Foreign firms set for tougher tax scrutiny

Government targets multinationals' use of transfer-pricing arrangements

China will establish a comprehensive system to monitor foreign companies' profitability to curb cross-border tax evasion, the State Administration of Taxation said.

The move is one of several steps against tax avoidance taken by the agency to protect the country's interests as the world's top destination for foreign direct investment.

The system will allow the agency to acquire profit information on foreign companies so that it can launch "targeted actions" and use information technology to prevent companies from shifting profits overseas, Zhang Zhiyong, deputy director of the SAT, said in an interview with domestic media, which was posted on the agency's website.

The ongoing campaign against corporate tax dodging has rippled through the foreign business community in China, following the government's move last week to levy $140 million in back taxes on United States-based Microsoft Corp. Microsoft has denied that it practiced tax avoidance.

Analysts said, however, that such actions will force foreign firms to be more prudent and serious about their tax structures and practices in China.

Last month in Brisbane, Australia, President Xi Jinping and other G20 leaders jointly called for greater efforts to prevent tax evasion and avoidance by improving international tax rules and tax information exchanges among governments.

Experts have estimated that tax evasion and avoidance by foreign companies have resulted in an annual reduction of at least 30 billion yuan ($4.9 billion) in tax revenues.

One common tactic used by companies to avoid tax is transfer pricing, through which a parent company sells its product or services to a subsidiary company overseas at a price below the production cost.

Such practices generate an apparent loss for the parent company, which has actually shifted its profits to a subsidiary in a lower-tax location.

Matthew Mui, a China tax partner at accounting firm PricewaterhouseCoopers LLP, said that the various tax standards and competitive tax policies among different countries have created the motivation and conditions for profit-shifting.

"Therefore, it is necessary to have relatively unified tax standards internationally with detailed and clarified regulations and to reduce the gray areas when it comes to implementation," he said.

In August 2013, China joined a multilateral tax agreement, known as the Convention on Mutual Administrative Assistance in Tax Matters, proposed by the Organization for Economic Cooperation and Development in 1988.

The participation of China, the last G20 member to sign the agreement, meant that the world's major countries could finally move toward the implementation of automatic tax information exchanges as a new global standard, analysts said.

Beijing will host the G20 summit in 2016 and collaboration on this issue will be on the agenda.

China has benefited from an improvement of its legal system since it introduced the Corporate Income Tax Law in 2008, a milestone for the development of anti-avoidance efforts in the country.

"China's approach to tax avoidance has changed from being reactive to proactive, with a focus on changing taxpayer compliance and conducting risk assessment-based tax investigations," said Yu Qisheng, a China tax partner at PwC.

The country's tax revenues from anti-avoidance measures rose to 46.9 billion yuan in 2013 from only 460 million yuan in 2005, according to data from the SAT.