China: Peculiarities necessitate a Transfer Pricing treatment

China’s colossal economy as well as its predominant role within the global market, result in the emergence of an increasing interest towards China Transfer Pricing (TP) Law matters. Since China is not a member of the OECD, any TP endeavor goes far beyond the classic TP practices, though.

More precisely, chinese legal framework comprises a part of OECD guidelines and a part of autonomous rules. Therefore, TP approaches China necessitate extra study and expertise into the realm of transfer pricing. Chinese tax authorities have used their own interpretation regarding several aspects and requirements on Transfer Pricing. The general impression considers that e.g. the sheer size of the Chinese market, the vast array of workers and production opportunities should provide more functions to the Chinese entity and therefore more profit count for the local enterprise. This insight – among others – is crucial for your company’s TP compliance. Industry experts deem that in 2019 and foremost in 2020 the adoption of TP policies will be extended to medium sized companies.

While this article aims at providing a first look into those who are potentially affected by Transfer Pricing Regulations, it is imperative that a case by case analysis be conducted by upon request. Given that there are only narrow levels of tax appeal in China, most taxpayers would rather avoid a tax dispute. Preventive action seems to be the key.

who, What & When

For the purposes of a quick briefing on the issue, an insight on Bulletin 42 [“Bulletin Gonggao 2016”] released by the SAT is necessary. This Bulletin constitutes the last ruling of China transfer pricing compliance requirements.

Under the Bulletin, any company that engages in a cross-border controlled transaction involving China, shall comply with the TP legislation. So, there are definite criteria to determine a “related” party to another. Indicatively, we talk about a related party transaction when:

(i) A share control is affirmed (direct, i.e. owning 25% or more of the shares of the other enterprise or indirect, i.e. a third party directly or indirectly owns 25% or more of the shares of both). Shares belonging to shareholders who are relatives to each other, are accumulated for the purposes of this test.

(ii) More than half of the board members or senior management of one enterprise are appointed or delegated by the other enterprise or such personnel of one enterprise simultaneously act as board members or senior management of the other enterprise or such personnel of both enterprises are appointed by a third party.

(iii) A catch-all provision also provides for a related party relationship, “when the two parties have other common interests in substance”.

One could possibly fall into the scope of TP legislation, even seemingly “compliance-free”. Therefore, the need for expert advice, even when in doubt, is of tremendously intense.

Compliance requirements

Once someone falls within the TP legislation, the next step is to make certain that he complies to the rules. Chinese TP legal framework, adopts the following documentation structure:

i) Α Country-by-Country (CbC) Report

MNEs report annually (for each tax jurisdiction in which they do business) some crucial information such as:

  • information on their global allocation of profit,
  • taxes paid,
  • borrowings,
  • employees and
  • certain indicators of economic activity among the countries in which they operate.

Moreover, a CbC Report is required if a Chinese resident company is the ultimate holding company of the group and the consolidated revenue is over 5.5 billion RMB. The same requirement is effective if this company is the “reporting entity” of the Group. Taxpayers should state in the master file which entity within the group should prepare and file the CbC Report. The liable entities prepare and submit the CbC Report by 31 May of the following year.

ii) Annual Reporting Forms for Related-Party Transactions (RPT Forms)

These forms include certain information so as for some general extended disclosure requirements to be satisfied. For instance, the disclosure of segmented financial results from overseas and domestic related party transaction is required.

iii) Transfer Pricing Documentation

The TP documentation focuses on the completion of:

  • A Master File, providing an overall description of the MNE’s global business. Bulletin 42 requests more detailed information than stipulated by BEPS Action 13 (such as details on industrial structure adjustments, and information on the main functions, risks, assets and personnel of the group’s major R&D facilities). 1 billion RMB constitutes the lower threshold for the annual related party transactions. Alternatively, the tax authoroty examines if the ultimate holding company of the MNE group has prepared a master file.
  • A Local File contains the calculation process of the service fee and a detailed benefit test from the service recipient perspective. Each Chinese subsidiary (or permanent establishment) that has related party transactions in excess of certain thresholds has to prepare and maintain a Local File. The above said thresholds are met when:
    • the tangible asset transfers exceed 200 million RMB;
    • the financial asset transfers exceed 100 million RMB and the intangible asset transfers exceed 100 million RMB or
    • the aggregate amount of other related party transactions exceeds 40 million RMB (including service transactions, intangibles licensing, tangible property rentals and interest on loans).
  • A Special Issue File, as bulletin 42 also provides documentation requirements for “special item files”. This requirement applies for taxpayers who enter into cost sharing arrangements or fall under thin capitalization rules. This special item file contains more particular information.

Liable entities shall complete the Local and Special Issue File by 30 June for controlled transactions executed during the previous year. Moreover, companies shall prepare the Master File within 12 months after the end of the reporting year of the group’s ultimate holding company. Taxpayers should submit a transfer pricing report within 30 days when requested by SAT.

As is the case globally, Arm’s Length Principle (ALP) serves as the cornerstone for TP purposes. However, the SAT seems open to other transfer pricing methods, in addition to the already accepted OECD methods. So as for two transactions to move on to the stage of the transfer pricing method, they have to be comparable in the first place, though. Finding comparable transactions can be a very delicate task as they do govern the procedure until the end. Of course, our multi-faceted experience can be of your aid here.

Penalties for non compliance

Companies affected by TP regulations in 2018 should prepare and – upon request – submit contemporaneous documentation for each tax year. In order to meet these requirements, the taxpayer must provide it to tax authorities within 30 days of the request.

If an enterprise fails to provide contemporaneous documentation, the tax authorities have the right to impose penalties (including fines between 2.000-10.000 RMB). The tax auditors “deem” taxable income based on their own calculations without the need to rely on specified transfer pricing methodologies.

What is more & How we can help

Advance Pricing Agreements (APAs) are available in China under some conditions. In more detail, as applicant’s related party transaction volume exceeds 40 million RMB for each of the past three years.

We can help you prepare and apply for APAs during and after negotiation and agreement with the tax authorities. For example, we can help you:

  • select appropriate transfer pricing methodologies and critical assumptions;
  • prepare supporting documentation for the APA application;
  • negotiate with the tax authorities, and
  • prepare annual reports during the APA’s implementation period.

In broad terms, complying with TP regulation in China could emerge with the preparation of a preliminary study. This study contributes to assess the intragroup margins in the provision of products or services. So, a competent TP analyst may use benchmarking data from reliable databases to facilitate managerial decisions.

Due to the local-favored TP legislation in China, outbound payments from the local entity are generally not deductible. In any case the tax authority deeply scrutinizes payments that include management fees, interest, technical consulting and royalties. Even if these services are not overpriced, the companies shall conduct a special full TP study. This documentation assists to assure TP compliance, mitigate potential risks and avoid any unwanted implications.


As an effort to tackle tax base erosion and profit shifting, China tax authorities have been focusing on transfer pricing administration. In this context, SAT enforces stringent local-flavored TP regulations, imposes detailed compliance requirements and invokes scrutiny on related party transactions.

Even the slightest differentiation from the general guidelines – like those of OECD – necessitate considerable attention to the detail. So the final result will be impeccable and in line with the “sui generis” Chinese rules. At this point, we should highlight the fact that, when in doubt, TAP seems to publish negative decisions.

From the question whether a company falls into the scope of TP rules and a full TP study, until the preparation for an APA agreement, peculiarities of the Chinese TP legal framework, render the provision of specialized TP services absolutely necessary.

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