China tax advisory for foreign-invested companies

Overview: Transfer Pricing in China

Transfer pricing in China is regulated by Article 13 of the Income Tax Law for Foreign Investment Enterprises and Foreign Enterprises, and Article 24 of the Law Concerning the Administration of Tax Collection.  These regulations, initially introduced in 1991 to attract foreign investment, have been strengthened through subsequent rulings issued by the State Administration of Taxation (SAT).  China’s transfer pricing regime, drawing on international best practices like those from the OECD and US, mandates that transactions between a multinational’s headquarters (or related parties) and its Chinese subsidiary adhere to the arm’s-length principle.  Entities are considered associated based on either ownership (at least 25% shareholding, loans comprising at least 50% of owner’s capital, or loan guarantees of at least 10% of total loans) or control (legal representative or over half of directors/management appointed by another organization, operational dependence on another’s proprietary technology, or control over raw material purchases/product sales).  Once deemed associated, companies must classify and price all inter-entity transactions – involving tangible and intangible assets, as well as services – according to the arm’s-length principle.

China TP Compliance at a Glance

Transfer Pricing Methods in China

• CUP — Comparable Uncontrolled Price
• Resale Price Method
• Cost-Plus Method
• Comparable Profits Method
• Profit Split Method
• Global Profit Allocation
• TNMM — Transactional Net Margin Method (frequently used in China)

China’s transfer pricing regulations offer several methods for pricing intercompany transactions. For tangible assets, the legislation prioritizes transaction-based methods: the Comparable Uncontrolled Price Method (CUPM), the Resale Price Method (RPM), and the Cost-Plus Method (CPM). However, recognizing the challenges of finding reliable public data in China, tax authorities also accept profit-based methods, including the Comparable Profits Method, the Profit Split Method, and Global Profit Allocation. These methods rely on performance measures from comparable companies and industries. For intangible assets, no specific method is mandated, but pricing must reflect arm’s-length charges between unrelated parties. Similarly, services should be charged at arm’s-length rates. The overarching goal of the arm’s-length principle is to ensure equitable tax treatment for both foreign-invested enterprises and domestic companies. Given the complexities of the Chinese market, the Transactional Net Margin Method (TNMM) is frequently employed, especially when comparable transaction prices or gross margins are unavailable. TNMM compares the net profit margin of a controlled transaction to that of comparable independent enterprises, using a suitable base like costs, sales, or assets. Its flexibility makes it well-suited to China’s diverse business landscape, assisting companies in meeting regulatory requirements and minimizing transfer pricing risks during audits.

Related Party Transactions

Chinese resident enterprises are required to submit annual reports detailing related party transactions alongside their annual Corporate Income Tax (CIT) filings.  In addition, businesses participating in cost-sharing arrangements with related parties must submit a separate, specialized report by June 30th of the following fiscal year.  This reporting requirement underscores the importance of maintaining accurate and comprehensive records of all related party transactions and cost-sharing agreements for scrutiny by Chinese tax authorities.

Detailed Transfer Pricing Documentation

Transfer pricing documentation in China is a crucial requirement for businesses with related party transactions, reflecting the country’s alignment with OECD BEPS Action Plan 13.  This documentation serves to demonstrate that intercompany transactions comply with the arm’s-length principle. Generally, it includes a master file containing standardized information about the multinational group and a local file focusing on specific transactions and the Chinese entity. The local file typically includes a detailed functional analysis, selection of the most appropriate transfer pricing method, and economic analysis supporting the arm’s-length nature of the transactions. Maintaining thorough and contemporaneous documentation is essential for defending transfer pricing arrangements during tax audits and avoiding potential adjustments or penalties.  Furthermore, specific requirements, such as those related to cost-sharing arrangements, must be adhered to, making expert guidance essential for navigating China’s transfer pricing landscape.

Country-by-Country Reporting

Chinese companies are subject to Country-by-Country Reporting requirements under specific circumstances.  A Chinese resident company must file this report if it is the ultimate holding company of a group with consolidated revenue exceeding RMB 5.5 billion in the previous accounting period, or if the holding group designates it as the reporting entity.  Furthermore, a Chinese subsidiary may be required to submit this report if its group’s ultimate holding company, located in another jurisdiction, is obligated to prepare it and one of three conditions is met: the group has not filed the report anywhere, the filing jurisdiction lacks an information exchange mechanism with China, or, despite a filing in a jurisdiction with such a mechanism, the information has not been successfully exchanged with China.  These reports, aligned with OECD BEPS Action Plan 13, are due to the in-charge tax authority by May 31st of the following fiscal year.

Special File

Chinese enterprises must prepare a Special File if they meet certain criteria.  This includes those involved in cost-sharing arrangements and those exceeding the related party debt-to-equity ratio (5:1 for financial institutions and 2:1 for other enterprises).  The Special File is due by June 30th of the following fiscal year.