• Outbound investing SOEs required to upgrade investment evaluation procedures (Cai Zi [2017] No. 24)
• FIE establishment and alteration rules clarified (MOFCOM Order [2017] No. 2 / MOFCOM Announcement [2017] No. 37)
• Environmental protection tax enforcement measures
• OECD branch mismatch rules under BEPS Action 2

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On 12 June 2017, the Ministry of Finance (MOF) issued Financial Administrative Measures for State-owned Enterprises Making Outbound Investment (Cai Zi [2017] No. 24, referred to as the “Measures”). The Measures seek to upgrade the rigour with which Chinese state-owned enterprises (SOEs) evaluate their outbound investments and entered into force from 1 August 2017. The Measures are released in parallel with an increased role for SOE Communist Party committees in overseeing and managing key strategic decisions at SOEs. Updates to the articles of association of various overseas-listed SOEs to reflect this has recently been remarked upon in the international business media.

The “outbound investment” in scope of the Measures includes SOE activities related to acquiring ownership, control rights, or business management rights over incorporated or unincorporated entities or projects (e.g. property management service arrangements, construction project contracting) outside of China (including Hong Kong, Macau and Taiwan).  This includes greenfield investment, mergers and acquisitions (M&A), joint ventures, and equity participations. 

There are certain exclusions from the scope of the Measures, including outbound investment by financial SOEs, and less significant outbound investments (such as SOE representative offices outside China).  Key points in the Measures are set out below:

* In 2016, reports in the global business media opined that the Chinese government was looking exert more effective control over outbound capital flows from China, and that the State Council had considered issuing guidance to tighten limitations on outbound investment. The media reported that outbound merger and acquisition (M&A) transactions exceeding US$10bn (US$1bn if acquisition was outside the core business of the Chinese investor) would not be approved by MOFCOM and other relevant authorities. In addition it was reported that SOEs would not be allowed to invest more than US$1bn in a single overseas real estate transaction. In response, on 6 December 2016, the State Administration of Foreign Exchange (SAFE) along with other three authorities, including the National Development and Reform Commission (NDRC), MOFCOM, and the People’s Bank of China (PBOC) clarified the supervision issues for China’s outbound investment [See KPMG China Tax Weekly Update (Issue 47, December 2016) for details].

Furthermore, a 26 January 2017 SAFE circular clarified that, when a domestic enterprise investor conducts a registration with a local forex authority in relation to an outbound direct investment (ODI), and plans to transfer funds out of China to pay for the ODI, it must state both the source of its investment funds and the purpose of the outflow (utilization plan).  The enterprise must submit the resolution of its board of directors in relation to the outbound investment, the investment contract, and other proof of investment authenticity, to the bank concerned. This is in addition to submitting the usual documentation required for bank verification [See KPMG China Tax Weekly Update (Issue 6, February 2017) for details].

On 30 July 2017, the Ministry of Commerce (MOFCOM) issued MOFCOM Order [2017] No. 2 with the revised Interim Measures for Filing Administration of Establishment and Alteration of Foreign-invested Enterprises (FIEs) (the “July 2017 Interim Measures”. The July 2017 Interim Measures came into force from the date of issuance and take the place of the Interim Measures for Filing Administration of Establishment & Alteration of FIEs (“October 2016 Interim Measures”) issued by MOFCOM in October 2016. 

The October 2016 Interim Measures had provided that the set up of new FIEs and alteration of FIEs (e.g. name changes, registered capital increases, and transfer of FIE equity interests between foreign investors) would be subject to MOFCOM recordal filings rather than to MOFCOM pre-approval procedures, as was previously the case. This new treatment, applied nationwide, extended to FIEs in sectors which were not on the national ‘Negative List” (which sets out sectors which are restricted/prohibited to foreign investment). For FIEs in restricted sectors the MOFCOM pre-approval process would still need to be followed.

Before the finalisation of the 2017 July Interim Measures, MOF solicited public comments on its draft in May 2017 [See KPMG China Tax Weekly Update (Issue 22, June 2017) for details]. Building upon the October 2016 Interim Measures, the July 2017 Interim Measures further provide that the following transactions will also transition from the pre-approval to the recordal process:

• M&A transaction resulting in domestically-owned companies becoming FIEs;
• Equity transactions through which a foreign-invested listed Chinese company gains a new foreign shareholder. 
  

The transition to recordals for these transactions is subject to the Negative List caveat noted above, and requires also that the M&A transaction is not conducted between related parties. Otherwise pre-approvals still apply. 

Simultaneous with the issuance of MOFCOM Order No. 2 and the July 2017 Interim Measures, MOFCOM also on 30 July 2017 issued Announcement [2017] No. 37 setting out the filing forms for FIE establishment and alteration (including through M&A transaction). 

* Foreign investors investing into non-negative list industries in China simply make a recordal with MOFCOM (or local commerce departments) and may proceed with all of their other registrations (e.g. business registration, forex registration) in tandem. This differs from the old system which required MOFCOM FIE set up approval first, and then allowed the FIE to continue with all the other registrations, which made for a very time consuming process.  The negative list covers sensitive industries for which the Chinese government still wants establishment and transfer of FIEs to be subject to a pre-approval process See [KPMG China Tax Weekly Update (Issue 39, October 2016) for details].

On 25 December 2016, the Environmental Protection Tax Law was approved by the Standing Committee of the 12th National People's Congress, and it will apply from 1 January 2018. It is intended that the conversion from pollutant discharge fee to tax should not raise enterprise fiscal burdens. The law adopts the current standards for pollutant discharge fees as a lower range. Provincial level governments now have the authority to raise tax impositions above this level based on the environmental situation in their jurisdictions [See KPMG China Tax Weekly Update (Issue 1, January 2017) for details].

To facilitate the implementation of the law, in June 2017, MOF, the State Administration of Taxation (SAT) and the Ministry of Environmental Protection (MEP) jointly issued the draft Implementation Regulations for Environmental Protection Tax Law (the “Draft Regulations”) to solicit public comments. The Draft Regulations noted that SAT will work with MEP to set up tax-related information sharing platform, and MEP will support SAT in conducting tax audit for environmental protection tax (EPT) [See  KPMG China Tax Weekly Update (Issue 26, July 2017) for more details].

Furthermore, SAT and MEP on 31 July 2017 signed a cooperation memorandum on EPT collection. The memorandum clarifies that SAT and MEP will work together, inter alia, on the following:

• Publish the standards on EPT collection;
• Formulate EPT relief policy and its implementation rules; and 
• Set up tax collection system and tax-related information sharing platform.

22 August 2016, the Organisation for Economic Cooperation and Development (OECD) invited public comments on a discussion draft on tax measures to counteract branch mismatch structures. This is an extension of the work completed in 2013-2015 under Action 2 (Neutralising the Effects of Hybrid Mismatch Arrangements) of the BEPS Action Plan [See KPMG China Tax Weekly Update (Issue 33, August 2016) for more details].

On 27 July 2017, the OECD released the final report (2017 report) which sets out recommendations for branch mismatch rules that would bring the treatment of these structures into line with the treatment of hybrid mismatch arrangements as set out in the 2015 BEPS Action 2 Report. 

Branch mismatches arise where the ordinary rules for allocating income and expenditure between the branch and head office result in a portion of the net income of the taxpayer escaping the charge to taxation in both the branch and residence jurisdiction. Unlike hybrid mismatches, which result from conflicts in the legal treatment of entities or instruments, branch mismatches are the result of differences in the way the branch and head office account for a payment made by or to the branch. The 2017 report identifies five basic types of branch mismatch arrangements, including:

• Disregarded branch structures – arising where the branch is not within the definition of a permanent establishment and does not have any other taxable presence in a jurisdiction;
• Diverted branch payments – arising where a jurisdiction recognizes the existence of the branch but the payment made to the branch is attributed to the head office in that jurisdiction, while the jurisdiction of the head office exempts the payment from tax because it was made to the branch;
• Deemed branch payments – arising where the branch is deemed to make a notional payment resulting in mismatch in tax outcomes under the rules of the residence and branch jurisdictions;
• Double deduction branch payments – where the same items of expenditure creates a tax deduction under the laws of both jurisdictions; and 
• Imported branch mismatches – arising where the payee offsets income from a deductible payment against a deduction arising under a branch mismatch arrangement. 

This report includes specific recommendations for improvements to domestic law intended to reduce the frequency of branch mismatches. It also includes targeted branch mismatch rules which adjust the tax consequences in either the residence or branch jurisdiction in order to neutralise the hybrid mismatch without disturbing any of the other tax, commercial or regulatory outcomes. 

As a non-OECD member China’s tax authorities are not bound to follow the OECD recommendations for branch mismatch. The recommendations, however, may be referred to by China’s tax policymakers in the development of China’s domestic hybrid mismatch rules. It is understood that work on the Chinese domestic rules in this space is under way. There is anticipation that progress on these rules may be made by late 2017/early 2018.