Notes

This is the third APA annual report released by the State Administration of Taxation (“SAT”) to describe the mechanisms, procedures, and implementation of the APA program in China. This report is intended to provide guidelines to enterprises interested in entering into APAs with the Chinese tax authority, and to serve as a reference for competent authorities of other countries[1] and the general public to better understand China’s APA program. It does not have legal validity, and therefore should not be regarded as a legal basis for enterprises or the Chinese tax authority to negotiate or conclude an APA.

This report follows the framework of the 2009 and 2010 reports while updating the statistics through December 31, 2011. Other additions include statistics related to “APA renewals signed in 2011” and “industries covered by signed APAs”, revisions to Section 2 of Chapter 3, and the newly included Chapter 6 “SAT Contacts (by Province) for APA Requests” intended to support taxpayers in the submission of APA requests.

With an effort to enhance transparency of the APA program, SAT intends to briefly describe in each Annual Report the operation of the APA program during the year of report, beginning with this Report.

The operation of the APA program in 2011 is described below:

During 2011, there were 8 unilateral APAs signed and 4 bilateral APAs signed. By December 31, 2011, a total of 53 unilateral and 20 bilateral APAs have been signed and 15 unilateral and 79 bilateral APA requests (and submitted intentions) are pending.

In contrast to the large number of pending requests for APAs, the APA program in 2011 had only 6 persons on staff at the SAT Headquarters (who are also entrusted with TP auditing and TP-related MAP cases). As part of the effort to address the serious understaffing, SAT has a strong commitment for the training of local anti-avoidance[2] personnel and mobilizes local human capacity and expertise in case examination and analysis. Local personnel are engaged in the APA team for each BAPA case so as to ensure that each case merit sufficient input of human resources.

With an effort to enhance the quality of personnel, SAT devotes a large amount of resources to training activities on a regular basis. Training sessions in 2011 include: (1) 3 training sessions featuring experienced APA negotiators from the SAT HQ and local offices and experts from the intermediaries to provide lecturing to APA and TP personnel nationwide on selected topics, i.e., IP, transfer of equity, and application of the income method. (2) 3 training sessions featuring experts from the OECD and other international organizations to present global experiences and address current issues emerging from China’s practical work. (3) 16 internal exchanges across regions aimed at sharing experiences on cases and reducing inconsistency in APA practice between regions. (4) 3 training sessions targeting senior management at local offices aimed at enhancing their awareness and understanding of the anti-avoidance and APA work.

Ⅰ Introduction to China’s APA Program

1. Definition

An APA refers to an arrangement whereby an enterprise applies in advance to negotiate and reach agreement with the tax authorities in respect of the transfer pricing methods and corresponding calculation methods to be applied to its related party transactions for future years in accordance with the arm’s length principle. An APA covers related party transactions for three to five consecutive years starting from the year subsequent to the year during which the enterprise submits its formal written application.

2. Categorization

An APA may be categorized as unilateral, bilateral or multilateral based on the number of competent authorities involved in the APA.

In a unilateral APA, the enterprise enters into the APA with one country’s tax authority. A unilateral APA can only provide certainty to the enterprise’s pricing policy and method with respect to its related party transactions within one country, but cannot ensure that the overseas related party(ies) will effectively avoid transfer pricing audits or adjustments with respect to its transfer pricing with the enterprise by the tax authority of the related party. Thus, a unilateral APA cannot prevent international double taxation.

In a bilateral or multilateral APA, the enterprise negotiates and enters into the APA with two or more countries’ competent authorities. These authorities will need to reach an agreement with regard to the pricing policies or methods used in the cross-border related party transactions of the enterprise in question. Bilateral and multilateral APAs can be used to effectively avoid international double taxation and provide certainty regarding the transfer pricing policies of the enterprise.

3. Advantages

An APA is an effective approach to deal with transfer pricing issues and potential transfer pricing disputes with the collaboration between tax authorities and an enterprise. An APA between the tax authority and the enterprise is binding on all parties. The enterprise shall proactively conform to all the provisions and requirements of the arrangement, while tax authorities shall monitor the implementation of the agreement.

An APA is a voluntary agreement conducted on the basis of equality and mutual trust. It provides an effective way to enhance understanding, strengthen collaboration, and mitigate disputes between enterprises and tax authorities. APAs have the following benefits:

a) Provide certainty for tax authorities and enterprises in regards to transfer pricing issues for future years, which will offer certainty with regard to taxpayers’ operations and relevant tax obligations and provide tax authorities with an expectation of stable revenue;

b) Reduce tax authorities’ costs related to transfer pricing administration and audit as well as enterprises’ tax compliance costs by mitigating the risk of a transfer pricing audit; and

c) Improve the tax compliance services provided by the tax authorities, facilitate the balanced development of administration and service, and assure taxpayers of the relevant rights and benefits.

Bilateral and multilateral APAs can also provide the following additional advantages:

a) Facilitate communication and collaboration among the competent tax authorities of different jurisdictions; and

b) Help enterprises avoid transfer pricing adjustments as well as double taxation risks in two (for bilateral APA) or more (for multilateral APA) tax jurisdictions.

Ⅱ Legislation and Practice Development of China’s APA

1. History

China began using APAs on a trial basis in the late 1990s. In 1998, an APA was included as one of “other reasonable methods of transfer pricing adjustments” in Article 28 of “The Regulation on the Taxation of Transactions between Related Parties (Trial)” [3]　(Guo Shui Fa 〔1998〕 No. 59). In 1998, the first unilateral APA was reached between a tax authority and an enterprise.

In 2002, the APA program was formally introduced in Article 53 of “The Implementation Rules of the Tax Collection and Administration Law of the People’s Republic of China”[4] (Guo Wu Yuan Ling No. 362), and APAs were elevated from an adjustment method to a program.

In 2004, the SAT promulgated “Implementation Rules on Advance Pricing Arrangements for Transactions between Related Parties (Trial Version)” (Guo Shui Fa 〔2004〕 No. 118), which provides details of the APA program and specific procedures such as negotiation and conclusion procedures, requirements, follow-up execution and monitoring, as well as guidance on APA administration in China. Such a step further regulated the administration of China’s APA program. From 1998 to 2004, a number of local Chinese tax authorities initiated trial programs and concluded unilateral APAs with enterprises. However, due to the absence during this period of implementation guidance that was specific, standardized and imposed nationwide, concluded APAs were usually found to be defective through over-simplified APA articles and insufficient function, risk and economic analysis. For this reason, this report does not contain statistics about APAs concluded during this period.

In order to standardize and ensure consistency of China’s APA administration across the country, the SAT has implemented rules for APA monitoring and administration since 2005 requiring the local tax authorities to submit the draft unilateral agreement to the SAT for review and approval before its conclusion. Meanwhile, local tax authorities are required to steadily promote APA programs and strictly conform to the relevant regulations to improve the administrative soundness of the APA program. China’s APA administration has since stepped into a new stage of well-founded regulation. In April 2005, Japan and China concluded the first bilateral APA in China’s history. Subsequently, China reached bilateral APAs with the United States, the Republic of Korea, and other countries. From 2005 to 2008, the Chinese tax authorities concluded 41 APAs, including 36 unilateral and five bilateral APAs.

At the beginning of 2009, Guo Shui Fa 〔2009〕 No. 2 “Implementation Measures of Special Tax Adjustments (Trial Version)” (“the Measures”) was promulgated to facilitate the implementation of the Corporate Income Tax Law of the People’s Republic of China and its Implementation Regulations. Chapter Six of the Measures provides more detailed rules and implementation guidance on China’s APA program. In 2009, China’s bilateral APA program experienced rapid growth; the Chinese tax authorities signed 12 APAs, including five unilateral and seven bilateral APAs.

In 2010, the Chinese tax authorities signed 8 APAs in total, including 4 unilateral APAs and 4 bilateral APAs.

In 2011, the Chinese tax authorities signed 12 APAs in total, including 8 unilateral APAs and 4 bilateral APAs.

From 1 January 2005 to 31 December 2011, the Chinese tax authorities received 99 submitted intentions or formal applications for bilateral APAs in total (of which 21 have been concluded). The countries involved amounted to 15.

In addition, the SAT has received numerous enquiries on bilateral APAs from enterprises. It is expected that the number of APA applications will continue to increase.

2. Existing Legal Basis

The legal basis and relevant laws, regulations and implementation rules governing APAs primarily include the following:

a) The relevant clauses in the agreements for the avoidance of double taxation (the “Treaty” or “Arrangement”) between the government of China and the government of the corresponding country (region);

b) Article 42 of the Corporate Income Tax Law of the People’s Republic of China;

c) Article 113 of the Implementation Regulations of the Corporate Income Tax Law of the People’s Republic of China;

d) Article 53 of the Implementation Regulations of the Administration of Tax Collection and Administration Law of the People’s Republic of China;

e) Chapter 6 and other related provisions of the Implementation Measures of Special Tax Adjustments (Trial Version) (Guo Shui Fa 〔2009〕 No. 2).

This article is released in the State Administration of Taxation of ThePeople’s Republic of China , If you have any questions please contact with us via email: newsletters@minterpku.com, or dial the number: + 86 10 5900 9170