21 August, 2016
SAT Bulletin [2016] No. 42
In accordance with the Enterprise Income Tax Law of the People’s Republic of China (hereinafter referred to as “Enterprise Income Tax Law”) and the implementing regulations issued thereunder, as well as the Law of the People’s Republic of China for the Administration of the Levy and Collection of Taxes (hereinafter referred to as the “Tax Collection Law”) and the detailed implementing rules issued thereunder, in order to further enhance the declaration of related party transactions and the administration of contemporaneous documentation, the relevant issues are hereby announced as follows:
1. When filing their annual enterprise income tax returns to the tax authority, resident enterprises which pay tax based on actual profit and non-resident enterprises which have a place or establishment1 in China and declare and pay enterprise income tax based on actual [income and expense] shall declare their related party transactions and enclose an Annual Statement of Related Party Business Transactions of an Enterprise in the People’s Republic of China (2016 version).
2. The term “related party relationship” (关联关系) as used in this Bulletin refers to one of the following relationships between one enterprise and another enterprise, organization or individual:
1 Translator’s note: the term “establishment or place” is a domestic, defined concept that is analogous to the concept of permanent establishment.
(1) one party directly or indirectly holds a total of 25 percent or more2 of the other party’s shares, or a third party directly or indirectly holds 25 percent or more of the shares in both parties; if a party indirectly holds shares in the other party through an intermediary, once the percentage of the intermediary’s equity held by such party reaches 25 percent or more, the percentage of equity held by such party in the other party shall be calculated as the percentage of the other party’s equity that is held by the intermediary;
if two or more individuals who are married, lineal relatives by blood or siblings or who have a financially dependent relationship hold shares of the same enterprise, the percentage of equity they hold should be added together for the purpose of determining the related party relationship;
(2) where one party owns the shares of the other party or a third party owns the shares of both parties and the percentage of shares owned does not meet the threshold as set out in item (1) of this Article, but the total debt between both parties accounts for 50 percent or more of the total paid-in capital of either party, or 10 percent or more of one party’s debt is guaranteed by the other party, excluding debt owed to or a guarantee from an independent financial institution;
The debt to paid-in capital ratio = Annual weighted average debt / Annual weighted average paid-in capital, where:
annual weighted-average debt = Σni=1 book value of debt i * actual days of debt i / 365;
annual weighted-average paid-in capital = Σni=1 book value of paid in capital i * actual days of paid in capital i / 365;
(3) where one party owns the shares of the other party or a third party owns the shares of both parties and the percentage of shares owned does not meet the threshold set out in item (1) of this Article, but one party’s normal production or business activities are dependent on the license of a patent, knowhow, trademark, copyright, etc., granted by the other party;
(4) where one party owns the shares of the other party or a third party owns the shares of both parties and the percentage of shares owned does not meet the threshold set out in item (1) of this Article, but one party’s business activities, such as procurement, sale, receipt of services, or provision of services, are controlled by the other party;
“Control” means that one party has the right to decide the other party’s finance and business policies and can obtain benefits from the business activities of the other party;
2 Translator’s note: this Bulletin does not address whether the Chinese term should be understood as “25 percent or more” or as “more than 25 percent”. Under most Chinese law and regulations (e.g., Guo Shui Fa [2009] No. 2), the Chinese term includes the number given, i.e., would be understood as “25 percent or more”.
(5) no less than half of the board members or senior management personnel (including the board secretary of a listed company, manager, vice manager, chief finance officer and other personnel stipulated by the articles of incorporation) of one party are appointed or delegated by the other party or concurrently serve as board members or senior management personnel of the other party, or no less than half of the board members or senior management personnel of both parties are appointed or delegated by the same third party;
(6) each of two individuals who are married, lineal relatives by blood or siblings or who have a financially dependent relationship has one of the relationships described in items (1) to (5) of this Article with one of the respective parties; or
(7) the two parties have other material interests in common. Except as otherwise specified in item (2) of this Article, if the aforementioned related party relationship changes within one year, the relationship shall be recognized according to its actual existing period.
If one of the relationships described in items (1) to (5) of Article 2 exists between two parties purely as a result of state ownership of shares or appointment of senior management personnel or board members by the state-owned assets administration department, the two parties should not be regarded as related parties under this Bulletin.
Related party transactions mainly include:
(1) transfer of the right to use or the ownership of tangible assets, where tangible assets include goods, products, buildings, means of transportation, machinery, equipment, tools, etc.;
(2) transfer of financial assets, where financial assets include account receivables, bills receivables, other receivables, equity investment, debt investment, assets resulting from financial derivatives, etc.;
(3) transfer of the right to use or the ownership of intangible assets, where intangible assets include patents, knowhow, business secrets, trademarks, brands, customer lists, sales channels, franchise rights, government licenses, copyrights, etc.;
(4) financing, including all kinds of long- and short-term lending, borrowing (including group cash pooling) and security, and
all kinds of interest bearing advance payments and deferred receivables or payments, etc.;
(5) service transactions, where services include market
survey, marketing planning, agency, design, consulting, administration, technical, contract research and development (R&D), maintenance, legal, financial management, audit, recruitment, training, central procurement services, etc.
An enterprise shall submit a country-by-country report when filing its Annual Statement of Related Party Business Transactions if:
(1) the resident enterprise is the ultimate holding enterprise in a multinational enterprise group, and the group’s consolidated revenue for the previous financial year exceeds RMB5.5 billion, where:
The ultimate holding enterprise refers to the enterprise that can consolidate the financial statements of all the constituent entities within the multinational enterprise group but cannot be included in any other enterprise’s consolidated financial statement;
Constituent entities include:
(a) any entity that has been included in the multinational enterprise group’s consolidated financial statement;
(b) any entity that is owned by the multinational enterprise group and should be (but has not been) included in the multinational enterprise group’s consolidated financial statement pursuant to public trading requirements;
(c) any entity that is not included in the multinational enterprise group’s consolidated financial statement merely because of its business scale and importance; and
(d) a permanent establishment that prepares accounting and financial statements independently; or
(2) the resident enterprise is designated by the multinational enterprise group as the reporting enterprise for the country- by-country report filing.
The country-by-country report mainly discloses the allocation of income, taxes and business activities of all the constituent entities within the multinational enterprise group to which the ultimate holding enterprise belongs, on a country-by-country basis.
A multinational enterprise group, of which the ultimate holding enterprise is a Chinese resident enterprise, may, in accordance with the relevant national rules, be partially or completely exempt from submitting the country-by-country report if the required information relates to national security.
Tax authorities may exchange the country-by-country report in accordance with a treaty, agreement or arrangement signed between the PRC and a foreign jurisdiction.
Where an enterprise is not required to prepare a country-by-country report in accordance with Article 5, but the multinational enterprise group to which it belongs is required to prepare a country-by- country report by the law of another jurisdiction, the PRC tax authority may require the audited enterprise to provide the country- by-country report during a special tax adjustment if:
(1) the multinational enterprise group has not submitted the country-by-country report to any country;
(2) although the multinational enterprise group has submitted the country-by-country report, the country that receives the country-by-country report and the PRC have not established an information exchange mechanism for the country-by- country report; or
(3) although the multinational enterprise group has submitted the country-by-country report and the country that has received the country-by-country report and the PRC have established an information exchange mechanism for the country-by-country report, the country-by-country report has not been successfully exchanged to the PRC.
If an enterprise requires a filing extension because submission of the Annual Statement of Related Party Business Transactions within the prescribed period is extremely difficult, the matter of the extension shall be handled in accordance with the relevant provisions of the Tax Collection Law and the detailed implementing rules issued thereunder.
An enterprise shall, in accordance with Article 114 of the Implementing Regulations of the Enterprise Income Tax Law, prepare contemporaneous documentation for its related party transactions for each tax year and shall provide such documentation when requested by the tax authority.
Contemporaneous documentation includes a master file, a local file and special documentation.
An enterprise shall prepare a master file if:
(1) the enterprise has cross-border related party transactions in the current tax year and the multinational enterprise group, to which the ultimate holding enterprise that consolidates the enterprise’s financial statement belongs, has prepared a master file; or
(2) the enterprise’s annual related party transactions exceed RMB1 billion.
The master file mainly discloses the overall performance of the global business of the multinational enterprise group to which the ultimate holding enterprise that consolidates the enterprise’s financial statement belongs. The master file shall include:
(1) Organizational Structure
Graphical illustration of the group’s global organizational structure, shareholding structure and geographical location of all its constituent entities. A constituent entity refers to any business entity within the group, including corporate enterprises, partnership enterprises and permanent establishments, etc.
(2) Business of Enterprise Group
(a) a description of the enterprise group’s business, including important value-contributing factors;
(b) a description of the supply chain and main geographic markets for the group’s five largest products and/or service offerings by turnover plus any other products and/or service offerings amounting to more than 5 percent of group turnover. The description of the supply chain can be illustrated in the form of a graphic or a table;
(c) a list and a brief description of important related party service arrangements other than R&D activities within the enterprise group, including description of service provider’s capabilities, allocation of the service costs and transfer pricing policies in determining prices of related party services;
(d) an analysis of the principal contributions to value creation by each constituent entity within the enterprise group, including key functions performed, significant risks assumed, and important assets used;
(e) business restructurings, industrial restructurings, and transfers of functions, assets or risks during the fiscal year of the enterprise group; and
(f) change of enterprise legal form, debt restructurings, equity or asset acquisition, merger and demerger during the fiscal year of the enterprise group.
(3) Intangible Assets
a) a description of the enterprise group’s overall strategy in regard to the development, exploitation and ownership attribution of intangible assets, including the location of major R&D facilities and R&D management, and information on the main functions, risks, assets and personnel in connection with intangible assets;
b) a description of the enterprise group’s intangibles or groups of intangibles that have significant impact on transfer pricing arrangements, and the owners of such intangibles;
c) a list of important agreements related to intangible assets between a constituent entity of the enterprise group and its related parties, where important agreements include cost sharing agreements, major R&D service agreements, license agreements, etc.;
d) a description of the enterprise group’s transfer pricing policies relating to R&D activities and intangibles; and
(e) an overview of related party transfers of ownership or use rights of intangible assets during the fiscal year of the enterprise group, including enterprises and countries involved, transfer price, etc.
(4) Financing Activities
(a) a description of the related party financing arrangements within the enterprise group and the main financing arrangements with unrelated parties;
(b) particulars on the constituent entity that undertakes centralized financing functions within the enterprise group, including the location where the entity is registered and the location of its place of effective management; and
(c) a description of general transfer pricing policies for financing arrangements between related parties within the enterprise group.
(5) Financial and Tax Positions
(a) the consolidated financial statement for the enterprise group’s latest fiscal year;
(b) a list and a brief description of the existing unilateral and bilateral advance pricing arrangements and other tax rulings relating to the allocation of income among countries of each constituent entity within the enterprise group; and
(c) the name and location of the enterprise that provides the country-by-country report.
13. An enterprise shall prepare a local file if its annual related party transactions meet any one of the following thresholds:
(1) the amount of related party transfers of ownership of tangible assets exceeds RMB200 million (for toll manufacturing business, this amount shall be calculated on the basis of the prices set out in the customs import and export declarations made over the course of the year);
(2) the amount of related party transfers of financial assets exceeds RMB100 million;
(3) the amount of related party transfers of ownership of intangible assets exceeds RMB100 million; or
(4) the amount of other related party transactions exceeds RMB40 million.
14. The local file mainly discloses detailed information on the enterprise’s related party transactions. The local file shall include:
(1) Enterprise Overview
(a) organizational structure, including each department’s set-up, responsibilities, number of employees, etc. within the enterprise;
(b) management structure, including the individuals to whom the enterprise’s management personnel report, the locations where such individuals maintain their principal offices, etc.;
(c) business description, including an overview of the enterprise’s industry and its developments, industry policies, the main economic and legal issues which affect the enterprise and the industry such as industry restrictions, etc., and main competitors;
(d) a description of business strategies, including business procedures, operational model and value- contributing factors of each department and each process of the enterprise;
(e) financial data, including the revenue, costs, expenses and profits for each business type and product of the enterprise; and
(f) particulars on restructurings or intangible asset transfers that involve or impact the enterprise and an analysis on those impacts on the enterprise.
(2) Related Party Relationships
(a) related party information, including information on any related party that directly or indirectly owns equity in the enterprise or that transacts with the enterprise, covering, in the case of a related enterprise, its
name, legal representative, the composition of its senior management personnel, its registered address and actual business address, and in the case of an individual related party, his/her name, nationality, domicile, etc.;
(b) the types and rates of income tax applicable to the above related parties and any relevant tax incentives for which they are eligible; and
(c) any changes in the enterprise’s related party relationships that have occurred during the fiscal year.
(3) Related Party Transactions
(a) overview of related party transactions
(i) descriptions and details of the related party transactions, including copies of the contracts or agreements for the related party transactions and notes on the details of the performance of the same, the characteristics of the transactional subject, the type(s) of related party transactions, the parties to the transactions, the times and amounts of the transactions, the currency or currencies of settlement, the transaction terms, the trading form, and the similarities and differences between the related party transactions and non-related party transactions;
(ii) the process for the related party transactions, including the flow of information, goods and cash for the related party transactions, and the similarities and differences with non-related party transactions;
(iii) a description of functions and risks, including functions performed, risks assumed, and assets used in all kinds of related party transactions by the enterprise and its related parties;
(iv) main factors affecting the pricing of transactions, including the intangible assets involved in the related party transactions and their impact on pricing, as well as location specific advantages such as location savings, market premiums, etc. (location specific advantages should be analysed from the aspects of labour costs, environmental costs, market scale, level of market competition, consumer purchasing power, substitutability of the goods/ services, government regulations, etc.); and
(v) related party transaction data, including the transactional amount involved in all types of related party transactions and non-related party transactions. The revenue, cost, expenses and profit for related party transactions and non- related party transactions shall be disclosed separately. If revenue, cost, expenses and profits cannot be directly segmented, the allocation rates used should be reasonable and accompanied by a statement confirming the grounds for such rates.
(b) value chain analysis
(i) a description of the enterprise group’s business flow, logistics flow and capital flow within the group, including the design, development, manufacture, marketing, sales, delivery, settlement, consumption, after-sales services and recycling of goods/services or other transaction subjects, as well as the participants in each process;
(ii) the latest fiscal year’s financial statements for all the participants in the above processes;
(iii) the measurement and allocation of the enterprise’s value contributed by location specific advantages; and
(iv) the allocation of the enterprise group’s profit in its global value chain and the principles used to allocate such profit.
(c) outbound investment
(i) basic outbound investment information, including the investment location, investment amounts, and main businesses and strategic plans for outbound investment projects;
(ii) an overview of outbound investment projects, including the project’s shareholding structure and organizational structure, the hiring methods for senior management personnel and the assignment of project decision-making power; and
(iii) outbound investment project data, including project operational data.
(d) related party equity transfers
(i) an overview of equity transfers, which includes background information, participants, dates, transfer price, payment methods and other factors that affect each equity transfer;
(ii) related information on the equity transferred, including its location, the timing, method
and cost of the transferor’s acquisition of the transferred equity, the gain from the equity transfer, etc.; and
(iii) other information that is relevant to the equity transfer, such as the due diligence report or the asset appraisal report.
(e) related party service transactions
(i) an overview of the related party service, including the service provider and service recipient; information on the content, characteristics, performing method, pricing principles and payment method of the service; each party’s benefits after the performance of the service; etc.;
(ii) the accounting and allocation methods, items, amounts, allocation keys, calculation processes and results of the service costs, etc.; and
(iii) a detailed explanation of the similarities and differences with respect to the pricing principles and transactional results between the related party service transactions and non-related party service transactions if there are identical or similar service transactions between the enterprise group to which the enterprise belongs and a non-related party.
(f) advance pricing agreements signed with or tax rulings issued by the competent tax authority of a jurisdiction other than the PRC if such advance pricing agreements or tax rulings are directly related to the related party transactions.
(4) Comparability Analysis
(a) the factors considered in the comparability analysis, including the characteristics of the goods or services transacted, the functions performed and risks undertaken by each party to the transaction, the contractual terms, the economic circumstance, the business strategies, etc.;
(b) relevant information such as the functions performed, risks undertaken and assets used by the enterprises under comparison;
(c) the search method, sources, selection criteria and grounds for selecting comparable enterprises;
(d) information on the selected internal or external comparable uncontrolled transactions and the financial information of the comparable enterprises; and
(e) adjustments to comparable data and the reasons for those adjustments.
(5) Selection and Application of Transfer Pricing Methodologies
(a) the selection of the tested party and the reason for that selection;
(b) the selection of the transfer pricing methodology and the reason for that selection; the enterprise must explain its contribution to the group’s overall profits or residual profits, regardless of the methodology selected;
(c) the assumptions and judgments made in determining the comparable uncontrolled price or profit;
(d) the application of the reasonable transfer pricing methodology and the results of the comparable
analysis to determine the comparable uncontrolled prices or profits;
(e) other materials in support of the selected transfer pricing methodology; and
(f) analysis and conclusion on whether the pricing of the related party transactions conforms to the arm’s length principle.
Special documentation includes special documentation for cost sharing agreements and special documentation for thin capitalization.
An enterprise that signs or implements a cost sharing agreement shall prepare the special documentation for cost sharing agreements.
If an enterprise with a related party debt-to-equity ratio in excess of the standard ratio needs to prove its interest payments conform to the arm’s length principle, it shall prepare the special documentation for thin capitalization.
The special documentation for cost sharing agreements includes:
(1) copies of the cost sharing agreement;
(2) other agreements reached among participants for the implementation of the cost sharing agreement;
(3) details of use by non-participants of the outcome of an agreement and the amount and form of payments made, as well as the allocation method among the participants for such payments received;
(4) details of the participants joining or withdrawing from the cost sharing agreement during the current year, including the names of the participants withdrawal compensation from the cost sharing agreement, the country in which each is located, the relationships among them, and the amount and form of the buy-in payment or withdrawal compensation;
(5) the particulars of any amendments to or termination of the cost sharing agreement, including the reason for amendment or termination and the handling or distribution of the outcome of the agreement;
(6) the total costs arising under the cost sharing agreement during the current year and details of the composition of those costs;
(7) details of the costs shared by the participants during the current year, including the amount and form of the costs paid, the party to whom they were paid, the amount of compensation made or received, and the party paying or receiving such compensation;
(8) comparison of the anticipated benefit and the actual outcome of the current year under the agreement, and any adjustments made as a result thereof; and
(9) the calculation of anticipated returns, including selection of measurement parameters, calculation method and justification for changes.
The special documentation for thin capitalization includes:
(1) an analysis of the enterprise’s ability to repay debts and provide loans;
(2) an analysis of the group’s ability to repay debts and of its financing structure;
(3) notes on any changes in the enterprise’s equity investment, such as its registered capital, etc.;
(4) notes on the nature and purpose of the related-party debt investment and the market conditions at the time when it was obtained;
(5) the currency, amount, interest rate, term and financing terms of the related party debt investment;
(6) whether a non-related party could and would be willing to accept the above financing terms, amount and interest rate;
(7) the particulars and conditions of the mortgaged object(s) provided by the enterprise for the purposes of acquiring the debt
investment;
(8) particulars of the guarantors and the terms of the guarantee;
(9) the interest rate and financing terms for similar loans of the same duration;
(10) the terms for the conversion of convertible corporate bonds; and
(11) other materials that can prove compliance with the arm’s length principle.
An enterprise may be exempt from preparing the local file and special documentation for related party transactions covered by
an advance pricing agreement. The transactional amount of such related party transactions should be excluded when calculating the amount of related party transactions under Article 13.
An enterprise may be exempt from preparing the master file, local file and special documentation provided it only has related party transactions with a domestic related party.
The preparation of the master file shall be completed within 12 months from the end of the fiscal year of the enterprise group’s ultimate holding enterprise. The preparation of the local file and the special documentation shall be completed by June 30 of the year following the year in which the related party transactions occur. Contemporaneous documentation shall be submitted within 30 days from the date of the tax authority’s request.
20. If an enterprise is unable to provide contemporaneous documentation on schedule due to force majeure, it shall provide the same within 30 days after the end of the force majeure.
21. Contemporaneous documentation shall be written in Chinese. The source(s) of information and/or materials cited in contemporaneous documentation shall be indicated.
22. Contemporaneous documentation shall bear the enterprise’s official seal and be signed or sealed by the legal representative or his/her authorized representative.
23. If an enterprise undergoes a merger or demerger, the surviving enterprise shall keep the contemporaneous documentation.
24. Contemporaneous documentation shall be kept for 10 years from its completion date as required by the tax authority.
25. For an enterprise that has declared its related party transactions and has provided contemporaneous documentation and other relevant materials in accordance with the relevant regulations, the tax authority may, in accordance with Article 122 of the Implementing Regulations of the Enterprise Income Tax Law, charge interest at the base rate published by the People’s Bank of China for Renminbi loans of the same period as the term for which the tax is unpaid when levying additional taxes during a special tax adjustment.
26. This Bulletin shall also apply to an enterprise’s transactions with a related party from Hong Kong, Macau or Taiwan.
27. This Bulletin shall apply for fiscal years beginning in or after 2016. Chapter 2, Chapter 3, Article 74 and Article 89 of the Implementing Measures for Special Tax Adjustments (for Trial Implementation)
(ref. Guo Shui Fa [2009] No. 2), and the Annual Statement of Related Party Business Transactions of an Enterprise in the People’s Republic of China (ref. Guo Shui Fa [2008] No. 114) are simultaneously repealed.
It is hereby announced.
Annexes: 1. 2.
Annual Statement of Related Party Business Transactions of an Enterprise in the People’s Republic of China (2016 version)
Instructions for Filling out the Annual Statement of Related Party Business Transactions of an Enterprise in the People’s Republic of China (2016 version)
For further information, please contact:
Jon Eichelberger, Partner, Baker & McKenzie
jon.eichelberger@bakermckenzie.com
