Earlier this year, the State Administration of Taxation promulgated the much-anticipated transfer pricing measures detailing the administrative rules for all special tax adjustments. These special tax adjustments, including cost sharing, thin capitalization, anti-avoidance and transfer pricing documentation requirements, were first outlined in Chapter 6 of China's Corporate Income Tax Law.
The new measures, which take effect retroactively from January 1, 2008, are divided into seven chapters: general provisions, reporting related party transactions, the administration of contemporaneous documentation, transfer pricing methods, transfer pricing investigations and adjustments, the administration of advanced pricing arrangements and the administration of cost sharing agreements.
The measures are intended to ensure high standards and consistency throughout the various local tax bureaus in China, making the administration and enforcement of transfer pricing-related issues uniform. The new rules will act as a foundation for future policy changes to China's transfer pricing regime.
Related party transactions
Nine different forms may now need to be filed, including:
Related party relationships
Summary of related party transactions
Purchases and sales
Foreign investment status and
The implementation measures state that in addition to resident enterprises in China, foreign companies with an establishment or place of business in China who file corporate income tax returns in China must also file these required documents.
Transfer pricing documentation
Enterprises with business in China must have relevant transfer pricing documentation or face an additional interest levy of 5 percent on any transfer pricing adjustments. There are 26 specific items of documentation needed, which break down into five basic categories:
Description of business operations
Description of related party transactions
Comparability analysis and
Selection and application of transfer pricing method
Companies that fail to submit this documentation could see the Chinese tax authorities determine what their taxable income is and assess a 5-percent penalty in addition to the normal People's Bank of China lending rate as part of an interest levy in addition to any fines.
There are some exemptions from this requirement for certain enterprises, and small taxpayers with limited related party dealings could qualify for this.
Transfer pricing methods
The implementation measures list six "appropriate methods" for transfer pricing:
Comparable uncontrolled price method
Resale price method
Cost plus method
Transactional net margin method
Profit split method and
Other methods consistent with the arm's length principle
When choosing a method, companies will need to take into account the characteristics of the assets or services involved in the transaction, the functions and risks of each transactional party, the terms of the contract, the economic circumstances and their business strategies.
The authorities will investigate companies that tend to have the following characteristics: significant amounts or numerous types of related party transactions; long-term losses, low profitability, or fluctuating patterns of profit and loss; below average profitability than industry standards or profits that do not match the company's functions; business dealings with companies established in tax havens; absent or incomplete transfer pricing documentation; obvious violations of the arm's length principle.
According to the implementation measures, no transfer pricing adjustment will be made to related party transactions between domestic related parties that had the same effective tax burden.
Other points of interest
The new implementation measures also provide administrative guidance on debt-to-equity ratios pertaining to the thin capitalization rules, further clarify how the Chinese tax authorities will undertake anti-avoidance investigations, detail the legal liabilities for failure to submit transfer pricing documentation and include a supplementary provision extending to December 31, 2009, the date for completion of transfer pricing documentation for 2008 (related party transaction disclosure forms for 2008 still need to be filed by May 31, 2009).
The author is the Senior Legal Associate of Dezan Shira & Associates Beijing Office (www.dezshira.com)