Measures to facilitate trading activity, which include enhancing China's bonded zones, and to clarify the use of the enhanced China-ASEAN free trade agreement were released during the course of 2019. This was paralleled by more granular guidance on customs impositions on royalties, as well as evolving practices in the interaction between transfer pricing (TP) documentation and customs valuation approaches.
Since 1990, China has introduced six types of special customs supervision areas with different functions. These range from the early free trade zones (FTZs), to the export processing zones, bonded logistics parks, bonded ports, cross-border industrial zones, and the comprehensive bonded zones (CBZs), which were introduced later.
In principle, CBZs are the most advanced of the special customs supervision areas and play an important role in promoting foreign trade, attracting foreign investment, leading the emergence of new industries and driving the comprehensive development of all the different types of special supervision area. Over the past decades, some of the special supervision areas were gradually converted into CBZs, and others are planned to be converted into CBZs.
In 2019, the Chinese government released a number of policies to institute a more facilitative business environment, especially from the trade and customs perspective. In particular, to advance the promotion of the CBZs, the General Administration of Customs (GAC), together with 14 ministry level departments including the State Taxation Administration (STA) and the Ministry of Commerce, published a draft version of the Opinions on Promoting High Standard Opening-up and High Quality Development of Comprehensive Bonded Zones (the Opinions).
The Opinions provide that the CBZs are to be developed into five types of centres. These include processing and manufacturing centres; research, development and design centres; logistics and distribution centres; inspection and maintenance centres; and sales and services centres. Guided by the Opinions, CBZs will extend their focus from traditional functions, such as export processing and logistics distribution, to other business areas, such as research, development, innovation, inspection, testing and sales services. This has the intention of cultivating new advantages for China as a business hub in the international market.
There are new measures to facilitate the movement of goods through CBZs, as well as to enable CBZ enterprises to make sales into the domestic market. For example, there is now an exemption from automatic import licence requirements for certain types of products produced in CBZs, permission for bonded storage and display of imported automobiles in CBZs, and other measures in this vein. These measures complement efforts to reduce operating costs for businesses operated in CBZs. For instance, materials consumed during R&D activities are to be exempted from requiring import licences, and bonded repair and maintenance of foreign made goods are to be subject to a preferential supervision approach in CBZs, with much lower operating costs.
The Opinions will allow CBZ enterprises to carry out their manufacturing, trade, R&D and other activities more conveniently and efficiently. These enterprises can follow up with their in-charge customs authorities for details of specific changes planned locally. Businesses located in other special supervision areas can also expect to enjoy the benefits of the new policies, once their special customs supervision areas are upgraded to CBZ status.
Evolving supervision methods: royalties
As noted in our previous publications, the Chinese authorities have been highly assertive in imposing customs duties on royalty payments, where the licensed intellectual property (IP) is viewed as integrated in products imported in parallel. New customs guidance in 2019 will further induce enterprises to review their exposures and self-declare accordingly.
Since March 30 2016, three 'confirmations' have been added to customs declaration forms: confirmation of special relationship, confirmation of price impact and confirmation of payment of royalties. Further official guidance has been issued since then, in particular with regards to the filing instructions on royalties.
In two announcements made in January and March 2019 (Announcements No. 20 and No. 58), the GAC took steps to clarify how China's customs will enforce the collection of customs duties on royalties, with detailed guidance on the time of declaration, declaration method, and surcharges for overdue tax payment. The biggest change is the stipulation of a declaration period for dutiable royalties and the provision for late payment surcharges if an enterprise fails to declare in time.
In this regard, Announcement No. 58 states that only dutiable royalties related to imported goods should be stated as 'yes', while those not dutiable and not related to import goods should be stated as 'no'. Compared with the previous regulation, the new rule has been aligned with Measures on Customs Valuation – this resolves the confusion that previously existed among importing enterprises. It has now been clarified that 'yes' should only be stated if royalties satisfy both criteria (that royalties are "related" to imported goods and "constitute a condition of sale").
Announcement No. 58 also stipulates that customs will collect late payment surcharges at a daily rate of 0.05% of underpaid import taxes, if the enterprise fails to declare and make tax payment to customs within the prescribed period (within 30 days after royalties are paid).
Considering the volume of documents to be included in the package for submission, and the new requirement to report within 30 days after remittance, it is recommended that preparation should start once planning gets underway for remittance of royalties.
Affected enterprises should contact the in-charge customs authorities as soon as possible to make arrangements for switching to the new declaration mode in order to avoid surcharges arising. As surcharges can be mitigated for enterprises that make a self-disclosure, this may be of value for enterprises with dutiable royalties who fail to make the initial declaration deadline.
Pioneer for new WCO practices
At the end of 2017, the World Customs Organisation's (WCO) technical committee on customs valuation (TCCV) published a valuation case submitted by the GAC. This was entitled 'Use of Transfer Pricing Documentation When Examining Related Party Transactions Under Article 1.2 (a) of the Agreement' (case study 14.2), and was discussed in last year's customs chapter. Case Study 14.2 was the first official reference document from China's customs which has been accepted by the WCO under the World Trade Organisation (WTO) valuation framework. Since the WCO released this Case Study 14.2 there has been a profound impact on China's customs valuation practices, as it has played a significant role for China's customs in valuation cases where related party (special) relationships are in point.
Transfer pricing (TP) documentation is now one of the key reference documents requested during various customs inspection processes (regular customs audits and price inquiries). However, it should be noted that there are still certain differences between TP and customs valuations, from adopted methodologies to reviewed data. Taking limited risk distributors as an example:
|Reviewed items||TP commonly recognised practice||Customs valuation recognised practice|
|Adoptable pricing methodologies||Transaction net margin method (TNMM) or resale price method (RPM)||Same or similar product analysis, or deductive price method|
|Profit indicator||Operating margin||Mainly focus on gross margin|
|Reference source for pricing comparison||Comparable functions and risk profile||Comparable products|
|Selection of comparable companies||Tend to choose Asia-Pacific region||Importing country preferred|
In light of the above, where the customs authorities raise inquiries on a company's customs valuation by making reference to TP documentation, it is recommended that the company align internally between its customs affairs department and finance department, before responding to customs on their queries.
In addition, considerations arise where special factor analysis (for example, industry analysis, financial analysis and adjustments) is set out in the TP documentation, such as where the profit is lower than a reasonable range. It is also recommended that the special circumstances be analysed from a customs valuation perspective, if the profit is higher than the inter-quartile range. Since customs authorities are open to reviewing special adjustment factors, there is also room to adopt a benchmarking study specifically for customs valuation purposes, with adjustable conditions, such as the selected comparable companies, adopted TP methodology and profit level indicator (PLI), etc.
New brick on the Belt and Road
On August 19 2019, the GAC released GAC Announcement  No 136: 'the Publication of Revised Measures of the Customs of the People's Republic of China for the Origins of Imported and Exported Goods under the Framework Agreement on Comprehensive Economic Co-operation between the People's Republic of China and the Association of Southeast Asian Nations (ASEAN)' (Announcement 136). This came into effect on August 20 2019.
The ASEAN-China Free Trade Agreement (ACFTA) took effect in 2005 and has been the largest and most influential FTA signed by China. Negotiations to upgrade ACFTA began in 2014 and after several rounds of negotiations, China and the ASEAN countries completed all the necessary domestic procedures for upgrading the FTA. It was officially implemented on August 20 2019.
The upgraded ACFTA contains major adjustments to its rules of origin (RoO). For instance, previously only 500 six-digit level HS code products were covered under the list of product specific rules, but now 2,000 are covered; the PSR list provides a list of products with specified HS codes, which are governed by designated origin criteria. Many more products in the leather, textiles, apparel, footwear, and other categories will now be treated as originating goods under ACFTA. This is so long as they can fulfill the change of tariff heading (CTH) criteria, which means the first four-digit HS codes of the 'non-originating imported materials' category are different from those of the finished products.
Enterprises should carefully study the upgraded RoO and the influence that these changes will have on the determination of origin.
It should be noted that China's customs has been increasingly focusing on country of origin compliance during the past years, especially with the experience gathered from recent international trade frictions, and the new FTAs (China-Korea, China-Australia, etc.) that China entered into over the past years. Enterprises should therefore pay special attention to mitigating the risks posed by country of origin verification. Import and export enterprises should fully understand and apply the correct RoO, understand the changes in the applicable RoO, follow the requirements in filling in certificates of origin, and adhere to compliance management requirements. Doing this will ensure that they correctly apply the preferential RoO and conduct origin management in a compliant manner.
The authors would like to thank Tony Chen, KPMG China manager, for his contribution to this article.
Eric Zhou worked for China customs for more than nine years before joining KPMG China in 2004, where he is now the national leader of the trade and customs practice.
Eric specialises in cross-border trade and customs advisory/defence services such as harmonised system (HS) code determination, customs valuation and processing trade management concerning multinational enterprises in industrial markets and consumer markets. He also has extensive experience of corporate income tax, indirect tax and transfer pricing, the latter of which are closely linked to customs valuation.
Eric is a chartered tax adviser (CTA) of the Chartered Institute of Taxation in China and is a member of the Association of Chartered Certified Accountants (ACCA).
Rachel Tao is a director specialised in trade and customs. She is an expert on customs valuation, tariff classification, the use of special trade programmes and special customs supervision zones.
Rachel assists companies with reviewing, auditing and assessing their import and export operations. In this regard, Rachel has worked for many clients facing enquiries and investigations, and has helped them to achieve favourable outcomes. She has taken the lead on several supply chain restructuring projects, providing expert support on inter-company transfer pricing, evaluation of duty savings opportunities and resolving trade related obstacles and barriers. Rachel regularly communicates with government officials to help clients obtain guidance from the government on new customs pilot project regimes and to obtain client specific approvals.
Rachel serves clients in many industries, including importers of consumer, pharmaceutical, medical and automotive products.
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