Efficient distribution of offshore services

published on 20 March 2025 | reading time approx. 3 minutes

A significant number of multinational groups will consider group centralized service fees allocation to their beneficiary subsidiaries globally, including Chinese ones. These service fees are usually allocated on the basis of group framework contracts in large amounts and cover different types of centralized service categories in practice. Therefore, in Chinese tax compliance practice, many financial personal of group headquarters and Chinese subsidiaries may be confused in self-assessment of these group service fees for tax filing purposes in China.

In practice, intra-group service fees are indeed subject to the strict scrutiny of the Chinese tax authorities. While offshore service fees are usually provided through hotlines, electronic transmission or other means as the service providers do not need to travel to China for service provision onsite, this type of service itself imposes higher requirements on taxpayers in terms of verifying the authenticity and benefit of the transaction.

Generally speaking, a related party service transaction that complies with the arm's length principle should be a beneficial transaction that brings direct or indirect economic benefits to the service recipient. For non-beneficial services provided, Chinese tax authorities can reject the deduction of such service fees in the calculation of Corporate Income Tax of the Chinese subsidiary. Therefore, how to prove the reasonableness and economic benefit of the related party's service fee is a key point in tax compliance filing.

Group centralized service fee is usually based on cost-effective considerations to centralize a part of the functions in the headquarters or other intra-group share service centers, in order to centralize professionals to provide the subsidiaries with functions that cannot be sourced locally, and charge the service fee in accordance with a reasonable basis. In practice, it is commonly seen with centralized functions for global customers or vendors support, centralized IT services, quality control, technical support, and other service functions. If the function itself is more a shareholders' activity such as centralized financial controlling and budgeting, cost allocation of the group management etc., it is very likely to be regarded as management fee which are not allowed to be deducted.

The following points are particularly important in the preparation of supporting documentation:

Substantial description of services nature, especially for the necessity of offshore services.
A description of the calculation basis of the service fee and allocation keys determination.
A complete list of service personnel and details of specific services (e.g. timesheet or task list, etc.). Here special attention on whether the personnel on the list have also provided onsite services to Chinese subsidiaries in the same calendar year, and whether they are high management personnels (CEO, CFO etc.) of the group, as the latter may trigger suspicion of management fee allocation.

In practice, many group services are centralized purchased from third parties and then allocated to the respective beneficiary subsidiaries. Such services usually can be considered as reasonably allocation. However, a case-by-case analysis of the pricing method and the availability of sufficient documentation such as invoices of third-party procurement contracts are required to support the authenticity of such services.

There are two typical scenarios of unfavorable tax compliance assessment that are easily overlooked in daily business operations:

The financial personal of the Chinese subsidiaries are not clear about the substance of the offshore services and how and by whom they were provided. As a result, when first challenged by the tax authorities, they are unable to provide any credible explanations and supporting materials other than the broad English framework contracts and pro forma invoices, which will lead to a negative impact on the tax authority's determination.
China's subsidiaries have suffered continuous losses but the self-assessment explanation for defending the reasonableness of the services fails emphasize the value of the services allocated and the outlook for future benefit to the company in order to prove that the loss is not directly related to the offshore service allocation.

Offshore centralized services usually include complex types of service categories, and therefore it is essential to have adequate communication and coordination between group HQ and subsidiaries, prepare sufficient and high-quality internal documents to prove the substance and benefits. When necessary, it is suggested to consider consulting tax experts for tax compliance especially in the event of large transaction amounts and complexity of services categories which are difficult to perform self-assessment sufficiently.

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