Taxing authority and tax law
Tax authority: State Administration of Taxation (SAT)
Tax law:
- People’s Republic of China (PRC) Corporate Income Tax Law, Chapter 6, Articles 41–48
- PRC Corporate Income Tax Law Implementation Regulations, Articles 109–123
Relevant regulations and rulings
- Notice Containing Related Party Transaction Annual Reporting Forms (Guoshuifa (2008) No. 114)
- Implementation Measures for Special Tax Adjustments (Guoshuifa (2009) No. 2)
- Notice on the Tax Deductibility of Interest Expense Paid to Related Parties (Caishui (2008) No. 121)
- Notice on the Strengthening, the Monitoring and Investigation of Cross-border Related Party Transactions [for Single Function Entities] (Guoshuihan (2009) No. 363)
- Notice on Intensifying the Transfer Pricing Follow-up Administration (Guoshuihan (2009) No. 188)
OECD guidelines treatment
In principle, the tax authority recognizes the OECD guidelines and the relevant transfer pricing methods.
Priorities/pricing methods
The tax authority accepts a reasonable method. The tax authority will accept CUP, Resale Price and Cost Plus. Other methods, including the Profit Split, and the Transactional Net Margin Method (TNMM), are also considered. For the TNMM, the profit level indicators most often used are operating margin and total cost markup. Balance sheet profit level indicators such as return on assets or return on capital employed are rarely used.
Transfer pricing penalties
Article 48 of the PRC Corporate Income Tax Law stipulates that interest will be applied to the under-reported tax resulting from special adjustments to tax payments, including transfer pricing adjustments. Article 122 of the PRC Corporate Income Tax Law Implementation Regulations references Article 48 and states that interest imposed on special tax adjustments is based on the base renminbi (RMB) lending rate published by the People’s Bank of China plus an additional 5% interest charge.
Additionally, per Article 106 of Guoshuifa (2009) No. 2, taxpayers that refuse to provide contemporaneous documentation or those that refuse to file, file false information, and/or file incomplete related-party reporting forms are subject to monetary penalties pursuant to Article 70 of the PRC Tax Collection and Administration Law and Article 96 of the PRC Tax Collection and Administration Law Implementation Regulations, as well as Article 44 of the PRC Corporate Income Tax Law and Article 115 of PRC Corporate Income Tax Law Implementation Regulations.
Penalty relief
According to Article 122 of PRC Corporate Income Tax Law Implementation Regulations, the additional 5% interest charge (applied on the basis of Article 48 of the PRC Corporate Income Tax Law) can be avoided if contemporaneous documentation has been prepared in accordance with the relevant law and regulations and can be provided within 20 days from the day of a request.
Documentation requirements
The PRC Corporate Income Tax Law and the PRC Enterprise Income Tax Law Implementation Regulations imply that taxpayers are expected to maintain contemporaneous transfer pricing documentation. Articles 13 through 20 of Guoshuifa (2009) No. 2 formally introduce and clarify China’s contemporaneous transfer pricing documentation requirements.
Article 14 of Guoshuifa (2009) No. 2 specifies five primary components of China’s contemporaneous documentation:
- Organization structure
- Information of business operations
- Information of related-party transactions
- Comparability analysis
- Selection and application of transfer pricing methods
Article 15 states that certain enterprises can be exempted from the preparation, maintenance, and provision of contemporaneous documentation:
- Those conducting RMB200m or fewer in annual related-party purchase and sale transactions and RMB40m or fewer in annual related-party “other” transactions (intangibles, services, and interest from financing transactions)
- Those with transactions covered by an advance pricing arrangement (APA)
- Those with a 50% or less share of foreign ownership that only conduct related-party transactions within China
Documentation deadlines
Article 16 of Guoshuifa (2009) No. 2 specifies that taxpayers should finish the preparation of contemporaneous documentation on or before 31 May of the following year and that all documentation should be submitted to tax authorities within 20 days of a request.
Statute of limitations on transfer pricing assessments
The statute of limitations for transfer pricing adjustments may vary; however, adjustments can be applied for a period of up to 10 years.
Article 20 of Guoshuifa (2009) No. 2 states that contemporaneous documentation should be maintained for a period of 10 years (starting from 1 June of the year following the transactions).
Return disclosures/related-party disclosures
Article 43 of the Corporate Income Tax Law and Guoshuifa (2008) No. 114 requires that taxpayers complete and submit nine comprehensive Related Party Transaction Annual Reporting Forms along with their annual tax filing. Per Article 16 of Guoshuifa (2009) No. 2, these forms must be submitted on or before 31 May following the fiscal year, including related-party transactions conducted during fiscal year 2008 (i.e., Related Party Transaction Annual Reporting Forms for fiscal year 2008 are due on or before 31 May 2009).
Audit risk/transfer pricing scrutiny
The risk of transfer pricing issues being reviewed under audit is high.
In 2009, 179 new transfer pricing audits were initiated and 167 cases were closed. Taxable incomes were adjusted by an aggregate of RMB16.09b during 2009 — a significant increase from the approximate RMB8.2b adjusted in 2008, RMB9b adjusted in 2007 and RMB5.9b adjusted in 2006.
The tax authority continues to focus on enterprises that have sustained losses in the past, especially those paying intercompany service charges or royalties. With the release of China’s final implementation rules contained within Guoshuifa (2009) No. 2, we believe there will be an increase in transfer pricing audit activity in the coming years.
Within Guoshuihan (2009) No. 363, the tax authority also reiterated its position that “single-function” entities should not be subjected to losses. Any such “single-function” entity that generates losses is required to prepare and submit contemporaneous documentation, regardless of its quantum of related party transactions.
Additionally, Guoshuihan (2010) No. 323 spells out the tax authority’s expectations that each of China’s local tax bureaus is to prepare a list of taxpayers required to prepare contemporaneous documentation, the names of the companies for which documentation was reviewed, and comments on the quality and completeness of each of the reviewed report, covering all taxpayers except for 45 enterprises directly managed by the tax authority’s Large Enterprise Taxation Department.
APA opportunity
APAs are available in China. Guidance regarding the APA process and procedures is provided in Articles 46 through 63 of Guoshuifa (2009) No. 2.
The validity of an APA is generally between three and five years. Enterprises no longer need to have ten years of operating history before applying for an APA and the ban on enterprises with major tax evasion history has been lifted as well. Annual related-party transaction volumes must only be greater than or equal to RMB40m, rather than the previously required RMB100m. Applications for APAs involving more than one in-charge province can be submitted directly to the tax authority in Beijing.
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