New documents will be required for Transfer Pricing in China

New documents will be required for Transfer Pricing in China


From our branch IC&Partners Asia

Transfer pricing is a complex phenomenon which governs the economic relations existing between companies based in different states but that are part of the same group. In order to avoid that taxable value moves from a country to another by changing the value of transactions between intra-group companies, every state adopted specific laws to ensure that intercompany transactions are carried out respecting the principle of free competition.


As regards Italy, the transfer pricing is ruled by Article 110 and Article 9 of the Italian Income Tax Law (TUIR), where the subjective and objective conditions under which it is possible to have a transfer pricing adjustment for intra-group transactions are listed.


In China, the rule (Guo Shui Fa [2009] No. 2) about transfer pricing issued on January 2009, introduced for the first time the obligation for the taxpayers to create and maintain a detailed documentation related to transfer pricing transactions in order to prove that these intra-group transactions respected the principle of free competition.


The companies (both Chinese resident companies and non-Chinese resident enterprises with establishments in China) that had intra-group transactions must prepare an annual disclosure report on related-party transactions to be submitted with annual income tax filing by 31 May of the following year.


The documentation related to intra-group transactions must be fully translated into Chinese language, kept for a period of 10 years and provided to Chinese authorities within 20 days from their request.


Generally, enterprises with more than 25% of direct or indirect ownership relationship are defined as related parties and subject to the transfer pricing rules.


However, Chinese companies are exempted to prepare the transfer price documentation when the amount of intra-group transactions related to tangible goods is less than 200 million RMB and intra-group transactions related to intangible goods is less than 40 million RMB.


Furthermore, the transfer price documentation is not required if an Advance Pricing Arrangement (APA) is in place or the foreign shareholding of the enterprise is below 50% and the enterprise has only domestic related-party transactions.


The Advance Pricing Arrangement (APA) is an effective tool in order to avoid potential disputes with the Chinese Tax Administration (procedures and details are in the APA in the Circular Guo Shui Fa [2004] No. 118):  APA is an agreement between the Tax Administration and the taxpayer to determine the criteria for calculating the right price to intra-group transactions.


The main criteria to determine the price between the affiliated parties is the Comparable Uncontrolled Price method (CUP), according to the OECD Guidelines: “when conditions are made or imposed between (…) two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly”.


The Chinese rules related to the phenomenon of transfer pricing should be considered together with Article 47 of Enterprise Income Tax Law according which the transactions between companies without any reasonable business purpose that lead to the reduction of taxable income may be adjusted by the Chinese tax authorities according reasonable criteria.


Furthermore, in September 2015, the Chinese State Administration of Taxation published a draft of reform concerning the transfer pricing, which refers to the OECD’s program called “Base Erosion and Profit Shifting” that aims to limit the transfer of profits from high-tax countries to countries with no taxation or low taxation.


This new regulation will provide for Chinese companies additional tasks and more complex documentation in order to easily identify the areas with risk of tax evasion and appropriately address the control activities.


In particular there will be the obligation to prepare the following three documents:

– the Master File that must specify the transfer pricing policies and the agreements between the companies of the group;

– the Local File that must report specific information about the intra-group transactions of Chinese companies;

– the Country-by-Country Report that must have a series of information related to the global allocation of income, about the taxes paid in each country where the group has business, and certain economic indicators that will allow the Tax authority to evaluate any risk related to transfer pricing.


In particular, the Country-by-Country Report must be prepared by the parent company of a multinational with a consolidated turnover of more than 5 billion RMB in the last fiscal year (if the parent company is a foreign company, the Country-by- Country Report must be filed with the tax authorities of the country where the parent company has its headquarters and the relevant information can be requested by the Chinese authorities).


It is expected that the final approval of this reform will be by the end of 2016; therefore, it is important that Chinese companies become aware how to  fulfill their obligations under the new regulation about transfer pricing.