Meaning
Standard tax audit procedures in China utilize a specialized examination to determine whether services or licensing arrangements billed to a domestic subsidiary were actually performed. This assessment, known as the authenticity test, requires the taxpayer to supply contemporaneous evidence of real, non-duplicative activities carried out by foreign affiliates. It governs outbound cross-border service transactions and royalty payments, drawing a firm line where physical or digital evidence of the service cannot be produced.
The evaluation halts when the taxpayer demonstrates a clear, verifiable chain of performance through operational records.
Regulatory Basis
Bulletin 16 of the State Taxation Administration establishes the operational framework for this specific scrutiny. Tax authorities use the measure to separate genuine commercial interactions from paper transactions engineered solely to shift profits out of the Chinese tax net. The audit process focuses on foreign parent companies that charge their Chinese subsidiaries for administrative overhead without performing specific, quantifiable tasks.
Legal compliance requires both formal service contracts and detailed activity logs.
Evidentiary Requirement
To satisfy the tax authority during an investigation, the taxpayer must present structured documents that detail the hours worked, the names of the executing employees, and the specific deliverables. These items include email chains, travel records, work schedules, and physical reports generated during the service period. An authenticity test fails automatically if the files presented are generic or if they do not match the timeline of the invoices.
Tax officers possess the authority to reject deductions if these items are missing or incomplete. Companies must establish global timesheet systems that track individual service tasks for their Chinese subsidiaries to prevent these documentation failures from occurring during an audit. This active tracking ensures that each invoice can be traced to a specific and verifiable task.
Operational Consequence
A negative result in this examination leads directly to the non-deductibility of the related service fees for corporate income tax purposes. The domestic subsidiary must then adjust its taxable income, which usually triggers additional tax liabilities and substantial penalties. This outcome also complicates future outbound remittance approvals with the State Administration of Foreign Exchange.
Multinational corporations operating in China must maintain detailed internal documentation systems to avoid these administrative and financial adjustments.
