Recently, the Shaanxi state taxation bureau is expanding their anti-avoidance investigation scope from the traditional manufacture industry to the real estate industry, by using sharing data inthe comprehensive collection and administration system database to analyze the related parties’ information. Currently, two anti-avoidance cases has been filed with the Shaanxi SAT for further investigation.
In past many years, the real estate industry has always been the focus of the SAT’s special audit and investigation, in the light of the characteristics of the real estate enterprise such as the large size of capital, covering various types of taxes and complex incompliance situation etc. With increasing anti-avoidance experience and sophisticated technical approaches, the SAT is paying attention to the anti-avoidance of the real estate industry. The national anti-avoidance meeting of 2012 held by the SAT made it clear that the SAT shall continue to conduct industry analysis and national related-party investigation to real estate industry, and shall expand the investigation scope from enterprise income tax to the land VAT, business tax and so on.
- 1. The reason why the real estate industry is becoming the focus of the anti-avoidance
(a) Long industry chain and multi-functions
Recent years, the Chinese’s real estate industry goes through vigorous development. In this process, the big real estate group developed more detailed division of work gradually and built a complete industry chain. The big real estate group normally sets up independent entities such as real estate development company, building & installation engineering company, designing company, landscape company, real estate management company and real estate agency company etc. These companies shall assume different functions and risks.
(b) Wild variety of the related parties’ transactions
The variety of the related parties’ transactions is attributed to the full industry chains. All of the following four types of related parties’ transaction may be involved:
- the purchase and sale of the tangible assets, such as the purchase of the construction materials and the sale of the real estate;
- Intangible assets transaction, such as the use of the proprietary technology and trademark;
- Provider of the services, such as the designing, advertising and consulting;
- Financing.
The real estate group intends to redistribute the profit among the related parties in order to improve the overall tax efficiency.
Due to the above reasons, the tax authority are gradually paying more attention to the related parties’ transaction incurred in the entities in the real estate group, to assess whether real estate group is avoiding the enterprise income tax, land VAT and business tax etc.
- 2. Key points of the tax authority’s investigation
(a) Financing between related parties
The loan/financing between related parties is common in the light of the long development cycle and the tremendous demand of funds. For example, for the real estate group, if the group headquarters lends its funds to profitable project companies, the interest incurred shall be subject to business tax and the applicable surcharges, whereas the total rate (about 5.6%) of the business and the surcharges are much lower than the enterprise income tax rate of 25%. As such, the overall tax payment of the group can be reduced. Therefore, the related parties’ loan is one of the focuses of the tax authority’s investigation.
(b) the royalty fee for the usage of intangible assets
The tax cases involved the real estate company show that the payment of royalties for the usage of intangible assets (for example, the trademark) is a common type of cross-border related party transactions. When paying royalties, the Chinese tax authorities may consider the following aspects:
- Whether intangible assets such as trademarks are necessary and closely related to the domestic company’s operation and；
- Whether the ratio (the most common pricing way) between the royalty fee and the sale revenue is appropriate.
(c) Deduction Items of the Land VAT
According to the prevailing land VAT rules, the amount of the deduction items shall directly affect the amount of land VAT payable. Therefore, for real estate enterprises, the higher costs incurred, such as the development of road networks, the laying of pipelines, the maintenance of landscaping, the greater of deduction, the lower the applicable rate of land VAT for the transfer of real estate shall be, and ultimately the amount of land VAT payable shall be reduced. As the related parties can manipulate the transfer pricing among them, the mentioned deduction costs can be artificially increased, as a result, the land VAT payable is reduced. As such, the tax authority shall pay great attention to the development costs and fees incurred by the real estate company.
- 3. Advisable Countermeasures
As of 1 July 2012, the tax authorities in Shaanxi, Shenzhen, Xiamen and Chengdu are beginning to strengthen the anti-avoidance supervision and investigation for the real estate enterprises. A storm of anti-avoidance investigation seems to be brewing.
Against this background, for the real estate group with large amount of related-party transactions, it is advisable to immediately make a self-assessment, reviewing the existing related-party transactions and the corresponding transfer pricing policies, evaluating the possibility that it is investigated by the tax authority, and adjusting the transfer pricing policies if necessary. In addition, when making tax planning, the real estate shall comply with arm’s length principle so that to reduce the risk of anti-avoidance investigation by tax authority.
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