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China: How can taxpayers deal with the stock market crash?

China’s economic problems came to a head early this week, with the benchmark Shanghai Composite index losing more than 15% of its value on Monday and Tuesday.

Monday’s losses, in particular, sent shockwaves around the world, though Western markets rallied on Tuesday after news that China would cut its one-year lending rate to 4.6% - the fifth interest rate cut since November 2014. The cut was less effective in China itself, however, as the Shanghai Composite fell by a further 1.3%.

The economic downturn has an effect on investors and local companies alike – but what are the most pressing concerns from a tax perspective?

Firstly, taxpayers must recognise that the tax authorities are likely to be far more active in times of economic struggle than they are during the boom times China has been used to, almost without interruption, for the last 30 years.

“The general observation is that China’s economy is not doing as well as before,” said Roberta An Chang of Hogan Lovells.

“It’s true – not just in China but elsewhere in the world – that when the economy’s not doing well, that’s when they [authorities] start really focussing on tax collection.”

Foreign companies are targeted more often in such situations, as authorities look to keep as much money inside China as possible.

“We’ve been seeing an increase in enforcement in terms of foreign companies doing business in China, and their subsidiaries paying money out from China,” said An Chang.

The authorities have been keen to crack down on several areas. State Administration of Taxation Announcement No. 16 of 2015 gave the tax authorities more power to make transfer pricing adjustments to payments to overseas related parties, and increased the amount of documentation required for companies to prove transactions have been carried out at arm’s-length.

The tax authorities may examine payments made to overseas related parties up to 10 years after they occurred, and implement “special tax payment adjustments” at any point during this time period.

The circular also tightened up intangibles rules:

“Where it is necessary for an enterprise to pay royalties for the use of intangible assets provided by an overseas affiliated party, consideration must be given to the degree to which the various affiliated parties contributed to the creation of such intangible asset's value, and determine the respective economic benefits to which they are entitled,” said the notice.

“If the enterprise pays royalties to an affiliated party which merely has legal ownership rights to the intangible asset, yet has made no contribution with respect to creating the value of such asset, and such payment does not comply with the arm's-length principle, the enterprise must not deduct such payment when calculating its taxable income.”

An Chang said: “Recently there has been a series of tax notices talking about they’re going to do a tax audit on dividends, service fees, royalty payouts from China to offshore. I think they’re going to look at the past five years’ records.”

The authorities are also getting tougher on affiliated party labour costs, and say that labour services “must be able to produce direct or indirect economic benefits for the enterprise”.

While the authorities are doubtless getting more aggressive, there is little prospect that companies will be eager to contest decisions.

“I think companies are still reluctant to officially challenge tax decisions in court,” said An Chang. “There are some law firms that are saying that a lot more taxpayers are going to court now in China, but I think they’re in the minority.”

“The majority still prefer to negotiate for a settlement before any kind of decision is reached. More aggressive? Yes. Adversarial? I have my reservations on that.”

Moving money out of the country

Taxpayers should also be aware of another issue which can make moving money out of China more difficult: the roll-out of VAT.

The authorities have been stringent in their requirements for moving money out of the jurisdiction, and this level of bureaucracy can only be expected to increase after China’s ‘Black Monday’.

“I wouldn’t say it’s a problem in terms of calculating how much tax you pay, it’s the process: what documents do I need to present to the tax authority to get approval? How long is the tax authority going to take to reach a decision on whether I can pay this money out or not?” says An Chang.

“That process has been prolonged because of the VAT change.”

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