China’s transfer pricing regime has experienced significant growth in the past few years and is in line with the OECD Guidelines. The enforcement of transfer pricing in China is regulated by the Corporate Income Tax (CIT) law and its Implementation Regulations (DIR), which encompass essential anti-avoidance concepts and transfer pricing guidelines. Transfer pricing refer to the prices of transactions between related or affiliated companies located in different countries. These transactions involve importing and exporting goods and services. China regulates transfer pricing through the State Administration of Taxation, requiring documentation to support arm’s length pricing.
Discover what transfer pricing means and how it can impact your business with this easy-to-read guide. Learn about the arm’s length principle, transfer pricing documentation, and related parties in China.
What is Transfer Pricing?
Transfer price is the price at which companies within the same multinational group, but located in different countries, buy and sell goods and services. For example, in the same multinational group, company A located in China is selling toys to company B in Japan, the selling price of this toy is the transfer price. This transaction involves importing goods from China to Japan within the same multinational group. By setting a transfer price for this transaction, Company A and Company B are able to distribute profits and expenses within the group and potentially reduce their overall tax liabilities. It is a critical issue for multinational companies operating in China due to the country’s significant foreign investment activity.
China’s transfer pricing regulations require companies to provide comprehensive documentation to support their transfer pricing arrangements. This documentation should demonstrate that the prices charged in related-party transactions are consistent with arm’s length prices (explained bellow). Compliance with China’s transfer pricing regulations is vital to avoid potential legal risks and penalties. With many multinational companies doing business in China, it’s important to ensure that transfer pricing between related parties adheres to Chinese tax regulations to avoid any negative impacts on your business.
What are the Transfer Pricing Regulations in China?
In China, transfer pricing regulations are governed by the State Administration of Taxation (SAT) and the Ministry of Finance (MOF). These regulations require companies to follow arm’s length principles when setting transfer prices for transactions between related parties in order to prevent tax avoidance. China’s transfer pricing rules are based on the OECD guidelines but also incorporate some unique provisions such as the use of a “comparable uncontrolled price” method for determining transfer prices and mandatory documentation requirements for related-party transactions. The regulations apply to both domestic and foreign-invested companies operating in China.
The Arm’s Length Principle
The OECD’s Base Erosion and Profit Shifting (BEPS) project includes the Arm’s Length Principle as a key element in transfer pricing. The arm’s length principle is a fundamental concept in transfer pricing regulations in China. It requires that transactions between related enterprises be conducted on the same terms and conditions as those between unrelated parties in similar transactions. This means that the price charged for goods or services transferred between related enterprises should be the same as what would be charged in a comparable transaction between unrelated parties. The arm’s length principle aims to ensure that profits are allocated fairly between different jurisdictions and that taxpayers do not artificially shift profits to jurisdictions with lower tax rates.
The related party in transfer pricing in China refers to any enterprise that has an associated relationship with another enterprise, organization, or individual, as defined by Chinese law. This includes situations where one party owns shares of the other party, a common third party owns shares of both parties or where there is a significant level of debt between the parties. The related party concept is important in transfer pricing because it affects the determination of arm’s length pricing between related entities.
- According to Notice 42, an enterprise is considered in a “related party relationship” with another enterprise, organization, or individual if one party directly or indirectly owns 25% or more shares of the other party, or if a common third party directly or indirectly owns 25% or more shares of both parties.
- Party A owns more than 25% of the shares or stock in Party B, either directly or through other entities such as subsidiaries or affiliates.
- a third party holds more than 25% of the equity interests in both Party A and Party B
Transfer Pricing Documentation
Chinese companies, including those with foreign investment, are obligated to file related party transactions. There are four types of transfer pricing documentation filing requirements in China, which include the master file, local file, special issue file, and country-by-country report (CbCR).
The master file is the primary transfer pricing documentation that provides detailed information on the transfer pricing policies and activities of larger multinational corporations. The Master File must comply with specific requirements to ensure accuracy and completeness.
The master file mainly includes the following information:
- The investment structure
- Description of the MNE’s business;
- Intangible assets
- Financing activities
- Financial and tax positions
The purpose of the local file is to demonstrate that the pricing of these transactions is consistent with the arm’s length principle and to provide the Chinese tax authorities with a clear understanding of the nature and scope of the transactions.
Local files mainly include the following information:
- Overview of the enterprise, providing information on its business activities, organizational structure, and financial performance.
- Related party relationships and transactions including the type of transaction, the nature of the products or services involved, and the amount of the transaction. It may also include a value chain analysis to provide a comprehensive view of the company’s operations.
- A comparability analysis is a critical component of the local file, which is used to demonstrate that the pricing of the intercompany transactions is in line with the arm’s length principle.
- Selection and application of transfer pricing method
Special Issue File
The special file is a supplementary document that provides additional information about the company’s transfer pricing arrangements and is designed to help tax authorities resolve transfer pricing disputes.It is used to provide additional information or analysis that is not covered in the master file or local file The contents and requirements of the special file are determined by the Chinese tax authorities and may vary depending on the circumstances of each case. The special file may include a detailed analysis of the company’s intangible assets, financial projections, pricing strategies, and any other relevant information not included in the master file or local file.
Chinese companies may be required to prepare Country-by-Country (CbC) Reporting if they meet certain criteria. CbC Reporting is a type of transfer pricing documentation that requires multinational enterprises to provide a breakdown of their global allocation of income, taxes, and other indicators of economic activity, broken down by country. In China, a Chinese resident enterprise may be required to prepare a CbC Report if it meets either of the following criteria:
1) It is the ultimate parent company of a multinational enterprise group with consolidated group revenue exceeding RMB 5.5 billion in the previous fiscal year; or
2) The holding group has appointed the Chinese company to serve as the reporting entity for Country-by-Country reporting.
It’s worth noting that the CbC Reporting requirements in China may be subject to change, and companies should keep themselves informed of any updates or changes in the regulations to ensure compliance.
What are the Common Transfer Pricing Methods?
In each situation, the pricing method that offers the most dependable measure of an arm’s length outcome should be chosen. In accordance with Chinese regulations, the following transfer pricing methods can be accepted by tax authorities:
- Comparable uncontrolled price method
- Resale price method.
- Cost plus method.
- Transactional net margin method.
- Profit split method
Chinese transfer pricing regulations do not specify a preference order for selecting an appropriate transfer pricing method, and alternative methods can be used if they are consistent with the arm’s length principle.
What is the Penalty for Transfer Pricing Violation
In the event of a company’s failure to prepare or submit Annual Related Party Transactions Reporting Forms or transfer pricing documentation, or providing false or misleading information, the tax authority reserves the right to impose a penalty ranging from RMB 2,000 to RMB 10,000. Failure to comply with transfer pricing regulations may result in special investigations by tax authorities, which could lead to special tax adjustments.
The tax authority may also charge an additional 5% interest on top of the lending rate published by the Bank of China, and a penalty interest charge may be applied on any of the penalties and interest charges mentioned are also in line with the guidelines provided by the State Administration of Taxation (SAT). However, companies should always check for any updates or changes in the regulations to ensure compliance with company transaction amount that exceeds the threshold for document preparation.
|In 2014, GlaxoSmithKline, a British pharmaceutical company, was fined approximately $500 million in China for tax evasion and bribery. The company was accused of inflating the cost of its drugs in China through transfer pricing, which resulted in a reduction of taxable income. Additionally, the Chinese government claimed that the company had bribed doctors to prescribe its drugs. This case is known as one of the biggest penalties for transfer pricing in China. The GlaxoSmithKline case serves as a critical example of the severe consequences that can result from noncompliance with China’s transfer pricing regulations
Best Practices for Compliance with China’s Transfer Pricing Regulations
Here are some best practices for compliance with China’s transfer pricing regulations:
1. Conduct regular transfer pricing reviews: Companies should regularly review their transfer pricing policies and practices to ensure compliance with Chinese regulations.
2. Keep contemporaneous documentation: Documentation must be kept for all related party transactions to support the pricing of such transactions. Documentation should be prepared contemporaneously (i.e., at the time of the transaction) and should include relevant financial and business data, analysis of comparable transactions, and any other relevant information.
3. Use appropriate transfer pricing methods: Companies should select and apply appropriate transfer pricing methods that are consistent with Chinese regulations and are based on relevant data and analysis.
4. Be aware of associated enterprise relationships: Companies should identify and understand the scope of associated enterprise relationships, including entities that have significant control over the taxpayer’s senior management, purchases, sales, production, and intangible assets.
5. Consider advance pricing agreements (APAs): Companies may consider entering into APAs with the Chinese tax authorities to establish certainty regarding transfer pricing policies and practices.
6. Understand the country-by-country reporting requirements: Multinational groups with consolidated annual revenue exceeding a threshold amount are required to file a country-by-country report in China. Companies should understand the reporting requirements and ensure compliance.
7. Seek professional advice: Companies may benefit from seeking professional advice from transfer pricing experts and tax advisors to ensure compliance with Chinese regulations and to mitigate transfer pricing risks.
The Connection Between Transfer Prices in China and Import/Export Activities
The transfer price in China is related to both imports and exports. When goods are imported into China, the transfer price determines the customs value and thus the amount of customs duty payable. When goods are exported from China, the transfer price determines the taxable income and the amount of corporate income tax payable by the exporting company. The transfer price, therefore, plays an important role in the overall tax liability of companies involved in cross-border trade with China.
How FDI China Can Help?
The Chinese government places significant emphasis on transfer pricing, as evidenced by its heightened scrutiny and enforcement activities in recent years, along with high-profile cases of noncompliance resulting in substantial fines and penalties. Don’t hesitate to get in touch with us for the transfer pricing process today to see how we can help your business succeed.
In China, there are rules for transfer pricing which means determining the prices for transactions between related parties. A related party can be a company that has significant control over another company’s management, purchases, sales, production, and intellectual property. To determine fair prices, accepted methods like comparing to similar transactions, adding a profit margin, or sharing profits are used. Documentation must be kept and filed, and if a company is part of a large group, it needs to report its profits in different countries. If a company follows the rules and reports correctly, they can get permission from the government on the prices they use for related-party transactions. These rules apply to individual taxpayers too.
Q: Can documentation be filed in a language other than the local language?
A: No. The document can only be filed in Chinese.
Q: In China, is there a specific timeframe within which a taxpayer is required to submit their Transfer pricing documentation when requested by the tax authority? If yes, what is the duration of the timeframe?
A: The normal deadline for annual tax declaration is the end of May. Upon receipt, of the declaration (may be earlier than the end of May), the tax office will review and notify the entity to prepare TP documentation if required
Q: Does the revenue authority in China require taxpayers to submit disclosures related to transfer pricing on an annual basis, such as with the income tax return?
A: Yes, the revenue authority in China requires taxpayers to submit disclosures related to transfer pricing on an annual basis.