Recent transfer pricing developments

In addition to focusing on traditional inter-company buy-sell transactions, the SAT now expands its focus to intra-group share transfers, intangible assets transfers and financing arrangements.

The SAT is also paying greater attention to cost-sharing arrangements, general anti-avoidance regimes and tax planning schemes involving overseas cost allocation and the use of intermediate holding structures and tax havens.

Focus on loss companies with single/routine function

The issuance of Guoshuihan (2009) No.363 in July 2009 requires all loss companies with limited functions and risks to prepare and submit contemporaneous transfer pricing documentation (CTPD), regardless of whether the amount of related party transactions exceeds the statutory thresholds. The SAT re-emphasised that single/routine function entities should not have losses. It has expanded its focus on simple function manufacturers and contract R&D service providers.

Focus on domestic companies other than foreign investment enterprises (FIEs)

As outbound investments are encouraged, the SAT is now paying more attention to domestic companies, especially those with overseas business operations.

Strengthening of tax audits and investigation teams

The SAT issued Guoshuifa (2009) No.85 to provide guidance to local tax bureaus on how to strengthen tax collection administration and anti-avoidance investigation. The SAT requires local tax bureaus to build up transfer pricing audit resources to undertake fieldwork, and to negotiate with taxpayers during tax audits and investigations. It is expected that audit activity in China will increase in the near future.

Based on experience, local tax bureaus invite taxpayers for discussion and require taxpayers to adjust their operating results to the median of the inter-quartile range adopted in their CTPD, even where the actual results are within the range but below the median. In some cases, taxpayers were requested to follow the results of the transfer pricing study conducted by the local tax bureaus.

The PRC tax authorities have become more aggressive and more sophisticated around issues such as location savings, market premium or local marketing intangibles, etc. As a result, when applying an appropriate transfer pricing methodology, the PRC tax authorities tend to rely less on transactional net margin method (TNMM), which is commonly adopted by the taxpayers in conducting their transfer pricing study, but rather exploring the applicability of other methods such as profit split.

Corresponding adjustments under the Mutual Agreement Procedure (MAP)

Corresponding adjustments should be allowed in the case of a transfer pricing adjustment to avoid double taxation in China. Taxpayers from treaty countries of China facing transfer pricing audits and adjustments should take the MAP into consideration when making their dispute resolution strategies with the PRC tax authorities. Application for the initiation of the MAP should be submitted to both the SAT and the local tax authorities simultaneously.

However, corresponding adjustments are not available in cases of income taxes assessed on deemed dividends that result from non-deductible interest expenses under the thin capitalisation rules.

Advance Pricing Arrangement (APA)

APA has become more popular in China as a way of seeking protection and obtaining certainty. The SAT issued the first “China APA Annual Report 2009” on December 30 2010.

The report provides official statistics on both in-progress and completed APA cases for the period from January 1 2005 to December 31 2009. It discloses the increasing trend of multinational corporations seeking bilateral APAs to secure certainty on transfer pricing issues and to mitigate double taxation risk.

Catherine Tse, Director, Mazars, Hong Kong