State Taxation Administration Announcement Sixteen Outbound Payment Benefit Test Compliance
Outbound payments to overseas affiliates require direct economic benefit proof to survive Chinese enterprise income tax disallowance under Public Notice 16.
DEMPE Principles
Meaning
Intangible asset valuation methodologies focus on the specific functions of development, enhancement, maintenance, protection, and exploitation to determine the appropriate allocation of profit. These dempe principles govern the assessment of which entity in a multinational group truly owns the economic rights to a trademark, patent or proprietary technology. The analysis stops applying to tangible goods where the value is derived purely from physical manufacturing rather than intellectual property.
It prevents the mere legal owner of an asset from claiming all the associated profits when the actual work to improve the asset is done by another subsidiary. Tax authorities use this framework to align the taxation of intellectual property income with the location of the people and activities that create the value.
Functional Assessment
The evaluation of who performs the work is the most important part of determining where the royalty payments should be taxed. Under the dempe principles, the entity that manages the research and development budget or makes the key decisions on asset protection is viewed as the economic owner. This means that a shell company in a low-tax jurisdiction cannot claim the profits of a patent if the engineering and legal work happened in China.
The tax bureau looks for evidence of control over the risks associated with the asset, such as the power to hire or fire the staff managing the technology. If the Chinese subsidiary performs the enhancement or maintenance functions, it must be compensated with a share of the global royalty income. This approach ensures that the profit follows the function rather than the legal contract.
Value Attribution
Profit allocation must reflect the relative contribution of each entity to the total value of the intangible asset over its entire lifecycle. The dempe principles require a detailed breakdown of the costs and risks borne by each affiliate in the group. If the legal owner only provides the funding but does not manage the asset, its return is limited to a simple risk-free financing rate.
The residual profit, which is the majority of the income, is then distributed to the entities that perform the development and exploitation functions. This attribution process involves comparing the intercompany agreements against the actual behavior of the employees on the ground. When the behavior does not match the contract, the tax authorities will ignore the contract and tax the profit based on the economic reality.
This mechanism protects the Chinese tax base from being eroded by offshore intellectual property holding companies.
Jurisdictional Evidence
Companies must maintain a clear trail of documentation to prove where the five dempe functions are actually carried out. These dempe principles are integrated into the local transfer pricing files that large taxpayers must submit to the State Administration of Taxation. The evidence includes employee job descriptions, internal emails regarding project management and records of who authorized the research expenditures.
If a company cannot demonstrate that it has the technical capability to manage the intangible asset, the tax bureau will reject its claim to the profits. This requirement forces multinational groups to be more transparent about their internal operations and to ensure that their offshore hubs have genuine substance. The boundary of this principle is that it does not apply to assets that are fully developed and require no further maintenance or protection.
However, most modern technologies are in a constant state of enhancement, making this analysis relevant for almost all high-tech businesses. The principles remain the global standard for preventing the artificial shifting of intellectual property income.