotiated many APAs and led numerous transfer pricing projects, including leading cross-functional efforts to structure and implement tax-efficient supply chain management strategies for many high-tech and e-business companies; leading the KPMG US effort in bilateral APAs with Japan, Australia and Canada; and acting as IRS APA team leader for a number of APAs dealing with the valuation of intangible property transferred in connection with cost sharing arrangements.

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