(b) The STP group has two companies in China, one in Shanghai and another one in Guangxi. The Shanghai company pays enterprise income tax (EIT) at 25%, while the Guangxi company enjoys the tax incentives and only pays EIT at 15%.
A consultant has proposed the following scheme as a way in which the STP group can pay less tax in China. Under the scheme, the Guangxi company would borrow RMB10 million from the bank at the market interest rate of 8% per annum. The Guangxi company would then lend RMB10 million to the Shanghai company at an interest rate of 30% per annum. As a result, the STP group would effectively shift the profit to a lower tax region.
Required:
State, giving reasons, why the proposed scheme would not reduce the enterprise income tax (EIT) payable by the STP group.
The interest payable by the Shanghai company to the Guangxi company should be determined on an arm’s length basis. Where this is not the case, the tax authority can disallow a deduction of interest to the Shanghai company in excess of the market interest rate of 8% per annum, while the Guangxi company will still have to pay enterprise income tax on the total interest income received at 30% per annum.
State any two other taxes which the STP group will need to pay (in addition to EIT) if it executes the consultant’s scheme.
The other taxes which the STP group will pay are:
– Business tax
– City maintenance and construction tax
– Education levy
– Stamp duty