Legally Recovering Tens of Millions of Tax! Foreign-funded Enterprise Found to Shift Profits via Royalty Payments

In August 2019, during the routine monitoring and analysis of cross-border profit data, the Shanghai Tax Bureau discovered that Company S had suffered a huge loss of CNY 54.06 million from January to June 2019. Meanwhile, the royalty payments made by the company amounted to CNY 9.85 million, nearly twice the amount paid in previous years.

Based on the company’s operating data and historical records, the Shanghai Tax Bureau suspected that the enterprise might be shifting profits abroad through related-party transactions to evade taxes.

In accordance with relevant regulations, the Shanghai Tax Bureau decided to launch an anti-tax-avoidance investigation into Company S’s business activities from 2012 to 2019. The bureau collected a large amount of case-related information, including the company’s basic profile, group background, and records of related-party transactions over the years. It also conducted investigations into the company’s relevant business activities through various means, such as personnel interviews, on-site inspections, and external investigations. The investigation revealed that the company had significant tax-avoidance suspicions in terms of related-party purchases and royalty payments to related enterprises. Company S was unable to provide relevant materials and evidence to prove that these two related-party transactions were in line with the arm’s length principle.

The Shanghai Tax Bureau selected over 600 comparable companies from a global database of large financial data of publicly listed companies. It was found that these comparable companies had an average net profit margin of 3.53% in the comparable years. Using the average net profit margin of the comparable companies as a reference, the bureau conducted a comparable conversion and calculation of Company S’s taxable income. It was ultimately determined that Company S should increase its taxable income by over CNY 300 million from 2012 to 2019. After offsetting the losses, the company was legally required to pay back taxes and interest totaling CNY 15.5 million.

Faced with a large amount of evidence, Company S accepted the adjustment plan proposed by the Shanghai tax authorities and paid the taxes and interest on time.

Dongjin Tips:

Chinese tax authorities are increasingly using big data analysis in tax supervision systems to identify potential tax violations by enterprises. Companies should prepare relevant materials and evidence to prove that their related-party transactions are in line with the arm’s length principle. Otherwise, the tax authorities have the right to adjust the taxable income of the enterprise based on the average profit margin of comparable companies. Companies may then be required to pay back taxes, interest, and even late fees.

If companies have any questions, they can contact Dongjin for consultation at any time.

Mike Chang

Partner

mikechang@shanghaiinvest.com